Ad Industry Holding Company Report Premium Version
Rich Tullo Trading Desk Analyst firstname.lastname@example.org (212) 422 – 7282 September 22, 2009 ** Note: Specific company reports MARKET COMMENTARY REPORT are available for IPG, MDCA and OMC.Madison Avenue Is Set To Benefit From An Economic Recovery, In Our View; We Expect Multiple Expan-sion As Industry Top-Line Growth Beats Consensus Forecasts And Credit Concerns Subside Report Synopsis: This Advertising Holding Company Industry Report is a comprehensive source of global analysis of advertising business trends , investment analytics and market color. This report will also discuss strategic trends influencing capital structure, M&A activity and business strategy. Introduction: While the halcyon days of Advertising provide salacious plotlines for AMC’s Emmy award winning TV Show Mad Men; today advertising in- Above: The tip of the spear is now IPTV, Mobile and Cable as advertisers follow consumers dustry conglomerates are at the vanguard of new technologies and onto the new media. Source: AMC’s Inside media. Thus, Ad Agency Holding Companies can provide interesting Mad Men Blog site investment opportunities in our view. Industry Investment Thesis: We think Advertising Industry Holding Companies are positioned to benefit from a multi-year cyclical recovery in advertising and from secu- lar outsourcing and technology trends. Key Points: • As Agency holding companies reduce head count as well as real-estate footprints; we forecast margin improvements will lift earnings and share valuations. • Ad agencies benefited from the growth in Internet Advertising during the last cycle and we expect agencies to benefit from IPTV, Smart Phones and Interactive Media in the next cycle. • As the recovery progresses, we expect multiples will expand as institutional investors are attracted top-line growth, double digit margins, strong cash flow and the industry’s recurring revenue model. • We see upside to Wall Street’s bleak advertising industry estimates in an U.S. economic recovery. • We also expect Ad Agency Holding Companies to benefit from globalization as emerging markets are a driver of Media and Advertising industry growth. • As the demand for business services increases agencies ,in our view, will benefit from opportunities to provide outsourc- ing solutions. We expect Agency clients will turn to Holding Companies for web development, direct marketing, public relations and strategic consulting services. • Potential industry consolidation also provides upside for some holding company shares. As credit concerns sub-side, we predict M&A activity will increase. See important notes, disclosures and disclaimers on page 37-38 before making investment decisions.
Industry Overview • Broadcast media and advertising is roughly an $800 million U.S. industry according to data supplied by U.S. Bureau of Economic Analysis. Globally, its a $1.3 billion global industry according to the World Bank. Broadcast Media derives roughly 25% of its revenue from advertising and the balance (75%) is derived from ticket sales, subscription fees and the sales of publications, video games, theatrical entertain- ments and music. • Modern advertising industry holding companies provide a portfolio of services for their clients such as : Creative Services - Incorporates the production of traditional media, print and interactive advertising elements as well as consultation on label- ing and brand strategy, Media Buying - Encompasses the acquisition of advertising time as well as the development of a media buying plan which maximizes consumer impressions generated from media purchases, Public Relations - Is a mix of ser- vices which includes the coaching of executives for media engagements, writing of press releases, investor relations, community relations and crisis management, Customer Relationship Management - CRM is comprised of client facing services such as call centers, direct marketing, database management and web services designed to improve customer experience and to cross sell clients using the adver- tisers pre-existing data bases. • The six publically traded ad agencies are WPP (OTC: WPPGY, NC), Publicis (OTC: PUBGY, NC), HAVAS (OTC: HAVS, NC), Inter Public Group (NYSE: IPG, See Pg. 1**), Omnicom Group (NYSE: OMC, See Pg. 1**) and MDC Partners (NASDAQ: MDCA, See PG. 1**) and all six agencies are in the top ten by revenue of all agencies. In 2008, the six publicly traded agencies posted sales of roughly $44 billion; about 30%-40% of total advertising industry sales by our estimates. • Agencies are usually compensated via a contract and annual retainer fee. Typically, an agency’s client has the option to cancel the contract given 90 days notice. On occasion agencies will charge fees on a cost-plus basis or alternatively take a car- ried interest (% of sales) in the sales out come of a client. Media buying agencies work on a retainer for consulting services and charge a commission on media pur- chases made on the client’s behalf. • The sales process (for creative and media agencies) is competitive, protracted and influenced by long standing relationships as well as professional reputation. Exhibit I Top Ten Advertising Categories Travel & Tourism Automotive Personal Care Products 7% 15% 7% Restaurants Telecom 8% 12% Food & Candy 9% Financial Services 12% Miscellaneous Retail 1 9% Direct Response Local Services 10% 11% Source: TNS Market Intelligence
Industry Growth Opportunities • The Broadcast and Advertising Industries have historically grown at a 2% to 3% premium to GDP in the U.S. and E.U. However, growth outside the industrialized nations growth is substantially higher at 7% to 15% according to data supplied by the media buying agency Group M. • Emerging market growth rates are roughly double EU and the U.S rates. Emerging market growth has been fueled by growth in Brazil, Russia, India and China (BRIC countries) , as well as the Middle East and Africa. The growth catalysts in emerging markets are: the proliferation of TV sets in Eastern Europe and Asia and the deregu- lation of media in Africa and the Middle East. For example, South Africa now has roughly 30 TV channels on its major cable network up from just two prior to the deregulation of the late 1990’s. • In developed nations, the Ad industry has completed a major round of consolida- tion. Today, there are just six publically traded global agency holding companies as compared to several hundred in the 1980’s. We think bolt-on acquisition opportuni- ties are limited at this point in the cycle, but argue strategic deals make sense as synergy supported mergers could reduce the number of publically traded holding companies to four by the end of 2011. • We think the advertising industry will benefit from an ongoing secular shift in con- sumer preferences. Since 1999, global consumers have switched from “Old” media such as newspapers and Broadcast Network TV to “New” media distributed on the Internet, 3G mobile networks and Broadband Cable Systems. In our view, the tran- sition to new media has and will continue to benefit ad agencies. Since 2005, ow- ing to the transition, total revenue growth at Advertising Industry Holding Compa- nies have out performed U.S. GDP by roughly 600 basis points annually, see Exhibit II. • We expect traditional media (Newspapers and, Radio and Local TV) will remain chal- lenged as reduced audience results in the departure of traditional local advertisers to the “New Media”. Thus, we see more work for Agencies as media spend on TV (roughly $47 billion in 2008), Newspapers ($34 billion), Radio ($17 billion) and Business Directories ($14 billion) migrates from low margin traditional media onto the Internet, 3G mobile Networks and Broadband cable networks where margins are better. See Exhibit III on next page. Exhibit II U.S. GDP Growth vs. Ad Agencies 14.00% 12.00% 10.00% U.S. Gross Domestic Product 8.00% 6.00% Six Publically Traded Ad Agencies 4.00% 2.00% 0.00% 2005 2006 2007 2008 Source: U.S. Bureau of Economic Analysis and Albert fried and Company LLC. Estimates
Industry Growth Opportunities Source: IAB and Pricewaterhouse Coopers
The Financial Crisis, Media and Advertising Industry Holding Companies • As advertising is a discretionary expenditure for many enterprises, organic revenue at Holding Companies has declined in a range of 8% to 17% in 2008 owing to the recession. We expect industry revenue growth to trail the economy in a cyclical re- covery. However, as the global economy recovers, we expect agencies to benefit from growth in new markets as well as a recovery in U.S. and E.U. ad spending. • We also think the dramatic decline in Ad rates has created the potential for a stronger than expected Advertising recovery. We think the 2008 collapse in ad rates ( of 5% to 29%) will encourage increased demand. As prices decline we foresee, the largest advertisers will spend more to increase market share versus weak com- petitors. We also think small local advertisers will also increase ad spending as lower rates enable entrepreneurs to expand their client base. • We also think “consumer de-leveraging” may benefit the Advertising holding compa- nies in the long run. During the boom times of the last cycle, consumers did not need encouragement to spend borrowed money to buy goods and services. We argue that in the next recovery, Advertising will be more critical to enterprises as consumers will not spend money haphazardly. As the recovery progresses Advertis- ers, in our view, will need to educate consumers about the “need for” and “benefits of” the products they are marketing. We think the afore mentioned scenario in- creases the demand for Creative, Media and Customer Care services thus benefits the Ad Agencies. • As the economy recovers we expect agency operating margins to expand as market- ers increase spending on Internet and Cable. According to our discussions with industry managers, operating margins on a typical Internet media campaign are roughly 15% to 20% as compared to 5% to 10% for a traditional campaign. Thus we expect industry operating margins to expand once the ad market recovers. Quarterly Advertising By Media Distribution 2008 vs. 2007
The Financial Crisis, Media and Advertising Industry Holding Companies • As depicted in Exhibit I on page 2, the Auto Industry is the largest advertising indus- try followed by Telecom and Financial services. Domestic automotive advertising declined roughly 40% in lockstep with industry sales as GM and Chrysler filed for bankruptcy. As ad budgets are linked to revenue, Auto advertising and Financial Service Ad budgets were slashed as the credit crisis unfolded. • As the crisis ebbs, Automakers are now in the process of re-evaluating marketing plans; as a result the Chrysler, Volkswagen accounts are under review. Moreover, GM and F are also re-evaluating marketing strategies although their accounts are not necessarily under review. As the dust settles, Auto ad spending will rebound, in our opinion. Despite a jump in production to 12 million vehicles annually from 9 million, owing to the U.S. Governments cash for clunkers program, global auto manufacturing is still at all time lows. We expect Auto advertising to rebound as U.S. makers are set to introduce more than 40 new vehicles. Increased demand and new products should benefit creative advertising as well as media buying as incre- mental demand should lift prices. • In order to reduce marketing costs major advertisers such as Proctor and Gamble and Unilever are exploring ways to aggregate their accounts at fewer agencies. As a result, acquisition opportunities for the large holding companies are vaporous but over the long term the lack of acquisition growth could be offset by better margins and market share gains. The chart below: The secular decline in Automotive Newspaper Advertising accelerates as the credit crisis unfolds and the U.S. Ad- vertising market collapsed in 2007-2009. Auto Newspaper Advertising $6,000,000 $5,000,000 Dollar Value Ad Sales $4,000,000 $3,000,000 $2,000,000 $1,000,000 $0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year Source: Newspaper Association of America and Albert Fried and Company LLC. Estimates
Investment Implications • We think top-line growth for advertising industry holding companies will out-pace U.S. GDP in the next business cycle. Advertising industry holding companies are currently trading at a discount to the S&P 500 market multiple. Based on our forecast for improved 2010 advertising prospects , we expect multiples to expand and see significant upside in Holding com- pany shares. In our view, the potential for the Advertising Industry Holding companies to significantly out-perform the market is high despite tepid comments by most industry CEO’s. • We think the Advertiser’s ability to bargain with agencies for lower rates on highly specialized mobile to IPTV marking campaigns will be limited . As today’s iterations of “New Media” campaigns prove effective (i.e. sell cars or drive store traffic) we expect Holding companies will be able to main- tain pricing power and margins. • We favor investing in individual Advertising Agency Holding Company shares as there are few ETFs, mutual and closed end funds with signifi- cant exposure to the group. The Power Shares Dynamic Media Portfolio (NYSE: PBS) lists OMC as a 2.67% holding. Interpublic Group is a holding in the Gabelli Small Cap Growth Fund (Open End) according to the Bloomberg professional service. The Gabelli Small Cap Growth Fund is up roughly 11.75% over the last ten years versus the Russell 2000 Index which is up 7.5% during the comparable time period according to com- pany reports. • Based on current valuation levels and data points, we think the whole group will out perform the S&P 500 over the next 12 to 18 months. Please ask for Albert Fried Trading Desk Reports for specific BUY/SELL recom- mendations Key Financial Metrics Recent PX∆ EPS Forward 52 WK 52 WK EBITDA LT Debt ROETicker Rating Price 3 MNTH 2010E PE High Low TTM Total Cap EV/EBITDA TTM OMC BUY $38.07 17.0% $2.72 14.0 $44.40 $20.90 1736.2 44.7 8.0 26.7 IPG BUY $7.47 29.1% NP NP $8.88 $2.57 860.2 38.9 5.1 NM WPPGY NC $43.66 27.5% $2.16 20.2 $48.52 $22.35 1767.6 42.7 10.2 11.6 PUBGY NC $40.59 31.4% $2.98 13.6 $39.76 $18.50 1300.1 34.0 6.7 19.7 MDCA BUY $6.60 14.3% NP NP $7.64 $2.19 54.7 54.3 6.8 NM HAVSF NC $3.00 19.5% $0.30 10.0 $3.05 $1.60 279.2 47.7 6.3 10.4Prices as of 9/15/09 Source: Bloomberg Professional service, Company and Albert Fried LLC and Company Reports
Investment Recommendations (Trading Desk Clients Special Report) • Interpublic Group of Companies Inc. (NYSE: IPG, BUY): Our favorite name in the group is Interpublic Group (as there is roughly 60% upside to our $11 target. IPG’s also controls McCann World Group; a creative advertis- ing market leader. We expect IPG’s quarterly comparisons will improve in 2010. In 2007 to 2009, IPG’s lost market share at its Microsoft account and revenue growth was also hampered by the recession. As IPG’s quar- terly comparisons improve; we predict continued margin improvement could provide upside to our estimates. Lastly, owing to the company’s business restructuring we suspect IPG has tremendous operating leverage and predict just 2%-3% upside to the top-line will create substantial up- side to our 2010 EPS estimate of $0.50. Moreover, IPG’s largest account ,GM, is expected to launch 25 vehicles in 2010 and increased advertising spending could provide upside to our estimates. • MDC Partners Inc. (NASDAQ: MDCA, BUY): We also like MDC partners as there is roughly 42% upside to our $9 Target. MDCA’s prospects to pitch for new accounts such as Chrysler and growth in existing clients such as Microsoft, Best Buy and Gap Stores could provide upside to our estimates. We expect MDCA to remain profitable in 2009 and forecast earnings growth to return in 2010 as MDCA’s clients benefit from an improved economy. We think MDCA is a takeover candidate as its Crispin Porter and Bogusky agency is a strategic fit with IPG, PUBGY and Dentsu (Japan). We suspect Dentsu is in the hunt for an acquisition as industry insiders have told they were on of the two final bidders for RazorFish which was sold to PUBGY. In an acquisition we see as much as 50% upside to our MDCA Price Target. • Omnicom Group Inc.: (NASDAQ: OMC, BUY) We think OMC shares are very attractive on a valuation basis as OMC is trading at roughly 14x our 2009 $2.70 EPS estimate. We argue OMC deserves a 18x premium multi- ple to the market and should be valued at $48 or which implies 30% up- side to the current share price. • Publicis Group S.A. (OTC: PUBGY, NC): While we do not cover, Publicis Group (OTC: PUBGY, NC)., PUBGY controls several leading agencies such as Saatchi and Saatchi, Digitas and Razorfish which it bought from Micro- soft in 3Q:09 for $600 million. Excluding the impact for the Razorfish deal PUBGY trades at roughly 13x 2009 EPS and its debt-to-cap ratio at 34% is below the industry average. • WPP Group PLC. (OTC: WPPGY, NC): While we do not cover WPP Group it is the largest holding company by revenue and owns Olgilvy, Group M and TNS market intelligence. Management has made negative comments regarding growth prospects but we think its acquisition of TNS Market Intelligence has shaded management prospective. • HAVAS Group S.A. (OTC: HAVSF, NC) Also not covered, 170 year old HAVAS is the second largest agency in France. HAVSF’s most known agency is Arnold in the U.S. HAVSF EV/EBITDA multiple is reasonable but its debt ratio is above the peer group average.
Rich Tullo Trading Desk Analyst email@example.com (212) 422 – 7282 September 22, 2009INTERPUBLIC (NYSE: IPG) TARGET $11 BUY PRICE $7.40Initiate Coverage of IPG with a BUY RATING and $11 CLOSETARGET MCAP $3.56BB THESIS SHARES 486.1M OUT. IPG is the Advertising Agency most levered to a cyclical recovery in the U.S and we like IPG’s exposure to foreign markets in particular India. We think IPG shares are undervalued at just 14x our 2010 EPS esti- 52 WEEK $8.55 mate of $0.50 and expect IPG’s multiple to expand to 20x or more as the recovery unfolds. HIGH 52 WEEK $2.57 LOW KEY POINTS: AVG. VOL. 6.7mm 10DY SHORT 27.8mm INT. SHS. • IPG is a leading global ad agency and while out of favor (owing to GM’s decline and the lost of some of the Microsoft account to MDCA) we like IPG as upside from new pitches is under the radar screen. • We expect IPG to maintain the bulk of the GM account and see upside in automotive as GM rolls out P/BV 1.9x 25 models in 2010/11. EV/ • As the recovery unfolds we expect EPS to remain positive in 2009 at $0.20 despite a significant 5.6x decline in revenue (13%) owing to the great recession. EBITDA • We expect EPS to recover in 2010 as IPG benefits from a recovery in industry ad rates, and in- P/E 14x creased U.S. economic activity. We forecast 2010 EPS will increase two fold to $0.50 from $0.20 in 2010 2009. WALL STREET CONCENSUS • IPG derives roughly 42% of its revenue from international sales. Thus the declining dollar and growth in China and India (where IPG benefits from its Unilever account) provides upside to our estimates. REVENUE (IN MILLIONS) • IPG is a takeover target in our view as IPG shares trade at a discount to peers on an EV/EBITDA mul- tiple basis. IPG also offers attractive synergies with its larger peers, notably WPPGY. 2007 $6,554.0 2008 $6,962.7 RISKS TO THESIS: 2009E $6,065.1 • Advertising is a cyclical business and a return of the recession could significantly reduce IPG earn- EPS ings potential. 2008A $0.52 • Advertising agencies have complicated accounting and unexpected accounting concerns could un- dermine shareholder value. 1Q:09A ($0.16) • The loss of critical employees could have negative implications on IPG’s client portfolio. 2Q:09A $0.04 Price Target: 3Q:09E $0.01 As the U.S. economic recovery unfolds, we think IPG’s top-line will grow faster than U.S GDP growth. IPG 4Q:09E $0.30 benefits from International markets, new technologies and increased demand to advertising, media and CRM services. Thus we argue IPG deserves a premium multiple to the S&P 500. To derive our $11 target 2009E $0.20 we apply a 20x multiple to our $0.50 2010 EPS estimate and with roughly 50% upside to our target, we initiate coverage of IPG with a BUY rating. 2010E $0.50 See important notes, disclosures and disclaimers on page 33-36 before making investment decisions.
Company Description • The Interpublic Group of Companies, Inc. is an advertising and marketing services company. The Companys agency brands create marketing solu- tions on behalf of clients worldwide. Its companies cover a range of mar- keting disciplines and specialties, from consumer advertising and direct marketing to mobile and search engine marketing. Its solutions vary from project-based activity involving one agency and its client to long-term, fully-integrated campaigns created by a group of its companies working together on behalf of a client. Interpublic operates in two segments: Inte- grated Agency Network, which consists of McCann Worldgroup, Draftfcb, Lowe Worldwide, Mediabrands and its domestic integrated agencies, and Constituency Management Group, which consists of the bulk of its special- ist marketing service offerings. In July 2008, the Company increased its stake in the Middle East Communication Networks from a minority posi- tion to 51% ownership. IPG Clients • IPG derives roughly 26% of its revenue from its top ten accounts. IPG’s largest account (GM by our model) accounted for 5.5 %of the company’s top line. IPG other notable accounts are Microsoft, Johnson and Johnson, Unilever, Verizon and Hyundai. • IPG is currently pitching to expand its franchise with Hyundai and Unilever and just won the account for Microsoft’s Pink mobile operating system as well as the Applebees account.Corporate Governance • IPG’s corporate governance is GOOD in our opinion and a marked im- provement over the situation that existed in the 2001 to 2004 era when the viability of IPG was in question. • Unfortunately, IPG has a combined Chairman and CEO which is not ideal. We note, Michael Roth has a solid reputation with investors and we expect at some juncture Mr. Roth will relinquish his CEO responsibilities as part of the company’s succession plan. • IPG has other beneficial corporate governance mechanisms. IPG to our knowledge does, not have a poison pill and IPG common shareholders have the right to call a special meeting with a 25% vote.
Recent Results • In 2008, IPG’s top-line grew 6.2% to $6.9 billion as compared to $6.5 billion in 2007. However, IPG’s revenue growth rate slowed to 6.2% in 2008 versus 9.3% in 2007 as the U.S. economy slowed. Despite eco- nomic challenges, the Company’s gross margins expanded to 37.6% in 2008 (from 28.3% in 2007) owing to cost cutting programs. As IPG posted modest revenue growth and maintained strong gross margins EPS grew 100% (to $0.52 per share in 2008 from $0.26 in 2007). • As Ad Agency results lag the economy, 1H:09 results for IPG declined dra- matically owing to the credit crisis and the following collapse of the U.S. Auto industry. The collapse in U.S. advertising, IPG’s revenue in 1H:09 declined 16% (to $2.8 billion from $3.3 billion in 1H:08). So as revenue declined, IPG posted a 1H:09 loss per share of $0.11 versus EPS of $0.03 in 1H:08. • IPG’s top-line declined roughly 20% in 2Q:09 to $1.4 billion (from $1.8 billion in 2Q:08). IPG’s revenue improved 11% in 2Q:09 versus the year ago period. Despite challenging economic conditions in 2Q:09, IPG’s EPS expanded sequentially to $0.04 as compared to a $0.15 loss per share in 1Q:09. Balance Sheet and Cash Flow • In addition to its ongoing overhead restructuring: IPG is also de-leveraging its business model. As a result, IPG’s long-term debt has declined to $5.7 billion in 2Q:09 from $6.8 billion on December 31, 2008. IPG’s near term maturities are not a risk (in our view) because the company is in a position to pay down its near-term maturities with cash on its balance sheet ($1.7 billion in the period ending June 30, 2009). • Like many media companies, IPG generates strong cash flow owing to high non-cash costs. In 2008, IPG generated Free-cash-Flow (FCF) of $1.40 per share which implies a Yield-to-FCF of 20%. In 2009, we expect FCF to advance to $2.37 (from $1.40 in 2008) owing to improvements in working capital. Earnings Forecast • We think IPG will face tough comparables in 3Q:09 as the Company bene- fitted from the Internet as well as International growth in 2008. We expect IPG’s 3Q:09 revenue to decline 17% (to $1.4 billion from $1.7 billion in 3Q:08). • We expect IPG’s gross margins to reach 33% and forecast the Company to earn $0.01 per share in 3Q:09 . As the U.S economy emerges from reces- sion, we expect IPG’s rate of revenue decline to moderate by 4Q:09. Therefore, we expect IPG to earn $0.20 in 2009 despite severe chal- lenges faced by IPG and the U.S. economy. • We expect IPG’s customers increase budgets in a recovering U.S. econ- omy and predict top-line growth to return in 2010 . Therefore, we forecast 3% revenue growth, gross margin expansion to 36% (from 33%) and pre- dict IPG’s EPS will nearly double to $0.50 in 2010.
Balance Sheet SummaryFigures in millions. Figures in parentheses are losses. 2006 2007 Mar June Sept 2008A Mar A June A 2009E 2010ECash and cash equivalents 1955.7 2014.9 1491.2 1831.0 1689.8 2,107.2 1,642.0 1,760.5 2,628.9 1,895.8Marketable securities 1.4 22.5 21.1 25.0 17.8 167.7 16.5 10.9 10.9 10.9Accounts receivable, net of allowance of $63.8 and $63.9 3934.9 4132.7 3752.7 3899.3 3821.2 3,746.5 3,159.1 3,205.4 3109.0 3086.1Expenditures billable to clients 1021.4 1210.6 1320 1325.6 1411.3 1,099.5 1,072.5 1,021.9 970.4 1,005.0Other current assets 295.4 305.1 357.5 343.2 301.5 366.7 379.2 355.7 276.2 360.0Total current assets 7,208.8 7,685.8 6,942.5 7,424.1 7,241.6 7,487.6 6,269.3 6,354.4 6,995.4 6,357.8Furniture, equipment and leasehold improvements, net of 624.0 620.0 616.8 598.6 571.8 561.5 529.5 521.8 500.06 427.72accumulated depreciation of $1,109.5 and $1,055.8 Deferred income taxes 476.5 479.9 535.0 491.8 474.6 416.8 453.1 447.3 447.3 479.5 Goodwill 3,067.8 3,231.6 3,265.4 3,272.6 3,325.0 3,220.9 3,243.0 3,298.0 3,338.0 3,398.0 Other assets 487.0 440.8 424.1 419.9 484.3 438.4 434.8 443.6 443.6 381.0Total assets 11,864.1 12,458.1 11,783.8 12,207.0 12,097.3 12,125.2 10,929.7 11,065.1 11,724.3 11,044.0Accounts payable 4,124.1 4,124.3 3,978.9 4,138.4 3,979.3 4,022.6 3,350.7 3,380.4 4,082 3,212Accrued liabilities 2,426.7 2,691.2 2,356.1 2,550.6 2,623.6 2,521.6 2,111.2 2,204.8 2,205 2,365Short-term debt 82.9 305.1 103.3 91.8 81.9 332.8 327.2 137.3 250 36Total current liabilities 6,633.7 7,120.6 6,438.3 6,780.8 6,684.8 6,877.0 5,789.1 5,722.5 6,536.5 5,613.2Long-term debt 2,248.6 2,044.1 2,050.3 2,045.8 2,043.1 1,786.9 1,781.9 1,901.1 1,651.1 1,615.1Deferred compensation and employee benefits 606.3 553.5 555.7 545.8 521.9 549.8 536.7 551.3 600.0 600.0Other non-current liabilities 434.9 407.7 412.1 412.0 436.4 378.9 395.0 367.4 367.4 400.0Total Liabilities 9,923.5 10,125.9 9,456.4 9,784.4 9,686.2 9,592.6 8,502.7 8,542.3 9,155.0 8,228.3 Total IPG stockholders’ equity 1,940.6 2,332.2 2,327.4 2,422.6 2,411.1 2,206.3 2,117.4 2,225.6 2,272.1 2,516.6Noncontrolling interests 37.9 30.7 34.4 34.4 37.8Total Equity 1,940.6 2,332.2 2,327.4 2,422.6 2,411.1 2,244.2 2,148.1 2,260.0 2,306.5 2,554.5Total Liabilities and Equity 11,864.1 12,458.1 11,783.8 12,207.0 12,097.3 12,125.2 10,650.8 11,065.1 11,724.4 11,044.1Book value per share 1,940.6 2,332.2 2,327.4 2,422.6 2,411.1 2,494.7 2,396.3 2,488.4 2,534.9 2,777.9Cash Per Share 4.6 3.9 2.9 3.5 3.3 3.9 3.3 3.5 5.2 3.7Current ratio 1.09 1.08 1.08 1.09 1.08 1.09 1.08 1.11 1.07 1.13Acid test ratio 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 1.0Long Term Debt to Capital 19.0% 16.4% 17.4% 16.8% 16.9% 14.7% 16.7% 17.2% 14.1% 14.6%Debt Ratio 19.7% 18.9% 18.3% 17.5% 17.6% 17.5% 19.3% 18.4% 16.2% 15.0%EBITDA-to-interest coverage ratio 1.28 2.20 2.77 3.02 3.33 3.53 4.81 3.92 2.62 3.33Days sales outstanding 232 225 215 203 200 207 185 201 190 180Accounts payable days 349 366 380 387 393 389 433 415 400 400Net operating profits 87 213 -34 122 81 262 -57 93 263.2 410.8Return on invested capital (ROIC) 0.7% 1.7% -0.3% 1.0% 0.7% 2.2% -0.5% 0.8% 2.2% 3.7%ROAE - 8.3% -5.3% NM 3.6% 11.6% NM 0.9% 4.5% 10.3%ROAA - 1.5% -1.0% NM 0.7% 2.2% NM 0.2% 0.9% 2.2%Source: Albert Fried and Company LLC and Company Reports
Statement of Cash FlowFigures in millions. Figures in parentheses are losses.Year Ended: 2006A 2007A 1Q:08 2Q:08 3Q:08 2008A 1Q:09A 2Q:09A 2009E 2010ECASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income (36.7) 167.6 (62.8) 97.7 43.10 295.0 (73.6) 31.4 101.8 251.2Adjustments to reconcile net (loss) income to net cash (used in) provided by operatingactivities:Depreciation and amortization of fixed assets and intangible assets 173.6 177.2 43.1 43.2 44.20 173.3 41.8 42.7 170.8 173.3Provision for (reversal of) bad debt 1.2 (3.6) (1.3) 0.9 6.70 17.0 3.9 4.7 38.6 60.0Amortization of restricted stock and other non-cash compensation 55.1 79.7 19.8 23.2 21.40 80.1 9.3 15.5 62.0 60.0Amortization of bond discounts and deferred financing costs 31.8 30.8 7.0 6.7 7.40 28.7 13.8 30.0 30.0Loss on early extinguishment of debt 12.5 — 7.6 17.0 24.6 12.0Deferred income tax benefit (57.9) (22.4) (53.5) 47.9 9.50 74.9 (48.2) 21.1 -27.1 (50.0)Other 90.6 41.9 0.7 6.0 7.50 29.0 (7.3) 14.1Changes in assets and liabilities, net of acquisitions and dispositions, providing (using) cash: Accounts receivable 235.4 43.5 499.1 (151.8) 118.1 283.9 520.9 81.4 712.2 22.9Expenditures billable to clients (87.7) (124.5) (88.3) (12.5) (104.4) 69.7 17.2 62.0 129.1 34.6Prepaid expenses and other current assets (6.9) 9.7 (31.7) 2.1 15.5 (19.2) (22.0) 14.8Accounts payable (370.0) (221.5) (256.0) 157.5 (226.7) 6.8 (612.5) (97.5) 59.1 (869.3)Accrued liabilities (21.4) 121.8 (363.7) 187.7 95.9 (147.7) (388.6) 51.1Other non-current assets and liabilities 1.9 (14.6) (0.4) (8.7) (4.0) (26.2) (5.8) (38.2) Net cash (used in) provided by operating activities 9.0 298.1 (288.0) 399.9 34.2 865.3 (557.3) 233.9 1,301.2 (275.5) CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions, including deferred payments, net of cash acquired (15.1) (151.4) (17.1) (9.2) (74.7) (106.0) (13.6) (18.6) (70.0) (100.0)Capital expenditures (127.8) (147.6) (31.9) (26.9) (24.0) (138.4) (11.7) (16.0) (100.0) (120.0)Net sales and maturities (purchases) of short-term marketable securities 112.7 (18.1) 1.6 (4.7) (0.5) (162.0) 150.7 6.7Other investing activities 41.8 49.3 0.4 3.1 (14.40) 2.1 0.4 (1.2) Net cash provided by (used in) investing activities 11.6 (267.8) (47.0) (37.7) (113.6) (404.3) 125.8 (29.1) (170.0) (220.0) CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of 4.5% convertible Senior Notes 5.8 (190.8) - - (190.8) (190.8)Proceeds from issuance of 10.0% Senior Notes due 2017 — 587.7 587.7Purchase of long-term debt 30.9 (3.5) (34.7) (698.3) (870.0) (250.0)Issuance costs (79.8) (0.8) 0.80 -11.3 (15.8) (27.1)Net increase (decrease) in short-term bank borrowings (5.3) (13.1) (4.9) 13.8 13.8Distributions to noncontrolling interests (24.4) (18.1) (3.0) (4.9) (2.4) (14.60) (6.5) (10.9) (32.0)Preferred stock dividends (47.0) (27.6) (6.9) (6.9) (6.9) (27.60) (6.9) (6.9) (27.6) (27.6)Other financing activities (9.4) 6.1 (1.1) (6.2) (10.7) 3.20 (2.5) (3.7) (11.2) Net cash used in financing activities (129.7) (37.3) (207.1) (31.9) (24.1) (275.8) (15.9) (134.1) (557.2) (277.6) Effect of exchange rate changes on cash and cash equivalents (11.1) 66.2 18.4 9.5 (37.7) (92.9) (17.8) 47.8 40 40Net decrease in cash and cash equivalents (120.2) 59.2 (523.7) 339.8 (141.2) 92.3 (465.2) 118.5 614.0 (733.1)Cash and cash equivalents at beginning of year 2,075.9 1,955.7 2,014.9 1,491.2 1,831.0 2014.9 2,107.2 1,642.0 2,014.9 2,628.9 Cash and cash equivalents at end of period 1,955.7 2,014.9 1,491.2 1,831.0 1,689.8 2,107.2 1,642.0 1,760.5 2,628.9 1,895.8 Cash per share 4.57 4.00 2.90 3.55 3.25 4.07 3.26 3.47 5.19 3.74Operating cash flow per share 0.02 0.59 (0.56) 0.78 0.07 1.67 (1.11) 0.46 2.57 (0.54)Free cash flow per share (FCF) (0.28) 0.30 (0.62) 0.72 0.02 1.40 (1.13) 0.43 2.37 (0.78)Free cash flow per share (less acquisitions) (0.31) (0.00) (0.65) 0.71 (0.12) 1.20 (1.16) 0.39 2.23 (0.98)Simple cash flow per share 0.15 0.55 (0.06) 0.27 0.16 0.79 (0.07) 0.15 0.46 0.72Yield to FCF -4.0% 4.3% -8.9% 10.3% 0.3% 20.0% -16.2% 6.1% 33.9% -11.1%Simple cash yield 2.1% 7.9% -0.9% 3.8% 2.3% 11.3% -1.0% 2.1% 6.6% 10.3%Shares outstanding 428.1 503.1 515.0 516.0 519.4 518.3 503.1 507.5 506.4 507.1Source:Albert Fried and Company LLC and Company Reports
Rich Tullo Trading Desk Analyst firstname.lastname@example.org (212) 422 – 7282 September 22, 2009OMNICOM GROUP INC. (NYSE: OMC) TARGET $48 BUYInitiate Coverage of OMC with a BUY RATING and PRICE $37.90$48 TARGET MCAP 11.7BB THESIS SHARES 310.8 OUT. Trading at just 14x our 2010 $2.72 EPS estimate, we think OMC shares are undervalued. OMC is the largest U.S. advertising agency whose BBDO, DDB and TWBAWorldwide are among the most awarded 52 WEEK agencies in the industry. The demise of Chrysler and rumblings at Proctor and Gamble are a concern but $42.32 HIGH we think investors have discounted these potential account losses. We expect OMC to lose the Chrysler account which is currently under review but argue that OMC will replace the Chrysler account with higher 52 WEEK $20.09 margin accounts as the U.S. economic recovery unfolds. LOW AVG. VOL. KEY POINTS: 2.2mm 10DY • OMC, in our opinion, has one of the best management teams in any industry and OMC shares are an SHORT INT. 6.06mm SHS. exceptional value at just 14x our 2010 EPS estimate. • OMC is positioned to benefit from WPP’s missteps as its acquisition of TNS Market Intelligence has burdened WPP’s balance sheet. Thus we expect OMC will increase market share at existing accounts P/BV 2.9 and acquire agencies on better terms where the Company competes head to head with WPG. EV/ • OMC is positioned for long-term growth in our view as OMC has an attractive sales mix; 43% of reve- NM nue is derived from higher margin advertising and 36% of revenue is derived from CRM. EBITDA • As OMC restructures its balance sheet, the risk of near term maturities diminishes in our view. P/E 2010 13.9x • By our model, we forecast OMC’s EPS will grow in excess of 10% from 2009-2010 however, if adver- tising recovers faster than we expect, we see significant upside to our estimates. WALL STREET CONCENSUS RISKS TO THESIS: REVENUE (IN MILLIONS) 2007 12,694 • Advertising in the US could decline faster than we expect. 2008 13,360 • A loss of critical employees and or accounts could significantly impact OMC’s prospects. • Increased competition from OMC competitors could reduce OMC’s advertising market share. 2009E 12,005 • Advertising agencies have complicated accounting and unexpected accounting concerns could un- EPS dermine shareholder value. 2008A $3.17 PRICE TARGET: 1Q:09A $0.53 As the U.S. economy recovers, we think there is upside to our OMC earnings estimates. We also think investors have discounted the loss of the Chrysler account which may, in our view, benefit OMC in the 2Q:09A $0.75 long term. We suspect OMC made deep concessions in 2008 to 2009 to retain Chrysler and we predict the loss of Chrysler will not weigh on OMC’s top or bottom line in 2009. In 2010, we think OMC will be 3Q:09E $0.56 able to offset Chrysler with stable higher margin accounts which could provide upside to our estimates. To value OMC, we use a 18x market multiple which we think is reasonable given the apparent U.S eco- 4Q:09E $0.76 nomic recovery. Thus, we derive a $48 Price Target for OMC shares and with roughly 30% upside to our target, we initiate coverage of OMC with a BUY rating. 2009E $2.48 2010E $2.72 See important notes, disclosures and disclaimers on page 33-36 before making investment decisions.
Company Description • Omnicom Group Inc. (Omnicom) is primarily a holding company. Omnicom, through its subsidiaries, provides professional services, such as advertis- ing, marketing and corporate communications. It provides professional services to clients through multiple agencies operating in all major mar- kets around the world. The Companys agencies provide a range of ser- vices, which it groups into four fundamental disciplines: traditional media advertising, customer relationship management (CRM), public relations and specialty communications. OMC Clients • OMC controls roughly 1500 advertising agencies, thus following the de- mise of Chrysler, no one client makes up more than 2.8% of revenue. • We suspect Proctor and Gamble (2.8% of revenue) is OMC’s largest client and Chrysler’s 2.6% in 2008 is less than 1.5% of revenue. • OMC’s top 100 accounts collectively represented about 50% of the Com- pany’s revenue in 2008 according to company reports. Corporate Governance • OMC has very good corporate governance (in our view) and perhaps the best corporate governance in the global media industry. • Similar to IPG, OMC has a well respected management and we think the separation of powers between Chairman and CEO is a benefit to OMC shareholders. • OMC has nine independent directors which are elected annually. • Management owns roughly 5% of OMC shares. • In our view, OMC ratio of audit to consulting fees of 9.5:1 indicates OMC financial managers are efficient.
Recent Results • In 2008, OMC’s top-line grew 5.2% to $13.4 billion versus $12.7 billion in 2007. OMC’s revenue growth rate slowed to 5.2% in 2008 versus 11.6% in 2007 as the U.S. economy slowed. Despite the U.S. economic slow- down, modest revenue growth and robust EBITDA margins (14%) resulting in 7% EPS growth (to $3.17 per share in 2008 from $2.95 in 2007). • OMC’s business cycle lags the global economy, thus OMC’s 1H:09 results declined dramatically owing to the credit crisis and the resulting collapse of the U.S. Auto industry. OMC’s 1H:09 top-line declined 19% (to $5.6 billion from $6.6 billion in 1H:08). Owing to revenue declines, OMC’s 1H:09 EPS declined to $1.62 versus $1.28 in 1H:08. • OMC’s top-line declined roughly 17% in 2Q:09 to $2.8 billion (from $3.4 billion in 2Q:08). As revenue declined, EBITDA margins at OMC also de- clined to 14.6% from 17% in the year ago period. Thus in 2Q:09, OMC reported a 11% EPS decline to $0.75 per share versus $0.96 in 2Q:08. Balance Sheet and Cash Flow • Following a period of growth through acquisitions, OMC is now de- leveraging its business model. As a result, OMC’s long-term debt has de- clined to $2.4 billion in 2Q:09 from $3.05 billion on December 31, 2008. OMC’s near term maturities are not a risk in our view. OMC has re- structured its long-term debt and now the bulk of its maturities are beyond 2014. • As a rule, media companies generate strong cash flow owing to high non- cash costs and OMC is no exception to the rule. In 2008, OMC generated Free-cash-Flow (FCF) of $3.84 per share which implies a Yield-to-FCF of 10%. In 2009, we expect FCF to expand to $5.15 expand (or 13.5% on a yield basis) owing to improvements in working capital and lower capital expenditures.Earnings Forecast • We think OMC will face tough comparables in 3Q:09 as the Company benefitted from a better Ad market in 2008. We expect OMC’s 3Q:09 reve- nue to decline 6% (to $3.1 billion from $3.3 billion in 3Q:08). • We predict OMC will maintain 11% EBITDA margins and forecast the Com- pany to earn $0.56 per share in 3Q:09 . As the U.S economy emerges from recession, we expect OMC’s rate of revenue decline to moderate to 3% by 4Q:09. Therefore, we expect OMC to remain profitable and to earn $2.48 in 2009 despite severe challenges faced by the ad industry and the U.S. economy. • We expect top-line growth to return in 2010 as OMC’s client mix shifts to higher margin clients in a recovering U.S. economy. Therefore, we forecast 5% OMC’s top-line growth in 2010, EBITDA margins to expand to 13.5% (from 12.3%) and predict EPS to grow 10% to $2.72 from $2.48 in 2009.