One of my favorite shows is "Mad Men." The story depicts life in an advertising agency in Manhattan in the 1960s. I was intrigued by the portrayal of the advertising business, since it involved maintaining client relationships for long periods of time if successful. I also wanted to look for ideas beyond the usual investment targets.
Advertising agencies have a very interesting business model. Businesses have to advertise their products or services, even during a recession. The business of advertising agencies is not characterized by heavy capital investment, typical of most other professional service organizations. However, because few of the companies have raised dividends for at least 10 years in a row, they are not found on typical dividend growth screens.
The business is characterized by having strong relationships with clients, who trust their agencies with everything related to the advertising process. This includes the creative process of making the actual ad across different channels such as print, TV or web, to purchasing ad space across multiple platforms. Once a client is working with a particular agency, chances are that the relationship can last for many years. After all, by working with clients for many years, advertising agencies know their business, their executives, and the needs of the business better than what a newcomer would. As a result, big accounts stay with their agencies for many years, which could translate into a steady stream of profits for those agencies.
Advertising companies also have the scale to implement the ads using a variety of channels within their control, either print, TV, radio, web or other channels. As new channels to reach the consumer like web and mobile are developed, there is an even higher opportunity for advertising companies to offer more services. The repetitive nature of advertising virtually guarantees revenues and profits for ad companies even during a recession.
Some pundits claim that the business of advertising agencies is threatened by online and mobile advertising. However, digital is not a threat but rather an opportunity, because it merely represents another channel through which to reach out to consumers. A company like Coca-Cola cannot advertise solely online. Thus, companies need companies like WPP Group (WPPGY) or Omnicom (OMC) to execute a marketing strategy consistently across different channels.
The business also has some float as well, which is created by the timing of payments from client to advertising agency and from advertising agency to media publisher. Because of their scale, advertising companies can negotiate much cheaper rates with media companies than those which the clients pay. Many share a portion of the savings back with the client, which creates a mutually profitable arrangement.
Revenue for creating ads is usually billed by the hour, plus a profit and overhead. In addition, most contracts allow for an incentive to be paid out to advertising companies if specific qualitative or quantitative results are hit.
Advertising agencies essentially have a toll-bridge type business model, that connects customers with TV, print, radio and online companies.
WPP plc provides communications services worldwide. The company seems to have frozen its dividend in 2009, which ended its streak of consecutive dividend increases. WPP was dropped from the list of international dividend achievers after the dividend freeze of 2009, although it would likely be added back in 2014 if it maintains a five-year streak of dividend increases. I reviewed the company site, and could find raises starting in 1995. This is the advertising company I would likely consider for inclusion in my dividend portfolio if it trades at attractive valuations.
Currently, the stock is slightly overvalued at 20.90 times earnings and yields approximately 2.30%. I would need to research the company in more detail and analyze it, before I initiate a position in it, but I usually require at least a 2.50% entry yield coupled with a P/E ratio below 20. The company might not end up delivering dividend growth every year, but over time, I expect it to grow dividends above the rate of inflation.
Omnicom Group Inc., together with its subsidiaries, provides advertising, marketing, and corporate communications services in the Americas, Europe, the Middle East, Africa and the Asia pacific. While the company has not raised dividends every year, over the past decade it has managed to quadruple the quarterly payment from 10 to 40 cents/share. When I initially started researching the basics of the advertising companies, I found Omnicom to be a company I would consider owning one day. Unfortunately, with the announced merger with french company Publicis, there are some changes to take into account. It looks as if the new company will be based in the Netherlands, which could pose issues for dividend investors from a tax withholding standpoint. In addition, companies that merge might lose focus on their brands, as Interpublic did in late 1990s. I also do not like the fact that the combined Omnicom/Publicis will have both Coca-Cola and PepsiCo as clients. I am not sure if these clients would be happy if their business is handled by the same advertising agency. Currently, Omnicom trades at 17.70 times earnings and yields 2.50%.
The third advertising company I reviewed was Interpublic, which provides marketing and advertising solutions worldwide. While it does not have a consistent history of raising dividends, the company could well be an acquisition target itself. The company went on a major acquisition spree in the late 1990s, lost focus, and eventually cut dividends in the early 2000s. It reinstated dividends a few years ago, and currently trades at 18.90 times earnings and yields 1.80%. Warren Buffett used to be a shareholder in Interpublic between the bear market in 1972 - 1974 and the mid 1980s.