So, in this article, we'll take a look at a type of company that I don't write about all that often. Advertising is an ever-changing landscape, especially in the modern world of internet/online advertising. Companies need to adapt yearly, bi-annually, even quarterly, to new trends and demands. It's a tricky business - and for a DGI investor, picking the long-term winners here is even trickier.
In this article, I've given a shot at picking ONE such winner - the Interpublic Group of Companies (IPG). While these types of companies will never represent growth monsters, they serve the purpose of diversifying into the sector - and out of the available companies, I consider IPG to be among the best choices to gain exposure to the space.
Let me show you why that is.
(Source: Everything PR)
IPG - A long tradition of advertising
Those of us who have watched the show "Mad Men" remember perhaps the name McCann-Erickson mentioned liberally in the show. This company was actually the predecessor of IPG and was the name the company was founded under in 1930. Much like the show indicated, McCann-Erickson was at one time the largest ad agency in the world.
Today's iteration, IPG, consists of hundreds of businesses organized into six basic groups.
- FCB is one of IPG's global networks
- IPG Mediabrands is IPG's media buying and data management arm, including 13 larger/significant agencies
- Marketing Specialists offer marketing services across the globe, including 7 larger agencies.
- McCann Worldgroup is a global marketing organization. It has over 100 companies with a total of 24,000 employees worldwide.
- MullenLowe Group is one of the company's communications networks, consisting of 5 components (Customer experience, digital marketing, PR, etc.).
- Independents is a database marketing company, which contains IPG's many different independent agencies, among other things the recent M&A of Acxiom.
These are then contained in two reportable segments:
- Integrated Agency Networks (IAN) (everything but specialist marketing)
- Constituency Management Group (CMG)
IPG is the fourth-largest advertising company holding company/agency in the world in terms of annual revenue, and as we can see going simply by the number of employees, companies, and representation, the company has its fingers everywhere it sees a profit - this includes global markets.
To go through each of these segments in terms of profit and development would make this article about 20 pages long - an exercise in futility, not to mention the individual data for these segments is sparse. My objective is to show you that the company, as a whole, is a profitable enterprise.
So, let's focus on that.
Finances and Strategy
The company has identified several core strategies with which to go forward into the 21st century and make sure that they continue to be a strong name in advertising. These include:
- Future-facing M&As in areas where the company sees a potential profit, much like the Acxiom acquisition.
- A strong focus on a data-centric ecosystem supporting their agencies and creating synergies for the modern advertising world.
- Investments in emerging and strategic markets, including Asia, Latin America, and others that are expected to grow exponentially in the coming years. The company has representation in China, Dubai, Asia Pacific regions, etc.
For those unfamiliar with the structure of an advertising business, IPG earns money through the planning and execution of multi-channel advertising, marketing, and communications programs around the world.
This means that:
- Revenues are directly dependent on advertising, marketing, and PR requirements of existing clients and the ability to execute strategies as well as win new clients.
- Individually negotiated contracts with wildly varying commissions and fees.
- Comparatively short termination notices of 90 days or less. (Source: IPG Annual Report 2018, page 6)
(Source: IPG Annual Report 2018)
The company's primary operations and results are to be found domestically in the US. Over half of the company's revenue is made here, with the UK representing by far the largest international single country sector (Asia Pacific being the otherwise largest geography in terms of revenue). We can see this below (yellow emphasis mine).
(Source: IPG Annual Report 2018)
Now, we have a global tendency for increased spending in advertising going forward. With the huge market for digital ads and spending, this only services to drive this industry forward further. While there's some expected global economic slowdown going forward, the impact this will have on an otherwise growing market (due to growing populations and growing middle classes) can be considered limited. Many even believe that digital ads will overtake traditional ad spending during this year (Source: TechCrunch)
This is the market the company is active in - and they've done it well for the past 10 years.
The tendencies since the last financial crisis have been nothing short of stellar.
The company has also been an active buyer of its own shares and has managed an overall sales increase of almost $2.25B in less than 12 years.
Having recovered from the slump experienced during the global meltdown, the ROE and ROIC are now very good and, in terms of sector trends, above many competitors. IPG is a very good manager of capital. Company margins are excellent as well, at above 12% (13%) in terms of operating margins for 2018 and 12% FCF margins, coming in at above average and industry.
As far as that goes, fundamental numbers look appealing indeed.
Debt & Ratings
The company does have its fair share of debt, especially following the acquisition of Acxiom, where they leveraged up beyond where they should comfortably be.
This is reflected in the agency ratings, currently giving the company an investment-grade BBB rating - but no more than that. As we can see above, however, the company has already taken steps to begin to de-leverage, and though the indebtedness will likely stay uncomfortably above historical norms for 1-2 years yet, barring something truly unforeseen, it's likely it will go back down.
(Source: 1Q19 IPG presentation)
The total debt stands at almost $4B, with one short-term debt due this year and another significantly larger in 2 years. Going forward two years, some of the company's focus will be firmly on de-leveraging the somewhat burdened balance sheet.
The debt and other challenges notwithstanding, however, the company is humming like a finely-tuned engine if we look at recent annual and now quarterlies.
1Q19 results were absolutely stellar and beyond expectation. The company beat EPS expectations by nearly 50% (Non-GAAP) and revenue expectations by $50M.
(Source: 1Q19 IPG presentation)
The company continues its tradition of revenue growth as well as organic growth. EBITDA, margins, and everything is showing very positive signs. Strong markets across the world were Spain, Germany, France, and Italy. The company also managed excellent results in markets such as Brazil, Mexico, Colombia, and Argentina - all nations providing strong organic growth.
More importantly, for a company of this kind, however, the internal cost control was once again managed well, with expenses growing almost 4% less than revenue growth, indicating not only revenue growth but also a continued focus on conservative expenses.
The company admits to certain business tailwinds somewhat unrelated to company performance, but the overall picture in terms of 1Q19 is outperformance once again, continuing a quarterly tradition of this for the past few years. One could talk about specific cases, but I don't think it is relevant for the purpose of this specific article - insofar as recent results go, these results impressed.
Let's look at some risks.
Key Business Risks
Just like when I downplay some of the headwind and company risks on the negative side for some companies, like in Healthcare, related to the long-standing nature of its business, contracts, and its entrenched position in the market, I'm going to do the opposite here.
I don't consider the recent short-term positive results from the company a guarantee that this company is on a long-term path to success. Unlike other industries, the ad space faces a significant amount of sell-side risk related to the nature of its contracts and customers. While certain customers may indeed form bonds and strong relationships with certain ad agencies, I believe that customers go where they can get two things - quality and competitive pricing.
While IPG seems to be currently delivering on both counts, going by their recent successes, it's in no way guaranteed that this will continue to be the case going forward. The organic growth so touted by the company comes from new clients, new contracts, and new commissions.
Unlike other industries, where these would represent years of profits, the contracts in the ad space/marketing are often limited to 90 days. The nature of the industry also means that clients who are dissatisfied with the services have a little issue leaving the agency and seeking other opportunities elsewhere - and the moat to starting a small advertising agency isn't exactly high. (Though competing with IPG would of course not be easy.)
So, in short, this sector, and IPG is something I consider harder than other sectors and company to forecast.
Beside these sector-specific risks, the company also faces:
- FX risks due to the 50%-international nature of its business
- Political/Socioeconomic risks due to the international nature of its business, including geographies that can be considered potentially unstable or affected by the current trade/tariff war
- Extreme sensitivity to macro, with downturns heavily influencing company results (as can be seen during the last depression/recession in 2009)
Like I said, I consider this sector harder than other sectors to forecast due to the somewhat short-term nature of its business cycle/s. What does this mean for our valuation?
It means that we can't afford to pay any premium for agency companies, and it means that in this space, getting a discount isn't a boon, it's a requirement, especially given the uncertain economy we now face.
Let's see where we stand.
(Source: F.A.S.T Graphs)
Looking at the graph, we can see two things.
- The effects of a recession aren't pretty when it comes to profits, with a -57% drop.
- The stock price is not currently taking into account the quarters of stellar growth the company has been showing nor its expectation of the continuation of this trend.
First of all - let's forget the premium valuation historically tied to the company. Given the macro situation we're heading into, paying any sort of premium in the ad/marketing sector is begging to be shoved into a value trap.
(Source: F.A.S.T Graphs)
Forecasting at a basic blended P/E of 15.0, the company yields an impressive, market-beating ~17% annually to the interested DGI investor. However, due to the already undervalued price of the stock today, the company could be traded at even lower valuations for some time going forward, and you would still not be losing money if you invested today (assuming the company could, during a downturn, keep up its dividend).
The assumption of market-beating annual returns here is partially tied to the expectation that IPG could continue to pay and even increase its dividend. At a payout ratio of below 60% (51%), the dividend can be considered conservative and safe for a company in this sector. I believe even navigating a 1-2 year economic downturn, the dividend would at the very least stay at current levels, which would mean that investing at today's valuation would, even at a worst-case scenario, not yield you a loss in your investment long term.
Current long-term investors of IPG have in fact done very well for themselves.
(Source: F.A.S.T Graphs)
The company has since the global downturn delivered stellar, market-beating returns at a total of 19.5% ROR annualized - almost 7% more than the S&P 500. The question facing the investor at this point is - is it worth investing into this today?
I say, yes. My own position in the company is a limited one and I do recommend careful sizing in terms of your allocation here, but the Interpublic Group Of Companies is a good company at a good price. It's survived the cut-throat world of advertising for almost 100 years and has built up a solid foundation of clients, a good sheet, and adds to this with many quarters of stellar, market/expectation-beating results.
Had this been any other sector, this would sort of been an undervaluation with regards to earnings and fundamentals would warrant a table-pounding recommendation. Because we are talking advertising/marketing, however, this does come with its own subset of challenges and characteristics - namely very short term and sensitive.
Many would say that given such short-term and sensitive characteristics, their demands for company dividend growth and capital appreciation are far higher than the company is offering, even at a best-case scenario going by its premium valuation.
This perspective would not be wrong.
My thesis is wanting exposure to some of the best names the industry has to offer, and given my demands for dividends, some of the more digital-oriented names are not interesting to me. I focus on those that have been around and pay me a dividend.
IPG, to me, represents one of the best companies in this space, and given its current valuation, I'm not disinterested in somewhat increasing my exposure here. I recommend that you, at the very least, read up about the company and consider putting this one on your watch list, if not an outright investment into its undervalued share price.
IPG is undervalued by key metrics and historical premiums, as the market has failed to take into consideration the past year/s of stellar results and the company's continued expectation of these successes. At a blended P/E of 11.3, I consider IPG to be a "BUY". If the stock price were to depreciate further, I would consider the company a "STRONG BUY" under the valuation of 10.0 if nothing fundamental regarding the market or the company changes.
I will update this article or publish an updated thesis should things change and/or in conjunction with future earnings updates.
Disclosure: I am/we are long IPG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.