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Another year older, but not deeper in debt?

It is too early to know what marketing agencies’ balance sheets will look like on 31 December, but there have been some signs that borrowing levels have stabilised.  A survey published in October suggested that balance sheets of most publicly listed marketing groups appeared to have remained fairly stable during 2011 despite the gloomy economic environment, and that trend seems to have continued.

A similar picture emerged among privately owned agencies in the “Private Plums” survey that reported: “There has been no overall increase in the number of companies that relied on borrowings.”

There have been casualties of course, but most of the survivors seem in fairly good shape.  So in this season of goodwill, what would help agencies if Santa Claus could bring it in his sack?

Top of the list would almost certainly be some economic growth – particularly if evidenced by consumer spending.  Secondly might be the delivery of even more imaginative and commercially aware creative teams.

Thirdly and closely allied with the second, would be more cultural emphasis on working as a “partnership” so that talented employees feel more valued and part of the decision-making process (and therefore less likely to leave).  Fourthly, more clients who understand that they will normally only get what they pay for and that, while macho antics by their procurement managers may produce short-term financial benefits, they will almost certainly lead to a longer term deterioration in the quality of their agencies’ marketing contributions.

And finally, we would welcome a gift of a bit more happiness generally – not just a Happy Christmas, but a very Happy Ever After!  And that seems an appropriate note on which to sign off the last of these blogs.

Bob Willott is editor of “Marketing Services Financial Intelligence

Must escalating staff costs continue to erode profit margins?

Lots of people no longer believe it is possible to keep staff costs down to no more than half an agency’s gross income.  Undoubtedly it is a difficult challenge – one that is increasingly dismissed as unrealistic by those who note how a number of US agency groups seem content to spend at least 60% of income on their staff.

The trouble is that any agency that wishes to achieve the traditional operating profit margin of about 15% will find that is very hard to do if staff costs escalate.  That’s because the rest of an agency’s expenses are not easy to vary – items like rent, for example.   So, if staff costs take a growing slice of income, less will remain available to shareholders as profit.   And it’s never been easy to increase client fees when margins come under pressure.

In the US the fixed costs tend to consume a smaller proportion of income, leaving more scope for profit if staff costs creep up.   That’s one of the reasons why US agencies have been in the vanguard of those that gear staff costs to performance and readily pay bonuses to staff that enhance the agency’s income.   At WPP, Sir Martin Sorrell has also sought to relate a chunk of staff remuneration to performance, although there appears to be less scope for improving the group’s profit margin by doing so.

In the UK, it has become all too easy to accept profit margin erosion as an inevitable consequence of staff cost inflation.   But there are still good examples of agencies that maintain their profit margins at a healthy level.  Eight of the 10 privately-owned agencies that had the best financial credentials last year also kept staff costs below 50% of income.  All of the top five did so, and they spanned a variety of disciplines that included media buying, advertising and direct marketing.

Even so, it is only a minority of privately-owned UK agencies that can keep staff costs below 50% of income.  Indeed, only 30% of the agencies in this year’s “Private Plums” survey succeeded in keeping staff costs below 55% of income – but that was an improvement on the 25% that did so in the previous year.

There is no magic solution to managing staff costs.  But there continues to be plenty of evidence that it’s an important aspect of agency management that is all too often ignored.

Bob Willott is editor of “Marketing Services Financial Intelligence

Reported profits: when nothing is quite as it seems

Anyone who thinks that businesses are easy to manage and that profits are easy to predict could learn a lesson or two from the results of two public companies in the marketing sector that reported this week.

On the one hand there was Weare2020 – what a ludicrous name – reporting an increase in profit that had a zero effect on a continuing decline in its share price that has lasted for the best part of a year, while on the other hand Next Fifteen Communications Group reported a profit decline that did little to accentuate the short-term dip in an otherwise steady increase in share price.

What the share prices reflect is roughly what the more thinking analysts and observers have worked out for themselves: the underlying profit at Weare 2020 is going down, but the underlying profit at Next Fifteen is going up.

In both cases the superficial picture painted by the results has been distorted by one-off events.  Weare2020 was able to present an underlying break-even position as a £0.5 million profit simply because it had succeeded in recovering part of a bad debt incurred years ago and written off at that time.  The recovery was due to a piece of good fortune, but had nothing to do with the underlying trading performance.

By contrast Next Fifteen suffered from a big piece of bad luck when a senior member of the financial team walked away with the best part of £2 million to which he or she was not entitled.  That’s every finance director’s nightmare and, while the company has not made public the nature of the fraud, or whether elementary controls were either lacking or inadequately policed, if a senior employee in the finance department is determined to commit fraud he or she will probably succeed for a time at least.

So without wishing to offer a palliative to Next Fifteen’s financial team, or to understate the merit of recovering a bad debt at Weare2020, it is at least as important to understand what is happening in the underlying businesses.  And in these two businesses, the underlying performance is the opposite of what the bottom line results portray.

Bob Willott is editor of “Marketing Services Financial Intelligence”

Economic gloom, but it’s an ill wind that blows nobody any good

As each week passes, we hear more gloomy outpourings about trading prospects from the major groups in the industry.   Huntsworth and Dentsu joined the gloomy chorus last week, countering Maurice Lévy’s attempt to cheer us up with news of better trading in October.   Even those companies that are currently on target for the year feel the need to counsel caution about their future prospects – witness Chime Communications and Levy’s warning about December.

It would be daft not to take notice of these miserable predictions and for businesses to prepare themselves accordingly.  But there is a point at which the predictions can become self fulfilling.

Market demand starts with the consumer and, if consumers aren’t spending, most manufacturers become more cautious and selective in their marketing initiatives.  That affects the amount clients will commit to their agencies – irrespective of the efforts agencies will make to emphasise the merits of clients exploiting a depressed economy by seeking to win market share from weaker competitors.

So agencies start muttering out loud about the weak economy, others join in and, before we can say “economic recovery”, consumers and  clients get even more nervous and cut back further.   In such a situation, perhaps agencies need to sound more positive, however cautious they may feel and however firmly they may be managing their back office costs.

But if nothing can be done to improve matters, maybe there are other opportunities to be seized.   For example, any agency that is suffering will be worth less than in boom times.  That provides an opportunity to introduce share incentive schemes for some more key people, with self-evident prospects of value growth when the economy recovers (particularly if the agency’s key people are better motivated).   The quiet economy may also allow time to be devoted to developing improved features in the way clients are serviced.   When the economy was booming, no-one ever had time for anything but getting the job out of the door.

It’s an ill wind that blows nobody any good.

Bob Willott is editor of “Marketing Services Financial Intelligence

Publicis bid for Lbi all over bar the cheering?

With 86% of LBi International’s shares either already purchased or subject to irrevocable undertakings, it is hard to envisage any circumstances that would prevent Publicis concluding its takeover bid next January – provided the regulators don’t intervene.

And the possibility of a counter-bid is even more remote although, as Publicis chooses not to remind us, the so-called irrevocable undertakings are actually not quite what they seem.   If LBi shareholders receive an offer worth at least 9% more than the Publicis proposal, the current deal may be terminated although Publicis has secured the right to match any other such superior offer.   Mind you, if the Publicis deal were to fall through in the face of a better rival offer or a withdrawal of the LBi management’s support, LBi may be liable to pay a termination fee of €7.5 million to Publicis.

Today Publicis followed up its original outline proposal with a formal offer that requires a response by 12 January 2013.  The issue of the formal offer implies that the regulators have either given their approval or intimated that approval is likely to be forthcoming.

So in a few weeks’ time many of the LBi managers and private equity backers will be pocketing a 100% gain and Publicis will own an even bigger share of the digital marketing sector. Whether that concentration is sufficient to merit examination by the European Commission remains to be seen, but you have to hand it to Maurice Lévy: he’s got vision and determination – qualities that must irritate his arch rival Sir Martin Sorrell.

Bob Willott is editor of “Marketing Services Financial Intelligence

Share incentive scheme and development costs wipe out Facebook profit

If share incentive schemes are intended to reward staff for building bigger profits for shareholders, the Facebook scheme is an unmitigated failure.  While revenues grew by 36% in the nine months to 30 September, profits have vanished completely.

Amounts charged in relation to the company’s share incentive schemes absorbed 43% of revenues – much of it in the research and development area.    So unless Facebook achieves some magical results soon from its development team, the incentives will have been entirely counter-productive.

In fairness to Facebook, the share incentive charges are based on the perceived value of the incentives rather than on cash outlay by the company.  The heavy charge this year stems from the fact that many of the shares will vest next month (six months after the IPO). Explaining the impact more fully, the company said:

“Our share-based compensation expense was materially affected in the second quarter of 2012 due to the terms of our RSUs granted prior to 2011, related to which we recognised a cumulative $986 million in share-based compensation expense in the period, despite the fact that these awards were granted and earned over several years.”

Accepting that the latest profit figure may have been distorted by timing factors, $986 million of cost is still one heck of a lot, irrespective of how many financial periods it was earned over.

Even without the share incentive charges, development costs almost doubled when compared with the same period in 2011.

Marketing costs too are eating into a bigger portion of revenues.  Excluding any share incentive costs, the marketing and sales expenses absorbed 11.6% of revenue in the latest nine months compared with 9.6% in the corresponding period of 2011.

It all smacks of panic or very loose management.  So it’s a good job the Facebook balance sheet is very strong with piles of cash swilling around and virtually no short-term liabilities to meet.

Bob Willott is editor of “Marketing Services Financial Intelligence”.

Publicis trumpets the past while WPP analyses the future

Publicis Groupe’s ability to continue building revenues at a seemingly faster rate than its global competitors – reflected in its third quarter results announced today - may well have been helped by favourable currency movements – not least the decline in the euro – and aggressive investment in digital acquisitions, but the fact remains that the growth is real enough.

Equally real is its gloomy prognostication for the rest of 2012, a view shared by WPP.  The one consoling glimmer is the impression gained so far that UK businesses may have been less vulnerable to adverse economic influences than either those in the US or continental Europe.

The US economy and its presidential elections are both creating negative vibes.  The eurozone is in a mess.   And nails are being bitten while we wait to see how China’s economic slowdown evolves.    All of these concerns will have a knock-on effect on UK business – particularly those with sizeable exports – so it is a time for caution rather than complacency.

It is also time a bouquet was sent to WPP for the fulsome manner in which it shares details of its performance and predictions about its prospects.   There is no other public company in the marketing sector that explains its thinking so fully.   Indeed many companies seem to adopt the policy that sharing anything but the most essential facts will prove a hostage to fortune and should therefore be avoided.  Today’s announcement from Interpublic is a good example.

Interpublic not only reported a serious fall in domestic revenue and a 15% fall in profit (leaving out the one-off gain from the sale of Facebook shares), but it offered no commentary on likely future trends.

In reporting on the past there will always be plenty of room for fudge and for overlooking the less cheering events by companies that choose that course.  But a more open approach is likely to build confidence. As for the future, whether the reader agrees with WPP’s economic analysis or not, it provides a valuable contextual backcloth against which future performance can be assessed.

Bob Willott is editor of “Marketing Services Financial Intelligence

It would be nice if sector share prices anticipated economic trends

There is some evidence – but not a lot – that the stock market anticipates trends in economic activity, pruning back share prices when a downturn is expected and cautiously lifting those prices back upwards when better times are seen to be on the horizon.

The accompanying chart compares quarterly movements in GDP with the MSFI Index of marketing company UK share prices.  There is some indication that, in the past, the share prices started moving in a new direction a few months before the economy changed direction.

If this evidence has any validity it would suggest that we are about to enjoy a period of economic recovery.  Share prices have been moving upwards while the economy is still bumping along its depressed path.
One factor affecting the current improvement in the industry share price index is the demise of the poorest performers – companies like Adventis Group and Media Square.  Thus the index is now benefiting from the better quality of its composition.

But maybe we are also seeing the first hint of a return to a more optimistic business mood.  That would be a pleasing thought, although the evidence is fragile and only time will tell whether a simple chart can be taken even a mite seriously.

Bob Willott is editor of “Marketing Services Financial Intelligence

Pinch yourself…agencies seem to be making bigger profits

It’s hard to believe that many of the financial results reported in the last week or so have been very positive.   What happened to recession and the financial crisis that we are all supposed to be experiencing?

Marketing software supplier dotDigital reported a 30% rise in operating profit and revenue.  Beattie McGuinness Bungay reported a massive 420% increase in operating profit.   Even poor old Profero managed to turn the previous year’s operating loss of £2 million into a breakeven position.  LBi reinforced the benefit of a Publicis takeover by forecasting a 26% rise in operating profit this year. And digital public relations outfit Hasgrove recovered from a £5 million loss to a profit of £471,000.

Of course there were some poor results as well.   But the fact remains that a number of companies have been able to improve their profits or recover from previous losses.   And that’s worth celebrating.

Equally worthy of comment are the reasons for the improved results which are very varied.    Dot Digital has simply expanded sales of its software products by innovation and good salesmanship.    Beattie McGuinness Bungay closed its New York operation after it had become a drain at a time when the agency needed all the profits it could get to maximise the proceeds of the sale to Cheil.

Profero woke up to reality after discovering that opening offices around the world on a virtually unmanageable joint venture basis looked good in its publicity material but not so good on its balance sheet.    Shedding some of those offices had a healthy impact on the bottom line.

LBi has gained its reward from rationalising a mishmash of under-performing past acquisitions and building a simplified global operation that does what the clients want.    And Hasgrove got rid of a loss-making public affairs subsidiary by selling it (or virtually giving it) to its management.

What emerges from the above is that profits don’t just come automatically.   They require innovation, talent, determination and – quite often – tough decisions.   And these are qualities that still seem to be in short supply.

Bob Willott is editor of “Marketing Services Financial Intelligence”.

Why does Maurice Lévy want to spend €416m on buying LBi?

Few would challenge the Publicis policy of investing in digital assets in the manner pursued so energetically by chief executive Maurice Lévy. It has proved to be a good strategy so far.  And, as a target, LBi has made great progress from its darker days to become a well respected business.

But why is LBi worth €416m to anyone?

It’s easy to play with figures and come up with some sort of justification, but the fact remains that LBi has a poor and erratic profit record, that it made €17.5m for its shareholders last year and it will have to grow consistently fast to justify the implicit price/earnings multiple of 23.7 ( – perhaps the reason for LBi’s forecast of a 26% rise in profit this year, announced this morning).  Even allowing for the estimated extra profit that might be generated from the Mr Young acquisition, the historic multiple only falls to 22.6.

The plus points about LBi are easy to see.   It is now a solid multi-disciplined digital agency that combines technical skills with marketing expertise.  It is big.  And it is international.

But, of all the global groups, Publicis has probably invested most heavily in digital assets already – nearly €2 billion was spent acquiring Digitas, Razorfish and Rosetta.  Wouldn’t it prove more profitable in the medium term to invest in the organic expansion of those agencies rather than buy yet another?

Or is the name of the Publicis game the desire to expand market share by taking out potential competition?   Is the move a defensive one – intended to ensure that no-one else gets their hands on LBi?  Everyone would have known that, with private equity funds involved, LBi would come up for sale soon as its existing public share listing was unlikely to offer the most favourable exit route for them.  Would Publicis want LBi to fall into the hands of WPP, Interpublic, Havas or even Sapient?

Has Publicis decided that it can work its cost cutting magic on LBi and gradually rationalise all Publicis digital businesses into fewer, but even stronger and more profitable, global brands?

Or is there another, rather simpler, explanation?   Will this deal help Maurice Lévy achieve global dominance before he retires?  A deal with Interpublic alone (if that company is also in Lévy’s sights) would probably still leave Publicis in the shadows of WPP and Omnicom, but perhaps a few extra million dollars of revenue from LBi would be enough to achieve that aim.

Even so it’s hard to believe that a few silver tongued private equity investors would have been able to persuade Lévy to part with so much money for LBi.  Surely nobody pays top dollar to buy another business just to be the biggest boy on the block…or do they?

Bob Willott is editor of “Marketing Services Financial Intelligence”.

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