Omnicom could stand test of WSJ allegations

Faced with a 30 per cent fall in share price and allegations of fraudulent misrepresentation of financial information, any chief executive would feel a little hurt. And that is how Omnicom's chief executive, John Wren, described his feelings last week in a conference call with investment analysts.

The principal cause was a hostile article in The Wall Street Journal which had been preceded by unsettling leaks of what it might contain.

One such rumour was that unease over financial matters had been the reason why the audit committee chairman, the 72-year-old Robert Callander, had resigned one day after the annual meeting on 21 May.

Another rumour was that Andersen's resignation as Omnicom's auditors was not just a consequence of its own disintegration in the wake of the Enron affair - even the firm's formal confirmation that it had no unresolved disagreements over Omnicom's accounting might not have provided quite as much comfort as in former times.

So what is all the fuss about?

At the financial level, it is a story about whether or not Omnicom is guilty of flawed accounting. And judging by the stock market, suspicions remain - the share price wallowed at $56 on Monday (17 June) after bottoming at $54.62 last Thursday.

The WSJ made six allegations. Two simply reflected a lack of knowledge of what US financial disclosure rules require. The WSJ wanted to know why Omnicom did not distinguish between the revenue and profit it derived in aggregate from new acquisitions and that derived from existing businesses.

The answer? It doesn't have to, and its main competitors don't seem to do so either. This information is required of UK companies, but the US rules are less demanding.

Also, the WSJ wanted to know why Omnicom didn't include as a liability in its accounts the amounts it may have to spend in the future on earn-out payments to people who have sold their companies to the group. Again, unlike UK rules, this is not a US accounting requirement.

In the US, Interpublic takes the trouble to voluntarily estimate the maximum liability for earn-outs and include it as a note whereas Omnicom has not done so in the past. Last December, Interpublic reckoned it might have to pay up to $550 million. Omnicom has now intimated that its obligations at that date may have been somewhere in the region of $350million to $450 million.

So, on two counts Omnicom is unquestionably "not guilty as charged, but it (and other US groups) could have been more helpful. On the next two counts, the report suggested first that the cash generated by Omnicom's ordinary trading activities had been declining over the years (and that it was negative after deducting the cost of acquisitions) and that its level of borrowings was increasing sharply.

In general terms, cash flow has improved gently over recent years and it would be a rare business that could finance all its acquisitions from this source alone. That's partly why companies retain some of their profits, issue more shares and/or borrow more .

But it is true to say that the amount borrowed by the group has been rising fast - and it always reaches a nail-biting level at the end of the March quarter as seasonal commitments come into play. This rise is not just because Omnicom has been gobbling up other companies, but also because - prudently or otherwise - it has been buying back some of its share capital, perhaps in the belief that with low interest rates it can improve the vital shareholder statistic of earnings per share by doing so. Even so, the level of debt last December represented a smaller proportion of total capital than a year earlier.

So, after examining four of the allegations, the scorecard is still in Omnicom's favour, although not entirely so. The next allegation is simply a nice arithmetical debate - albeit a serious one - that revolves around how a company calculates "organic growth".

Should it compare revenue and profits of businesses owned throughout its latest year with the revenue and profits earned by those same businesses for the whole of the previous year, irrespective of when those companies were acquired? Or should it only compare the revenue and profit of businesses that were owned for the whole of the previous year with the revenue and profits of the same companies in the latest year? Both compare apples with apples, but the apples are a different variety in each case. Answers on a postcard please to John Wren, John Dooner and Sir Martin Sorrell.

That brings us to the final allegation, which concerns a skillful way by which, in May 2001, Omnicom was able to offload its investments in internet companies such as Agency.com and Razorfish to a venture capital outfit called Seneca Investments owned by some Americans who specialise in revitalising distressed enterprises. And, by gosh, those internet businesses were distressed as they headed for accumulated losses exceeding $700 million.

In essence, the principal financial risk was transferred to Seneca, and Omnicom's profits escaped any dent. The questions now being asked are about whether the deal was entirely at arm's length, whether it was adequately disclosed and whether there might still be some lingering potential liabilities that might come back to haunt Omnicom in the future. Omnicom is adamant that it has been as open as possible. It now has to convince investors.

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