Bob Willott, editor, Marketing Services Financial Intelligence
Bob Willott, editor, Marketing Services Financial Intelligence
A view from Bob Willott

Think BR: It's clean up time - thanks to the economy

Aside from the misery caused to staff, a few company failures may not be a bad thing, argues Bob Willott

It may be a mixed blessing, but one of the effects of a depressed economic environment is that it can drive the weak businesses to the wall or into the protective arms of an acquirer. Thus the financial profile of the sector and its survivors recovers again.

So it may be both predictable and encouraging to find that, in the latest annual analysis by Marketing Services Financial Intelligence, the most recent balance sheets of most publicly quoted UK marketing groups portrayed a relatively sound picture, stripped of failures like Media Square and Adventis Group. 

The analysis also suggests that there are fewer vulnerable public companies in the sector today than a year ago. 

Even those that looked weak at their last balance sheet date have taken steps to rebuild their capital strength since then - Ten Alps and Progressive Digital Media Group have both restructured their balance sheets and raised extra long-term share capital, although with only a small part of their business in marketing they are probably not the most representative of the sector.

The main lesson to be drawn from this analysis is not a new one, but simply a reminder that it is unwise to rely on too much borrowed money to fund acquisitions, particularly if there is a risk that those acquisitions will fail to deliver healthy profits.  

Yet it is a lesson that some ambitious entrepreneurs are happy to overlook, persuading themselves that they will make better decisions than anyone else and be less vulnerable to the common or garden risks that beset any growing business.

The analysis arrives at a 'vulnerability index' by looking first at the ratio of debt to shareholders’ funds and then examining the extent to which those funds had been invested in acquisitions where the purchase price was represented predominantly by intangible assets like goodwill.

The theory is that any highly borrowed company is inherently vulnerable, but that the position can be made worse if shareholders’ funds are likely to be eroded by write-downs in the value attributed to past acquisitions.

As if to validate the approach, a footnote refers to the track record of eight years of balance sheet analysis and says: "All those companies that had a vulnerability ratio materially in excess of 2:1 have subsequently had to undergo a capital reorganisation and/or to raise more capital from shareholders, or have reduced debt by disposing of major subsidiaries, or have been sold to or rescued by other companies.  A few have finished up in administration."

Inevitably there are some idiosyncrasies among the findings. For example, the digital media sales company Asia Digital Holdings appears with the label "no exposure". 

As a company that has found profits extremely elusive and whose shares are currently suspended from trading, that label seems rather hard to believe. 

But the reality is that at the last published balance sheet date the company had no borrowings - presumably because no-one would lend money to it any more. 

And it had shed most of its past acquisitions to keep afloat, so there was nothing more to write off their cost.

Another curiosity is the almost identical vulnerability scores given to WPP and Adventis Group at their last balance sheet dates. 

Given that Adventis has fallen into administration since that time, WPP’s score might prompt a few questions. But the report goes out of its way to distinguish the two. 

Insolvency prevented publication of any recent accounts by Adventis and so the final picture might have been much worse than shown in the previous year’s balance sheet on which the analysis was based. 

Equally importantly, Adventis was a small company that made bad buying decisions resulting in it acquiring companies that failed to generate the profit streams necessary to support its capital base.  

Over the years WPP has made a mixture of big buying decisions - where the financial credentials and durability of the target could be readily ascertained beforehand - and much smaller "infill" acquisitions that posed minimal risk. 

So while the scale of acquisition may often have been bigger, the risk involved may have been relatively smaller… hopefully.

Bob Willott is editor of Marketing Services Financial Intelligence