CLOSE-UP: LIVE ISSUE - Has Interpublic done enough to heal its financial problem?

IPG has raised some cash but is still a long way from recovery, Bob Willott writes.

As 2003 drew to a close, Interpublic was showing an unusually high - almost frenetic - level of financial activity.

The group sold most of its shareholding in the internet consultancy Modem Media for $55 million. It raised $41 million cash from the sale of shares received in part consideration for the sale of its NFO WorldGroup research operation to Taylor Nelson Sofres last summer.

And it settled out of court the $115 million legal action initiated by shareholders after the company admitted to major accounting errors in 2002.

Then the company recapitalised its balance sheet by a $627 million issue of shares and convertible preferred stock to replace the $245 million worth of convertible loan notes that were due to mature this year and to "strengthen the company's balance sheet and financial condition". And just after the year-end, it sold off four of the racing circuits owned by the troubled Brands Hatch subsidiary for an undisclosed, and probably very modest, sum.

In total, the above moves raised at least $450 million in extra cash as well as resolving the uncertainty about what the shareholder litigation might eventually cost. Why was this necessary? Is it because other earlier moves to restore Interpublic's overstretched balance sheet to a more stable condition seem to have been offset by further financial shocks emerging from the woodwork, making the need to reduce borrowings remain a top priority?

And has it succeeded at last in radically strengthening its capital base?

Take, for example, the sale of NFO WorldGroup last July for $450 million, of which more than $400 million was in the form of immediate cash. No sooner had this been accomplished - providing a much-needed reduction in borrowings - than Interpublic was confessing to another string of losses and write-offs that reduced shareholders' funds by $416 million. These included further restructuring charges and a massive extra write-down in the value of its Octagon Worldwide sports marketing business. Yet less than a year ago the company was suggesting that all the Octagon ghosts had been exorcised.

Does it matter if the shareholders' funds are eroded as quickly as borrowings are reduced? Unfortunately the answer is "yes". No financial institution is comfortable with the idea of a company borrowing more money than the total amount invested by its shareholders. This relationship is called the debt/equity or "gearing" ratio.

A highly geared group such as Interpublic would be hoping to improve that ratio by cutting its borrowings while at least maintaining the level of funds provided by shareholders (including any retained profits).

So if funds invested by shareholders are slashed by unexpected write-offs or losses, the hoped-for improvement in the gearing ratio never materialises.

Interpublic, along with most of its competitors, is quick to emphasise that the writing down of the value of previous acquisitions, such as Octagon Worldwide, does not affect the current cash balance. But that misses the point. Although the write-off doesn't harm the gearing ratio by increasing current borrowings, it does equivalent harm by reducing the amount of shareholders' funds in the business.

At Interpublic, the group's debt/equity ratio at 30 September last year was a delicate 0.94:1 - only a little better than in 2002, and way above the more acceptable ratio of 0.79:1 in September 2000. So action was necessary if its year-end balance sheet was to give greater comfort to investors and bankers.

All the noises coming out of Interpublic during the roadshow promoting its December fund-raising initiative suggest that the financial position has indeed been radically improved. Indeed, if the gloomy September picture were to be adjusted retrospectively to include the proceeds of the subsequent cash-raising efforts (and assuming no more major financial shockwaves emerge), the gearing ratio would become a dramatically better 0.57:1.

Not only has the group raised more cash, but it has also managed to ease pressure on short-term borrowings by replacing them with various types of permanent share capital. And $95 million of the $115 million litigation claim was shrewdly settled by the issue of new shares rather than incurring another cash drain.

But there is a lingering worry. Why has the group chosen to raise so much new share capital as well as reducing its borrowings by the estimated $450 million of new cash generated since September? Are we to expect some more bad news within the year-end results expected shortly? Has the group failed to generate any new cash from its day-to-day trading operations in the final quarter of last year?

The signs remain that the group still has some serious profitability problems to overcome and inevitably this will take time. Even after rewriting its performance for the third quarter of 2003 in the most favourable light, the operating profit margin was a mere 7.7 per cent, whereas by more normal accounting conventions it was minus 12.1 per cent.

Only time will tell whether the arrival of the storm troops at Interpublic's McCann-Erickson network in the shape of Rupert Howell and friends will help to restore its fortunes. But if rumours of a management buy-out attempt at the Lowe network have any substance, at least the group should now have the financial strength to resist that and any similar initiatives.

For the time being, at least.

- Bob Willott is the editor of Marketing Services Financial Intelligence ( and a special professor at the University of Nottingham Business School.