Close-Up: Live issue - Why mini-groups are feeling the strain

An economic downturn makes these companies less attractive to investors, Kate Nettleton writes.

"Markets are like herds of wildebeest: once one gets a scent of something on the outskirts of the herd, they all scatter and run away after something else. And at the moment, the wildebeest are galloping away from us at a very fast rate," Mark Lund, the chief executive of the Creston-owned Delaney Lund Knox Warren & Partners, says.

It's certainly fair to say that the "buy and build" mini-holding companies have been plagued by falling share prices.

But Lund believes that Creston's share price, which was at 70p in April before falling steadily to 39.75p last week, is symptomatic of a total disconnect with the stock market, rather than a reflection of the declining health of the sector. Share prices may be sliding, but advocates of the mini-holding company model argue that the decline in share value is indicative of a lack of understanding and faith in the structure among investors.

As the UK descends towards economic downturn, it is the mini-holding companies that seem to be bearing the brunt of investors' newfound tentativeness, with shares in Chime Communications also falling from 170p to 112.5p in the past year, while Cello Group's dropped from 158p to 72.50p in the same period. Meanwhile, although the media sector ranges from TV companies and regional newspapers to marketing services companies, investors tend to place them in the same bracket.

Don Elgie, the group chief executive of Creston, says: "Private investors don't look at the make-up of each individual company in our sector. So when they see ITV, Yell or Trinity Mirror come off very sharply, we, and our peers, get tarred by the same brush."

What investors seem to be ignoring are the relatively healthy profits of these small holding companies, which were reporting pre-tax profit growth of between 25 and 29 per cent for their last 12 months.

"There's only three explanations as to why they are no longer an attractive investment opportunity," one industry source argues. "One is that all these individual companies are rubbish, which I certainly don't think is true. Two, that small holding companies are basically a bad idea, in which case why were they supported so strongly originally? Or three, investors think they're going to be in for a hard time so they're not interested in buying the shares. I think the latter, although the most prosaic, is probably true."

This is a view corroborated by Chris Satterthwaite, the group chief executive at Chime Communications: "The fund managers are working from historical data that advises them to beware of sectors like 'buy and build' during times of economic downturn. But it's been so long since a consumer downturn that some of those policies might be outdated."

And there is one point on which most concur: the popularity of investment in mini-holding companies is predetermined by economic cycles. When times are good and their revenue is increasing, they are popular with investors because the companies can issue new shares and raise the funds to make new acquisitions and grow further. But in a downturn, the opposite is true.

As David Tope, an analyst for the stockbroker Brewin Dolpin, explains: "A 'buy and build' strategy only works when the share price is going up because it requires the issuing of new shares to make new acquisitions earning enhancing."

Another concern plaguing investors is that because many of the agency heads within these holding companies are reaching the end of their earnouts, they might run out of steam to grow the business any further. And there are fears that the market itself has been "over-fished", leaving very few strong independent agencies left to buy up.

It is this rather bleak outlook that led to speculation that some were planning to take their companies private. "They'll either privatise or get snapped up by bigger predators cheaply," an industry insider says.

Others, however, foresee a different future. "There is a future for them if they prove they can cross-sell within the businesses, enabling them to acquire new clients at minimal cost," Tope says.

The challenge now for the mini-holding companies is to hang on to their talent and fuel organic growth by cross-fertilising their businesses and driving innovation.

Whether all this will help them regain popularity in investors' portfolios remains to be seen, but with the economic forecast looking bleak for some time yet, it could be a long haul.

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HOLDING COMPANY HEAD - Don Elgie, group chief executive, Creston

"The actual share price is irrelevant to the financial stability of a public company; it's a complete red herring.

"The operational performance, managing overheads and the ability to win and retain clients is far more important than what's going on in the economy.

"It's not true to say we'll have to sit on our hands, though. We have to show to investors we're not incurring any additional debt and we have to demonstrate we're growing organically as well as taking minority investments in fast-growth niche companies, such as in digital and analytics. This will enable us to continue with our strategy in spite of any weakness in share price."

ANALYST - Lorna Tilbian, executive director, Numis

"The share prices are falling because they're reflecting the increasingly tough economic outlook, fuelled by consumer debt, falling property prices and rising inflation.

"Investors are viewing these mini-holding companies in a negative light because they're concerned about potential debt levels, earnouts and deferred payments against a backdrop of potentially falling revenues and squeezed margins.

"But the strategy is viable as long as entrepreneurs in vendor companies are buying in and not selling out, and the balance sheet is not weakened in the attempt to bolster the P&L."

AGENCY HEAD - Mark Lund, chief executive, Delaney Lund Knox Warren & Partners

"All the new smaller holding companies started at a time of upturn when there was a general sense that marketing companies and stocks do well.

"They got over-hyped on the up cycle and when you hit a consumer downturn, all stocks related to marketing get hit. The small ones get hit hardest, regardless of the quality of their businesses, because less is known about them.

"By comparison, WPP is jolted by the same market anxieties but it doesn't affect them as badly because they're very well known and have massive scale, which is viewed as protection. If the market took the time to know the small companies better, they might treat the stocks better."

HOLDING COMPANY HEAD - Chris Satterthwaite, group chief executive, Chime Communications

"It's really important for the marketplace that there are small independents. If you're more fleet of foot, you can innovate quicker and keep ahead of the market.

"But the sentiment among the City is that small cap and media stock are high-risk investments right now because no-one knows how deep the downturn is going to be.

"I'm not pretending it's easy and it's certainly more difficult to make acquisitions. You have to be careful of your cost, but if you're just careful of your cost it becomes a rather stagnant way to work. We have to remain one step ahead of our competition, constantly innovate and understand client needs."