Ian Whittaker
Ian Whittaker
A view from Ian Whittaker

Investor view: Hamsters on a wheel – changing the agency acquisition merry-go-round

WPP's run-in with the SEC in the US has raised interesting questions about the acquisition model for agency holding groups.

Last month, the US Securities and Exchange Commission fined WPP $19m (£14m) for various violations of the Foreign Corrupt Practices Act after it found WPP had failed to ensure local advertising agencies in "high-risk markets" met its accounting standards.

A fuller detail of the claims is outlined in the article here and it should be noted both that WPP has denied any wrongdoing and that WPP's former chief excutive, Sir Martin Sorrell, has denied responsibility for what happened.

Putting aside the specifics involved, there are some interesting questions raised here about the acquisition model for the agency holding groups and how things may change moving forwards.

One thing to point out is that many of the acquisitions made by the agency holding groups fall under the radars of analysts, as they are usually too small to be of consequence in the wider scheme of things.

Yes, once in a while, a game-changing deal such as Publicis' purchases of Sapient and Epsilon, or IPG buying Acxiom, comes along, which attracts greater scrutiny and a more detailed explanation. But, more often than not, there is usually a brief description of the asset purchased with (usually) no details of either the price paid or the financials, followed by a short explanation of how the purchase fits into the wider picture from a geographical/product standpoint and, lastly, a few words from the holding group CEO. The point here is that, from an outsider's standpoint, it can be hard to know the quality exactly of what the holding group is buying.

A second, more pertinent point is that these acquisitions often are central to the holding group's desires to accelerate or, at least, maintain their organic growth rates. There is an interesting, long-term point here, namely that, for all the multi-year purchases of supposedly fast-growing assets, the holding groups' overall organic growth rates never seemed to accelerate and, in several cases, decelerated. Take WPP: its average annual organic net revenue growth from 2014-2016 was above 3% but fell to an average of about -0.8% for 2017-2019. It wasn't alone in seeing such a trend.

This raises some interesting questions. Did these acquisitions decelerate in growth once acquired? Or did they counter-balance worsening trends in existing assets which meant that the agencies' organic revenue growth rates would have been significantly worse if these assets hadn't been acquired? Arguably, the acquisitions saved the agencies from reporting poorer numbers as their media businesses came under pressure.

That leads into a further point, namely the pressure on the holding groups to meet analyst and investor expectations, which can then lead to pressure travelling downwards to individual agency groups.

In such an environment, especially when central management teams are scrutinising the performance of individual agencies, it maybe should not come as a surprise that a few individuals may be tempted to push the envelope to deliver on their targets. The question then is how well the central functions of the holding groups can pick up on such infringements.

However, while investor pressure certainly can play a part in pressurising agencies to meet numbers, a more likely common culprit is the way that many agency acquisitions were structured historically, with a percentage of the price paid upfront and then the remainder of the amount subject to earnouts based on performance criteria at the individual agency.

While such a structure has its benefits, it has two major drawbacks. First, it can (but not always) incentivise managements to stray into the territory of illegitimate means to boost numbers. Second, it encourages a mindset where the focus is on the performance of the individual agency itself rather than the holding group as a whole. In a worst-case scenario, this can lead to individual agencies taking actions that are to the detriment of the group.

It is unlikely the SEC fine will have much impact on investors' views of WPP or the other agency holding groups (in fact, the share price reaction has been muted). However, what it does feed into is the debate as to whether it is better for the holding groups to scrap earnouts for acquisitions and instead focus on straight forward buyouts.

This is what Sorrell's S4 Capital has done, with acquisitions being a mix of 50% cash and 50% equity in S4 Capital, the latter to ensure that the incentives of acquired management teams are aligned with the interests of the group.

The established holding groups are already moving in this direction but it seems fair to say the days of the earnout may be fading away. If so, it may give greater comfort to investors of the holding group model and lessen the risks of similar incidents in the future.

Ian Whittaker is founder and managing director of Liberty Sky Advisors. He is writing a regular column for Campaign about the advertising landscape from a financial standpoint. For further insights and articles, subscribe at www.ianwhittakermedia.com

Read his Campaign Investor View column from September: Investing in brand works, so why do agencies lack confidence?

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