WPP Plc (WPP, Financial) is an advertising agency and holding company in the U.K. engaged in providing communications services. Under its coverage of operations are activities like media investment management, public relations and public affairs, branding and identity, and programmatic media.
Recently, the company has been in the headlines because of the departure of its legendary CEO Sir Martin Sorrell. During his 33-year career at WPP, Sorrell built it from the ground up into a holding company encompassing more than 400 agencies that provide marketing campaigns for clients such as Unilever PLC, Coca-Cola Co., Procter & Gamble and Ford.
It all started from early April, when WPP said law firms have been appointed to look into "an allegation of personal misconduct" of Sorrell after The Wall Street Journal reported on the probe. According to WPP’s statement, this announcement concludes that investigation, which “did not involve amounts that are material.” The statement did not address whether those amounts and the allegations of misconduct were separate matters. Ultimately, WPP has said Sorrell's departure is being treated as a retirement and although it is looking into the potential misuse of company assets, the amounts in question weren't material. Sorrell has denied any financial impropriety.
In reality, Sorrell's departure isn’t the biggest problem. A major change in the advertising industry is. WPP and its major rivals Omnicom, Publicis, Interpublic and Dentsu (all of which have been very profitable) face challenges on every front, from the might of Google and Facebook to the rapidly encroaching professional services firms Accenture and Deloitte. The advertising industry is being rocked by a shift from TV and print ads to digital spots, which are cheaper to produce and easy for companies to make without help from an ad agency. With clients demanding ever-lower fees, big advertising groups must learn to be more nimble and efficient to protect their revenues and avoid pressure on them to break up.
The challenge isn't replacing Sorrell. The real problem is that the business model doesn't work. That business model was designed to insulate the company from downturns in ad spending in different countries. But digital disruption is leading advertisers that once splurged on ad agency-led campaigns to redirect their spending. WPP last month posted its worst sales performance since the financial crisis and projected no revenue growth for the year. Its stock price slide of a third over the last year. We have to admit that the structure Sorrell began with now looks dated. And this has happened when Sorrell was in charge.
In fact, the situation at hand can be a great opportunity for WPP. With the departure of Sorrell, we see the beginning of the end for a generation of media and advertising leaders, and the responsibility being handed over to the new generation. The next CEO will need to review WPP's strategy.
The big question is whether the holding company is the right structure anymore and whether it can be turned into something that is nimble and agile in a reasonable timetable that is going to satisfy investors. There has been speculation about breaking up the group. Some have even claimed that separating the company's digital, advertising, market research and other assets could lead to a 40% rise in the share price. WPP has responded strongly that it doesn't believe that makes sense. Insiders at the company they feel need to get closer together, not further apart.
One way or another, advertising agencies needed to provide creative services and strategies for planning and buying media space, all reinforced by data insight, public relations and input on how a user shops and acts online. To improve their offering, the ad groups could start by being more transparent. Clients wanted to see more clearly how their money is spent.
The valuation of the company is at least interesting. The price-earnings ratio is 8 (the median is 16-17), EV/Ebit is 8.23, return on equity is 19.3% and net margin is 11.9%. Further, there is no reason to forget good 4.9% dividend yield combined to reasonable low (under 0.50) payout ratio. Based on the numbers, we can well say that the company is inexpensive but still highly profitable.
Sometimes, the market has already discounted the "worst case scenario" that may never materialize. Surely the company is facing some short-term pressure after the departure of Sorrell, negative growth in 2017 and weaker guidance for 2018. But don’t forget that WPP’s media and digital businesses are performing well and have good growth prospects. WPP still provides a powerful service, wrapping data analytics and insight with its creative work that helped clients navigate changing markets.
I do not think advertising agencies have the same fate as the brick-and-mortar retailers. It is hard to imagine that this will be end of the game for historically very profitable companies such as WPP, Omnicom, Publicis and Interpublic. Some will come out better than others, but WPP now has an excellent opportunity to be among the winners of the future.
Disclosure: No positions in the stocks mentioned in this article.
