|Shares Out. (in M):||1,244||P/E||11.2||10.7|
|Market Cap (in $M):||17,185||P/FCF||11.2||10.7|
|Net Debt (in $M):||4,670||EBIT||2,307||2,402|
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WPP PLC Investment Thesis
CY18 P/E of 10.7x (around its 10-year low) implies little-to-no growth despite the fact that agencies have historically exhibited organic, GDP type growth similar to that of their clients
Applying a 13.5x P/E (average forward P/E multiple over the last 10 years) to 2020E EPS of £1.45 plus dividends equates to £21-22 or a total return of nearly 60% over the next 2-3 years
Dividend yield of 4% and strong balance sheet
Ad spending at FMCG companies (~30% of WPP’s revenue) could begin to accelerate after a period of cost cuts, AT&T account loss lapse [TM1] in Q4’17 and Walgreens account win is additive beginning Q4’17
Highest exposure to emerging markets of the large advertising firms coupled with scale advantage in media buying should allow for growth above the industry avg. over the long-term
Shareholder friendly management: 50% pay-out ratio (4% dividend yield) plus another 2%-3% via share buybacks while still providing management capital to properly reinvest in the business and make sensible strategic, tuck-in acquisitions
WPP PLC is the largest global advertising company in the world by revenue (£14.4B) with ~31% market share. The company helps its advertising clients with their creative strategy, ad production, media buying and marketing services.
WPP is a strategic holding company with corporate offices in London, New York, Hong Kong, Singapore, and San Paulo. These offices develop the financial strategy of the company and complement the operating companies by encouraging collaboration across disciplines for the benefit of clients and relieving the operating companies of time-consuming administrative work such as strategic planning, budgeting, reporting, treasury, tax, legal, etc. (Source: 10-K)
WPP organizes its business into four segments: Advertising and Media, Branding & Identity Healthcare, Consumer Insights and Public Relations. Geographically, WPP is the most diversified of the big four advertising firms and has the most exposure to emerging markets (and the least to North America as a percentage of revenues). In 2016, ~37% of the its revenue came from North America, ~20% Europe, ~13% UK and ~30% rest of world.
Advertising & Media Investment Management (46% of revenues, 48% of EBIT, 16% op. margin): revenue comes from commissions on media placements and fees for advertising services. Delivers the highest margin of the WPP group and has the highest like-for-like sales growth. Key businesses on the advertising side are Ogilvy, Y&R and Grey. On the Media Investment Management side, key businesses are Mediacom, Xaxis and Mindshare.
Branding & Identity, Healthcare, Specialist Communications (27% of Revenues, 28% of EBIT, 15% op. margin): revenue stems from retainer fees and company-by-company agreements. This segment includes WPP Digital, which provides services in mobile, commerce, data and tech, content development and social media marketing. Healthcare and Specialist Communications have recently weighed on growth.
Consumer Insights (19% of Revenues, 16% of EBIT, 13% op. margin): focuses on generating market research and consumer insights through data collection and analysis. Key brands include Kantar, TNS, Millward Brown and comScore. This division has both syndicated and custom research. Custom research (50% of segment sales) has been slowing due to zero-based budgeting from WPP’s clients. WPP’s measurement capabilities (Kantar and comScore) differentiate WPP from its competitors.
Public Relations (8% of Revenues, 8% of EBIT, 16% op. margin): revenue generated from retainer fees and company-by-company agreements. Key brands include Finsbury Buchanan, Burson-Marsteller and Hill & Knowlton.
WPP’s Role in the Ad Campaign Planning Process
There are three major steps in the ad campaign planning process: (1) creative advertising, (2) ad production, (3) media buying.
Ideally, WPP would like to provide all of these services to each of its clients. However, in practice, this does not always happen. Large advertisers (i.e. the P&G’s of the world) might break up their ad spend across agencies. For instance, one division of P&G might retain WPP exclusively to execute an ad campaign from start to finish, while a different division of P&G might use one of WPP’s competitors. As the largest player in the industry with the most services, WPP has the ability to take market share over time by deepening client relationships.
Creative Advertising: the client lead has the responsibility of sourcing internal (or in some cases third-party talent) to develop the idea (or creative message) that will drive his/her client’s campaign. As a result, the account manager contacts a number of his operating companies that focus on idea generation, which creates some internal friction. One of the account manager’s jobs is to manage this friction.
Imagine a situation where all of these creative agencies reach out to the account manager’s client directly to “pitch” their expertise. This would make WPP look unprofessional. This is one example of why “horizontality” has become an important focus for WPP. Management consulting firms have recently been moving into this stage in the advertising process. Since consulting firms already have access to a corporation’s top executives, cross-selling corporate strategy advice with marketing advice has grown in prominence.
Deloitte, Accenture, and IBM are the largest consulting players. Consultants are not full-service providers. As a result, consultants can be competitively disadvantaged when competing against large agencies since corporate marketing departments, who are often resource constrained, hire large agencies for the cost advantages associated with full-service providers. Having said that, the rising influence of consultants has been a squeeze (in terms of revenue, efficiency, etc.) on the industry.
Ad Production: designing the advertisement and deciding whether it will run on traditional mediums (TV/print/radio) or digital platforms (social media, websites and e-commerce). About 70% of global advertising expenditures currently take place offline. Over time, digital is expected to make up over 50% of all advertising expenditures. Currently, 39% of WPP’s revenue comes from new media and the company would like to increase this to 42.5% by 2020.
In traditional media, ~75% of the client’s total ad spend is paid to the publisher, ~15% is paid to producers (videographers, photographers, etc.), with the remaining ~10% collected by the ad agency as compensation for its services. The transition from traditional forms of media to digital will save advertisers money in the ad production stage. These savings could be reallocated to optimize the campaign (in the media buying stage), which would be good for ad agencies.
Alternatively, advertisers could simply just save the delta (from using digital vs. traditional mediums). This could lead to media price deflation, an obvious negative for agencies. Advertisers will likely choose to optimize the campaign. CMOs want to be in charge of large advertising budgets. Choosing to save the money would make it harder for CMOs to request ad budget increases in the future.
Through their media plans, agencies add value by providing relatively unbiased advice to CMOs in terms of how they should allocate their advertising dollars across mediums. However, because 70% of advertising remains offline, it is worth noting that agencies likely continue to be slightly biased toward suggesting production for offline mediums. The reason is that as a greater proportion of global advertising dollars are allocated to digital, less advertising dollars will be allocated to linear TV.
Ad agencies have very strong relationships with TV publishers. Digital disruption will diminish the value of these relationships. Consequently, media owners like Facebook and Google will gain more power. Nevertheless, agencies would still be able to provide more independence than Facebook and Google in terms of where advertising dollars should be spent. If Facebook and Google were serious about entering the ad planning business, it is not difficult to see how their advice might be (and likely seen as) biased toward their own platforms. The importance of independence cannot be overstated, which is why the disintermediation and price deflation concerns may be overblown.
Media Buying: This is the most profitable segment for agencies (~16% op. margin). Unlike most of the creative and ad production agencies that do not exhibit much operating leverage (all people based), in media buying, scale improves margin. The largest players in terms of media buying market share are WPP (35%), Publicis (19%), Dentsu (16%), Omnicom (13%), IPG (11%) and Havas (6%). The main advantage of using agencies for media buying is that agencies purchase in bulk from publishers and receive discounts in return.
In 2015, several agencies were accused of keeping rebates that were contractually supposed to go the client (though the terms of each agency/advertiser contract differ with respect to rebates). Before the 2015 investigations took place, most contracts were structured to disallow advertisers from auditing agencies from the operating level to the holding group level. For the most part, the rebate issue was U.S. centric (because programmatic trading is more prominent in the U.S. and the terms of programmatic trading can sometimes be opaque). In 2015, over $20B of accounts across agencies were audited. In several cases, the results of the audits led major advertisers to switch their providers. WPP and Omnicom were the primary beneficiaries. The audits also led to redrafting of contracts. In situations where redrafting occurred, advertisers often sought the right to audit their ad agency all the way up to the holding company level.
Within media buying, WPP’s core functions are to:
WPP has a structural advantage in media buying vs. other agencies. One of the reasons WPP’s CEO is regarded so highly is that he saw the move to programmatic coming before others and invested in it heavily. By virtue of this investment, WPP has the largest media-planning arm and most data compared to its competitors.
Agencies collect information about customers’ browsing habits off their clients’ websites. They use this information to deliver targeted advertisements on digital platforms. By personalizing advertisements, WPP is able to deliver useful content to consumers. Because consumers perceive the advertisement as useful content rather than an annoyance, WPP’s clients are able to improve their return on investment.
WPP is the incumbent when it comes to media buying because it has more data than the other large ad agencies. Bears will point out that GOOG/FB likely have better consumer data than WPP (and can therefore better segment audiences, deliver content that is more relevant and potentially bypass WPP by working with WPP’s clients directly). The counterargument is GOOG/FB are less likely to aggressively attempt to disintermediate WPP because it could strain their relationship with WPP, who allocates over $5B/$2B in annual ad spend to their respective platforms. Even if GOOG/FB were to pursue media buying more aggressively, issues around transparency and performance measurement would remain. For instance, FB has previously had some issues with miscalculating viewership metrics. The bottom line is that WPP is an independent third party.
Corporate Strategy: WPP’s Four Strategic Priorities (2016 10-K)
Advance the practice of “horizontality” (connected know-how) by ensuring its people work together for the maximum benefit of clients: through cross-Group Communities and Practices, Global Client Teams, and Regional, Sub-Regional and Country Managers. The two horizontals are account leaders and regional leaders.
Account leaders example: 48 account teams covering one-third of company-wide revenue equal to about 40,000 people working on those accounts across 113 countries
Currently 19 country and regional managers and their role is to focus on people—making sure that WPP has the best people in each country
Increase the combined geographic share of revenues from the faster-growing markets of APAC, LatAm, Africa and the Middle East to 40%-45% of revenues (from ~30% in 2016)
Increase digital portion of revenue from 39% (in 2016) to 40%-45%
WPP has a complex operating structure. Hundreds of agencies sit underneath the holding company. These agencies typically have very specific areas of expertise (creative ad planning, ad production, ad buying, etc.). It is the responsibility of each client lead to find the best resources within the agency to complete a given client project. This can be challenging for the client lead given the breadth and depth of WPP’s offerings. WPP is now investing in internal resources to help client leads find these resources more efficiently. The company refers to this initiative as “horizontality”.
WPP’s competitors are also investing in similar initiatives. Cost pressures at WPP’s clients gave rise to horizontality. Large advertisers (particularly those within the fast-moving package goods industries) are under pressure from investors to show earnings growth. Because these companies are experiencing difficulty growing their top lines they have been cutting costs to meet earnings expectations.
One of the costs companies have been very focused on is advertising. This has hurt WPP since its clients are reducing ad spend, but demanding that their ad dollars go further (example: P&G slashing ad budget from $2.0B to $1.4B). Consequently, WPP has been forced to become more efficient, which has driven increased investment. Eventually ad spending at FMCG companies should rebound as managers shift their focus from driving internal cost efficiencies to driving growth.
Long-term, it is tough to know if WPP will execute better than its competitors with respect to its horizontality initiative. However, a few factors provide confidence in WPP’s ability to execute. First, WPP’s Founder/CEO (Martin Sorrell) has successfully guided WPP through industry transitions before and has significant ownership in the company. Second, WPP has the balance sheet and resources to execute. Lastly, as the largest agency with the most services, WPP should be able to improve cross selling and deepen client relationships as client leads collaborate more efficiently across WPP’s agencies.
The largest global advertisement agency with 31% market share
Leading position in media buying (programmatic trading and data analytics) with 35% market share. This helps WPP maintain its industry leading margin position.
Broadly diversified across business type and geography with highest exposure to emerging markets ~30% vs. peers ~18%
Strong management team, particularly Martin Sorrell (Founder/CEO) who owns ~1.5% of the shares outstanding equal to ~$350M
EM exposure near-term: the pace of ad spend in developing markets has recently been outpacing that of emerging markets
Martin Sorrell (Founder/CEO) is nearing retirement age (72) and he has driven the company’s success over the last 30+ years
Management wants to improve EBITA margins by ~30bps per year to its 2020 target of 19.7%, which would include 1% from IT and efficiency savings. Consensus assumes ~18% by 2020.
WPP’s large data sets and technology should allow it to tap into sales and distribution budgets (~$24B market)
Deepen client relationships through horizontality
Threats to WPP
Growth of new media: digital as a proportion of global ad spend has grown from 3% in 2001 to 30% by year-end 2015. Digital is expected to grow to 40% by 2020. Consultants and GOOG/FB are more competitive in digital than in traditional media
Convergence of consulting, tech, IT, and advertising has created a more competitive environment. Strategy consultants continue to take share in digital marketing (~30% currently vs. <5% six years ago)
Google’s / Facebook’s scale, control of data, and place in parts of the value chain such (ad networks, DSP and SSP)
Fee pressure from procurement departments is high
Correlation with clients marketing budgets: during the last recession the P/E ratio fell to the high single digits
Financial Targets/Incentive Metrics for Management Compensation (2017-2021)
EPS 7-14% annual compound growth
ROE: 15-18% annual avg.
Relative TSR: median to upper decile
Important Disclaimer: This report does not constitute a recommendation to buy or sell the security discussed herein. The report is an example of the author’s company write-ups / research process; its breadth and coverage may differ materially from other such reports. Certain statements reflect the opinions of the author as of the date written, are forward-looking and/or based on current expectations, projections, and/or information currently available. The author cannot assure future results and disclaims any obligation to update or alter any statistical data and/or references thereto, as well as any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements/information may not be accurate over the long-term. The views are those of the author acting in his individual capacity and not as a representative of any firm; in no way does this report constitute investment advice on behalf of any firm.
Nothing specific aside from being a good value. Time is the friend of a good business (that can continue to grow) at a cheap valuation.
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