Corporate activity reached a new pitch in September, but the City appears to be unconvinced by the motivation behind some of it. By David Forster
Last month, I commented on the almost frenzied level of acquisition activity that was taking place in the UK media sector, with 20 acquisitions announced in August alone. In fact, August turned out to be the warm-up act for September, with a further 23 acquisitions announced, of which WPP Group and Aegis Group accounted for seven. This represented an impressive feat of corporate concentration, given that Aegis is currently besieged on all sides by various parties, including WPP.
This buying spree is coming against the backdrop of an increasingly challenging trading environment, especially in some of the more consumer-facing sub-sectors of media. September (along with March) is the heart of what is known in the trade as “the results season”. With most companies operating to a financial year-end of December, September is the month when many quoted companies update their shareholders on first-half trading and second-half prospects. EMAP put out a trading update that was broadly symptomatic of the sentiment expressed by many media companies: “Having reached the half-way stage of the year in what is undoubtedly a tough environment, current trading indicates that the group remains on track to deliver results in line with its expectations.”
From a City perspective, “expectations” are normally focused on the delivery of a level of earnings per share, being the amount of profit after tax available to each ordinary shareholder. Meeting or beating “expectations” is key to a healthy share price and happy shareholders. There are various ways of meeting or beating expectations, which can be broadly summarised as growing revenues in line with or faster than the plan; growing costs in line with or more slowly than the plan; or making earnings-enhancing acquisitions. On balance, most media companies are struggling to meet the revenue-growth targets they posted at the beginning of the year. Some, such as GCap, which has recently announced an extra &£18m of “annualised gross merger synergies”, are compensating with additional cost-savings. However, there is growing evidence that acquisitions are increasingly the strategy of choice for companies needing to bridge the gap between “expectations” and the real performance of their businesses.
One of the attractions of a low interest-rate environment, such as the one we are in, is that almost any acquisition of a profitable business will prove earnings-enhancing, providing you have cash or a sufficient borrowing capacity. Put crudely, if you buy a company making profits of &£1m for &£10m cash, which you borrow at six per cent, you have just added &£400,000 to your profits – being the &£1m of profit you have just bought, less the &£600,000 of interest you have to pay on the borrowed money. In fact, you would have to pay &£17m for the &£1m of profit for the deal not to be enhancing to your short-term profits.
Needless to say, the above maths have little to do with how to evaluate an acquisition properly, but it does follow that if most media acquisitions are being done on profit multiples nearer ten times than 17 times (which they are), then there are an awful lot of earnings-enhancing acquisitions going on. All other things being equal, media company forecasts and expectations should be being raised. But they are not. In other words, many companies are relying on acquisitions to provide the growth their core businesses are failing to deliver. Of course, it is unfair to tar all media companies’ acquisition strategies with the same brush. There are some strong companies, whose core businesses are performing well and for which an acquisition strategy makes strategic and financial sense. However, for those that are relying on acquisitions to meet City expectations, the moment of truth will arrive when the means of financing acquisitions becomes exhausted and/or the true (poor) underlying performance of the group becomes apparent.
There are signs that the City is starting to take a more cautious view of the media sector’s prospects. As noted in previous articles, smaller, AIM-listed media stocks have made most of the running this year in terms of share prices, which is symptomatic of investors expecting media stocks to rise because smaller companies tend to outperform a rising market. However, in September, fully listed media stocks were unchanged – whereas AIM-listed media stocks gave up nearly half of their gains in the year to date, and fell on average by 5.2 per cent during the month. For the second month in a row, Aegis Group was one of the best-performing media shares, as it confirmed that it had received an indicative offer of 140p from Publicis. Meanwhile, Groupe BollorÃ© has continued its stake-building, while Havas has stated separately that it may participate in pursuing an offer. Omnicom has been conspicuous by its silence, especially as many industry insiders have seen it as the long-term favourite to acquire Aegis. The presence of Sir Martin Sorrell’s WPP Group as a contender, alongside private equity group Hellman & Friedman, is interesting, given that it is widely recognised that WPP’s media buying presence is already at EU regulatory limits. This implies that Hellman & Friedman believes it can afford to pay more for Aegis’ media buying assets than a trade buyer, with WPP presumably taking the market research businesses. It is difficult to assess how the battle for Aegis will play out, although it is worth noting that Sorrell has a lousy track record of coming second, even when he means to, as was the case with his bid for Tempus.
Profit warnings accounted for the falls of each of the worst three performing fully listed media companies. Sanctuary Group’s shares are now down over 86 per cent so far this year, suggesting that shareholders are questioning the company’s survival prospects. One of the consumer publishing sector’s most acquisitive groups, Future, announced that trading was below expectations, while IMD put out a further warning as it found the cost of getting into digital television advertising distribution against a strong incumbent more expensive than previously anticipated, while its core radio business continues to come under pressure. Dealgroupmedia was another company to issue a profit warning after it confirmed the loss of substantial revenues from one its largest and most profitable clients. The fall was exacerbated by the company’s hitherto aggressively bullish positioning, with subsequent director share-buying seeming to have little impact in terms of restoring confidence.v
The IBIS Capital Media Indices
IBIS Capital is a corporate finance advisory and investment business focused on the media sector. The IBIS Capital Media Indices are a set of proprietary analytical tools developed to monitor the UK media industry from the perspective of the share price performance of publicly listed companies.
The indices group companies with similar business models into sub-indices. Over time, significant variations in sub-sectors’ performances can be seen. The indices also include a split between media companies fully listed on the London Stock Exchange and those listed on the Alternative Investment Market (AIM). The junior market, with its less stringent listing requirements, has been enjoying a relative boom in investor interest, and many media companies have listed on it. However, fashions change, and when the AIM does suffer a setback, its lack of liquidity relative to the LSE means it is likely to underperform the senior market. The IBIS indices will highlight the relative performance of the two markets and may give an early indication of a change of direction.
As well as being of interest to those concerned with the performance of the UK’s media industry and its sub-sectors, the indices are useful to directors considering a flotation of their own company, or for anyone else considering the purchase or sale of a media company or shares.
The indices monitor all UK media companies listed on the London Stock Exchange and on the AIM with a market capitalisation over &£10m. Some companies are included that are listed overseas or have split listings.
The indices are based on the market capitalisation of each constituent company but, in common with the practices of other recognised stock market indices, they make various adjustments.
Factors taken into consideration in the compilation of the indices include: changes in the share prices and number of issued shares of the constituent companies and the number of shares in free float. The effect of initial public offerings, bringing new companies into the indices, and of mergers and acquisitions, which may take companies out of the indices or create new companies, are also considered.