WPP’s valuation destiny to be determined in US

I was told the other day that if you own a marketing-services company, you had better sell it by next March. I’m not sure what the significance of March is – the ides, perhaps – but the drift seems to be that economies will go pear-shaped in the second quarter of next year.

If this turns out to be an accurate prognosis, then a widely predicted May general election will be an interesting affair. It should also make for some demanding planning in the boardrooms of the likes of Omnicom, IPG, WPP and Cordiant ahead of the final quarter of this year. Before we disappear with our buckets and spades for August, it’s an idea to review the prospects of our very own WPP which, as the largest advertising group in the world following the Young & Rubicam (Y&R) acquisition, might be considered something of a bellwether.

The WPP/Y&R deal struck in May wasn’t short of melodrama. There was, for a start, WPP chief executive Sir Martin Sorrell’s brinkmanship when Y&R’s proposed golden parachutes went down like a lead balloon and he walked away from the deal. And there was the arbitrage in New York between the WPP and Y&R share prices that deflated the former’s market valuation – subsequent to the deal, WPP hit a low of 769p, against a high this year of 1323.5p.

WPP’s shares were trading in London early this week at about 955p. This represents some recovery from the clutches of the arbitrageurs in the spring, but promises further improvement come the autumn, when the Y&R offer formally closes.

At that stage, probably sometime in October, WPP will jump from a market-capitalisation ranking in the early 40s of the FTSE 100 index into the top 30. With the pre-dominance of index-trackers among institutional investors, that should trigger a good deal of re-weighting among the major fund managers in WPP stock.

Of the top 30 UK institutions, about two-thirds will find themselves underweight in WPP stock. The likes of the Prudential, which doesn’t appear to own any shares in WPP, Schroder and MAM can be expected to be buyers at that stage, pushing WPP’s share price well past the &£10 mark again.

But the UK institutional picture is only part of the story – it’s in the US that the valuation destiny of WPP is to be divined. And it represents a parable for our stock-market times, telling us all we need to know about how supine and conservative the London Stock Exchange has grown in the shadow of New York.

There are some 150 US institutions invested in Omnicom and IPG that don’t hold stakes in WPP or Y&R. Of that 150, about 100 are able to hold foreign-listed paper. It becomes clear that a priority task for WPP and its advisers over the next couple of months – when Americans are less likely to be on the beach than their European counterparts – is to convince these institutions that WPP represents better or at least as good value as Omnicom or IPG.

Omnicom is reckoned, on both sides of the Atlantic, to be a well-run company. IPG is less well regarded and WPP must have an opportunity to make a competitive case to IPG’s shareholders. If nothing else, relative share-price performance over the past 18 months would appear to support this view. IPG’s shares have risen 45 per cent; Omnicom is up 75 per cent, while WPP has turned in an increase of 180 per cent.

Now, UK institutions rate this market by the performance of Cordiant, the old Saatchi empire, and WPP. The US reference points historically are IPG and Omnicom. But WPP now finds itself 40 to 45 per cent owned by Americans, a high proportion for a FTSE company. WPP’s acquisitions, J Walter Thompson, Ogilvy & Mather and now Y&R, were all quoted US companies in their own right. It follows that the Americans are better disposed to buy this story – that WPP is an attractive alternative to IPG – than are the British.

The implication of this for the UK markets is rather depressing. It means that British companies – or British enterprises that have gone global – are pushed up the UK valuation scale by American investors, whereupon the dozy old London stock market catches on and buys in at an inflated price.

It happened with Cadbury-Schweppes, which used to rank about 70th in the FTSE index. US buyers pushed it up to the top 30, UK institutions found themselves caught short and bought stock only belatedly. Little wonder the London market has garnered such a reputation recently for being inert and conservative, full of index-trackers (for which read trackers of US investment) and weak on developing value models.

At its most worrying, it means that the best of UK industry will be bought by the US. The US capital markets are bigger and more efficient, share-prices are generally higher so p/e ratios are lower, as is the average cost of capital. And WPP’s share price will most likely be an exemplar of this syndrome over coming months.

The telling moment, of course, will be when the heralded correction comes in US equities. Then value-investors will come into their own again, as will the qualities of managements. That should separate the wheat from the chaff – not to mention WPP and Omnicom from IPG and Cordiant.

George Pitcher is a partner of issue management consultancy Luther Pendragon