Advertising's 'big short'

WPP’s stock has been hammered in recent weeks—as have its competitors. Yes, there are likely failures in WPP’s overall strategy. Slowness to consolidate its brands and back-office operations, as well as its overall acquisition strategy, are known points of weakness. At the same time, it’s also true that media markets have changed fundamentally and many of their most important clients are under pressure from new competitors as well as activist investors.

As WPP goes, so goes the advertising industry. Nearly all advertising holding companies are facing similar challenges.

Our collective financial competitiveness is something we should consider as we reshape our business (or have our business reshaped for us).

Data from Bloomberg Markets, captured on 3/21/2018, shows the performance of some of our industry’s most influential holding companies: WPP in the United Kingdom (WPP:LN); Omnicom in the United States (OMC:US); Publicis in France (PUB:FP); and Dentsu in Japan (4324:JP). While WPP is lower than other holding groups on a percentage basis, declining 32.5% over a 12-month period, the sector trendline is unmistakable. Omnicom is down about about 14% and Publicis, perhaps because it started consolidating its brands and operations earlier than its competitors, is doing a little better at minus 8% or so. Dentsu’s stock is down 23% over the past year. The Japan side of the business can only take so much of the blame here, as the bulk of Dentsu’s revenues come from its international operations.

OK, this is an incomplete and simplistic analysis. Nevertheless it’s hard to argue that the numbers here are telling a positive story, especially considering that SPY, a S&P 500 tracking stock (SPY:US) is up a little over 15% over the same period of time. (The S&P 500 is a broad, multisector market index of large cap equities listed in the US.)

For a professional investor, short term financial weakness in our sector might indicate an opportunity to buy. So, let's take a look at the performance of these same equities over a five-year horizon to see if this downturn is a short-term issue rather than a long-term trend.

Judging from the data above, the financial weakness of these stocks doesn’t appear to be a short term phenomenon. Advertising agency holding company stocks performed poorly when compared to the broader equities market in the United States—and most other countries as well. A possible exception here is Dentsu which, while on-trend with its peers, lags Japan’s Nikkei 225 Index by only 14% and also about 14% when compared to the S&P 500 tracker stock SPY over the past five years. Note that Dentsu acquired Aegis in 2013 and Merkle in 2016.

According to the 14 March 2018 Financial Times (FT), hedge funds have “amassed bearish bets of more than US$3 billion against the world’s largest advertising companies”. Our industry’s financial weakness is no longer a family affair. Hedge funds and and other institutional investors have begun to notice that our fly is down.

The FT reports that hedge funds are shorting Omnicom’s stock to the tune of US$2.2 billion (about the value of 13% of total shares in the company). Interpublic has US$426 million bet against its stock. The bet against Publicis is €280 million. Short sellers realised significant gains on WPP’s recent downturn—betting £920 million against the stock and exacerbated the their stock’s volatility. 

From a more sanguine point of view, short sellers are disruptive, but they are likely a net positive over the long run. They will force holding companies to root out inefficiencies, change growth strategies, and improve their boards and overall corporate governance. If you’re rolling your eyes when your parent company acquires yet another “best-in-class marketing company,” rest assured, so are many of their investors.

There’s an inexplicable recalcitrance among many senior agency leaders to double down on on developing in disciplines where they can, at best, patch together “me too” propositions rather than invest in fundamentally new and differentiated revenue streams. For example, in your heart-of-hearts, do you think that agencies trying to compete with management and design consultancies is a realistic path to bolster their balance sheets? Put another way, would you bet your retirement savings on their long term financial success?

Short sellers and activist investors shouldn’t be seen as interlopers. They will likely play a forceful and important role in facilitating the evolution advertising companies. Even if their motivations are not altruistic, they’re not ideological either. They will stop betting against your company’s stock when they are convinced that it’s on a sustainable growth path. Activist investors won’t cause problems for your company’s board of directors if internal governance and company strategy improves.

As with any period of major disruption, for the strongest amongst us, it’s a time of opportunity. Smaller, privately held agencies—if they can figure out how to work at-scale—may have more opportunities to compete with the majors as they will not be subject to the pressures of shareholder returns. (Note: the new competitors, management consultancies, are primarily structured as private partnerships rather than public companies to maintain greater control over their own destinies.)

Forgive the pun, but take stock. If you like your job and, are objectively good at it, you’ll be fine. Even if your agency is under pressure, demand for advertising agencies is not going to disappear anytime soon. You’ll be more in demand than ever if you stay the course.

If you’re concerned about your ability to survive the changes ahead, a solid strategy is to get better at what you do now and invest in yourself. Take a class. Read. If you’re a supervisor, upgrade your craft skills.

It’s possible that the age of the agency holding company dinosaurs may be ending as we know it. Not tomorrow. But in the foreseeable future. The meteorites that ultimately force us to change may well be professional investors who seek to exploit our weakness and profit from our recovery. If this is the case, it may be good for your career in advertising and, yes, for the holding companies themselves. Dinosaurs are capable of evolving into birds.

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Barry Lustig is managing partner of Cormorant Group, a Tokyo-based business and executive search strategy consultancy.