Publicis definitively brought the period of strategic uncertainty following the withdrawal of the Omincom merger to a close last week by announcing its largest ever acquisition, the $3.5 billion purchase of Sapient Corporation, a NASDAQ listed digital services provider.
This deal stands out amongst Publicis’ acquisition history for more than mere size; priced at over 20x historical EBITDA, more than double Publicis’ own valuation, and settled all cash, it is clear that this is not the routine operation of a consolidator consolidating.
The metrics say unambiguously that Publicis believe this transaction to be very significant to the future of their business; we agree, and think it says three important things about the marketing industry in general:
1. A digital generation is reaching maturity, driving consolidation
The generation of digital marketing services companies that has grown since the late ‘90s is reaching maturity; whilst still high revenue growth rates across the industry have been consistently declining for several years, and are forecast to slow further.
As this shift from a fluid, emerging segment to a mature part of the industry takes place, so the permanent scarcity of significant market positions becomes clear.
In an increasingly zero-sum environment, consolidators are then drawn to grab territory or risk being left out of what is still the fastest growing market segment. As Publicis articulated, this strategic imperative can outweigh the value-driven acquisition model generally followed by the consolidators.
At the same time, management teams and shareholders of the digital generation come to understand that the window of maximum value – balancing strategically-meaningful scale with growth fast enough to support a premium valuation – is relatively narrow, and are therefore open to approaches from strategic acquirers.
2. Pressure to consolidate will continue to act from the top down
With £40 billion in market value, the big four marketing services groups tower over the industry. Generally conservative financing and defensible, cash-generative core businesses give them ample firepower to take part in a land-grab in the digital segment. Their management teams and shareholders have strong incentives to invest to maintain growth and market share and, due to the synergies available within multi-national agency groups, the commercial rationale to support prices higher than any other acquirer could justify.
3. Organic growth drives value
The premium rating paid for Sapient – more than double Publicis’ valuation on every metric – illustrates the value of one characteristic above all; organic growth potential.
As table 2, below, illustrates on several headline metrics – revenue per capita, gross margin, revenue CAGR – it is not clear why Sapient is more than twice as good a business as Publicis.
The answer lies in Sapient’s ability to grow fast whilst making few acquisitions; to achieve its 9.3% revenue CAGR, Publicis had to spend more than half its operating cashflow on acquisitions, whilst Sapient spent less than 20% and still grew faster. This organic growth drives Sapient’s extraordinary returns on invested capital, its excellent cash generation, and its premium valuation.
So what does it all mean:
Aspiring vendors and consolidating acquirers alike can draw one conclusion above all from this: focus respectively on building and buying businesses that have the ability to consistently make themselves bigger.
There will continue to be strong appetite from strategic acquirers for digital marketing services businesses; both sides will find the market for strategically meaningful assets very interesting as the consolidation continues.
Notes to table 1
Source : Mergermarket, S&P Capital IQ, Livingstone Analysis
Notes to chart 1
Source : S&P Capital IQ, Livingstone Analysis
1) Non-annual reporting periods co-terminated
2) Future periods represent market consensus forecasts
Notes to table 2
Source : Company Accounts, Livingstone Analysis
1) KPIs calculated over the three most recent full financial years.
2) FCF conversion excludes financing cashflows.