Ad land is a reliable source of bust-ups. Barely a year goes by without one advertising executive (usually male, often wearing natty glasses) falling out with another. Sir Martin Sorrell’s bitter resignation from WPP (WPP) after an investigation into his conduct – and his decision to set up rival group S4 Capital (SFOR) – is a prime example.
The Saatchi brothers have had their fair share of quarrels too. After founding Saatchi & Saatchi in 1970, they were ousted from the company in 1995 after a shareholder rebellion. M&C Saatchi (SAA) was formed a few months later. However, an accounting blunder in 2019 prompted Lord Maurice Saatchi to abandon his namesake once again (his older brother, Charles, had already stepped back to focus on the world of art).
The shares have yet to recover from the 2019 scandal, which involved overstated revenues and understated costs. However, things are on the up – at least according to Richard Power, head of the quoted smaller companies team at Octopus Investments.
“It has got its mojo back,” he said. “But people are still looking in the rearview mirror.”
Back from the brink
Power takes a longer-term view than many fund managers. “We’re thinking about what a company can become – not necessarily in one or two years, but five or 10 years,” he said. Having first invested in M&C Saatchi in 2011, he is certainly used to a bit of turbulence.
“You can put a negative spin on almost any business at different points of the cycle, and there are a lot of challenges in the global economy at the moment. But we try to focus on the potential of a business.”
M&C Saatchi, he argued, has made a great deal of progress in the past 12 months – and has learnt from past mistakes. “Many fiefdoms and businesses have been created under the [M&C Saatchi] brand heading,” said Power. “And you had a business that was not overly efficient because of that. There were all sorts of trading subsidiaries. The accounting issues it went through in 2019 forced the business to have a hard look at itself and ask ‘how can we streamline this business? What efficiencies can come?’... It has reorganised its divisions, how it reports, how it thinks about itself.”
The group is now on a central cost-saving drive, and plans to rationalise its lease properties in London and reduce its audit and legal fees. Power stressed that staff cuts were not on the table, however. “They’re in growth mode,” he said.
Rapid growth is not something many investors associate with traditional ad land – not, at least, in the current climate. While Saatchi is arguably the most famous name in the industry, nippy tech companies are increasingly running rings around traditional players. Next 15 (NFG), for example, has invested heavily in its digital operations and has repurposed itself as a “growth consultancy”.
Power is adamant that M&C Saatchi is not part of a bygone age, however, but “something rather more modern and thrusting”. While advertising remains the revenue bedrock, according to management, 75 per cent of operating profit now comes from “growth specialisms” such as consulting, PR, data analytics and influencer management, which are higher-margin and less exposed to macro pressures.
In 2022, ad sales shrank by 4 per cent on a like-for-like basis and delivered an operating profit margin of just 9 per cent. By contrast, the specialisms reported an average operating margin of 24 per cent and organic sales growth of 14.4 per cent.
The new divisions are not infallible. The ‘media’ specialism, for example, which plans and buys media across digital channels, saw profits fall last year as a result of the tech sector downturn. They are nonetheless breathing fresh life into the company. By 2027, management expects these segments to represent 60 per cent of revenue (up from 55 per cent today) and to grow collectively at a compound annual growth rate (CAGR) of 10 per cent.
Advertising is likely to remain under pressure for the foreseeable future, despite some cheerier forecasts from the likes of WPP. However, M&C Saatchi has plans to improve profitability in the longer term, and has appointed its first 'global head of advertising network' to drive a more unified approach. Analysts at Numis expect ad sales to dip in 2023 and 2024, but think divisional profits will rise nonetheless.
There have been some encouraging client wins, including Diageo, Tinder, LVMH and PepsiCo. Power also suggested that companies are returning to old-school ad campaigns. “We’ve seen a lot of brands pivot back to more traditional, above-the-line advertising spend to increase wider brand awareness. It has held up much better than analysts were predicting.”
Bargain territory
M&C Saatchi’s valuation doesn't seem to have caught up with its improved outlook. The shares trade on just 8.7 times forward earnings, compared with a five-year average of 15.5. The multiple is not completely out of kilter with the rest of the sector, which has been battered in recent months, but analysis by Peel Hunt suggests that peers with worse prospects are trading on higher multiples.
It’s worth noting here that M&C Saatchi’s operating margin is slimmer than many of its rivals, and hostile takeover bids haven’t helped market sentiment either. In 2022, M&C Saatchi warded off competing offers from AdvancedADVT (AdVT) and Next 15, costing it an eye-watering £10.8mn in defence costs. This hurt its statutory profit before tax, which fell from £21.6mn to just £5.4mn.
“As shareholders in businesses with a long-term view, we’re not going to be supportive of opportunistic takeover bids that want to buy businesses out when their true potential isn’t being recognised,” said Power. “But it’s behind them.”
Looking ahead, M&C Saatchi is keen to embark on some of its own M&A. The group hasn’t made an acquisition since 2018, so this is largely uncharted territory, and its lack of track record is a valid concern. However, M&A is an obvious way to boost its tech capabilities. “The core high-growth areas of the business will be coming to the fore, and there will no doubt be bolt-on acquisitions to accelerate growth in those areas,” Power said.
The group has some sizeable lease liabilities, but it is churning out a good amount of cash. Last year, it generated net operating cash flow of £42.2mn, with cash conversion sitting at 99 per cent – and even after using £10mn to fight off Next 15 and AdvancedADVT it had £30mn of net cash in the bank at the end of December.
Financing acquisitions shouldn’t be a problem, therefore, and anything that's left can be returned to shareholders (management reinstated the dividend in April after a pandemic hiatus).
Charm offensive
M&C Saatchi’s ambitions are suitably headline-grabbing for a company that makes ad campaigns. At its capital markets day in February, it announced a net revenue target of £400mn for its 2027 financial year, and an operating profit target of £74mn. Net revenue reached just £271mn in 2022, while operating profit was £35.4mn.
Power is enthusiastic. “For the rating it’s on today, and the growth it’s likely to achieve over the next five years, have we got an investment that’s likely to achieve quite significant returns? Absolutely. And I say that acknowledging that we could well see some headwinds in the next 12 or 18 months. At the entry point today, the opportunity is substantial.”
Five years feels like a long time for a company with a history of volatility. However, the group is responding well to its new management team, and feels significantly better positioned than it did a few years ago. The market doesn’t seem to have clocked this, and despite its expertise in brand-building, M&C Saatchi is often still portrayed as outdated and slow moving. Things could be about to change.
