On the heels of last February’s Omnicom downgrade, BMO Capital Markets analyst Dan Salmon this morning downgraded Publicis to “perform” from “outperform” and another influential Wall Street analyst -- Pivotal Research Group’s Brian Wieser -- issued downgrades for both those holding companies, as well as two others: Interpublic and WPP.
Wieser, who lowered Interpublic’s stock to a “hold” from a “buy” rating, and reduced Omnicom, Publicis and WPP to “sell” from “hold,” tied at least some of his downgrades to a controversial development in the ad industry: the growing awareness that many big agency holding companies make a significant amount of their profits from various media kickback schemes.
“Emerging concerns among marketers around different forms of agency rebates in the United States causes us to partially (if slightly) re-assess some of our views on long-term holding company growth,” he wrote in an equities research report to investors, adding: “With a drumbeat of negativity to come from marketers only now learning about the issue, we recommend investors move to sidelines or exit the sector for the time being.”
Wieser went on to point out that new revelations about the size and extent of agency media rebates -- a subject that gained significant traction at the Association of National Advertisers’ media conference, where former Madison Avenue media chief Jon Mandel turned whistleblower -- is significant enough to have tempered his long-term positive view on the advertising agency business.
“Behind our favorable long-term view on agencies over the years was the notion that fragmentation and reliance on digital advertising helps agencies -- especially those with heavy exposure to media trading -- given the reliance on labor required for digital media, and value-added services such as branded content production, barter and programmatic trading,” he wrote, adding: “However, we have reassessed our view in recent weeks with growing awareness of the topic of undisclosed agency rebates (aka “kickbacks”) in the United States.
“The volume and specificity of allegations by aggrieved media owners, former agency executives and marketers are difficult to ignore. Rightly or wrongly, there is a growing perception among marketers that agencies have been misleading, transferring value associated with media volumes without clients’ full understanding or support.”
Wieser implied that the real issue isn’t the nature of the rebate arrangements per se, but the fact that few marketers “fully understand the specific arrangements their agencies undertake with media owners.”
Among the big agency holding companies, he opined that WPP probably is “most immunized” from the problem, mainly because WPP’s management has been vocal and explicit about the non-transparency surrounding its business relationships with media suppliers.
In fact, WPP actually changed the accounting methods of its profitable unit Xaxis over the past year to reflect that it isn’t just buying media for clients, but takes possession of it and resells it.
Alluding to a famous position taken by GroupM Global CEO Irwin Gotlieb about being “transparent about being non-transparent,” Wieser wrote: “This is an appropriate position to take, even if under-paying clients don’t like to hear it.”
He characterized the fact that other agency holding companies have not made similar disclosures about rebates, spreads, margins and the overall lack of disclosure between their “gross revenue vs. revenues net of media trading” as “unfortunate,” and implied it puts them in especially vulnerable positions vis a vis their clients.
“How much of a haircut to growth might follow is subjective, not least as we don’t know the scale of revenues and cash flows at risk,” he continued, adding that the situation is serious enough to at least warrant a 0.5% reduction in the long-term growth of Madison Avenue’s Big 3: WPP, Omnicom and Publicis. He downgraded Interpublic’s long-term growth by 0.25%.“As marketers become more vocal about undisclosed rebates and more specific allegations come to light, a drumbeat of negativity will build around the sector over the course of this year,” he concluded, adding: “Given this risk, we’d recommend that investors move to the sidelines or exit the sector altogether while it all plays out.”