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Comparing an established player and an upstart in the global advertising market
Thursday 09 Sep 2021 Author: Mark Gardner

The former chief executive and founder of advertising giant WPP (WPP) Martin Sorrell has pursued a ruthless growth strategy with his new digital marketing upstart S4 Capital (SFOR), which he heads up as executive chairman.

 His departure from WPP was mired in acrimony but Sorrell has moved on fast with the strategy for S4 predicated upon the premise that embracing the transition to digital advertising is critical to success.

In 2018, when S4 Capital was founded, digital advertising accounted for 45% of total global advertising expenditure. Sorrell has publicly stated that this share should grow to approximately 55% by 2022.

Being a relatively newly formed entity, S4 Capital has a distinct advantage over its peer group with programmatic advertising (the automation of buying and selling digital advertising space) working symbiotically with the creative department. S4’s rapid growth has been contingent upon a rapid series of acquisitions.

S4’S STUNNING SUCCESS

Since its inception S4 Capital has acquired 24 companies, and industry observers believe that future acquisitions are likely in both Asia and North America. The success of Sorrell’s strategic approach has been reflected in the share price that has risen from 164p in April 2020 to 829.6p.

This equates to a 405% increase and a corresponding market value of £4.55 billion, an impressive feat for a company that was only listed on the London Stock Exchange in October 2018.

The phenomenal success of Sorrell’s new company contrasts with the difficulties encountered by WPP, the advertising agency where Sorrell was CEO for more than three decades until April 2018 when he departed following allegations of personal misconduct and misuse of company assets. Sorrell has strenuously denied these allegations.

WPP’s share price peaked at nearly £19 in early January 2017, falling to a level of 568p in early June 2020, before recovering to its current level of 999.8p, helped by a recovery in advertising activity.

Arguably the marked disconnect in the share price performance of the two advertising companies is indicative of S4’s ability and WPP’s struggle to embrace the shift to an increasingly digitally orientated world.

Moving forward the key question is will WPP be able to close the digital divide with its rival, S4?

DIFFERENTIATED APPROACH

As early as 2017 when Sorrell was at WPP he recognised that digital disruption was forcing companies to change their business models and reach customers in different ways.

This observation formed the central tenet in the philosophy behind the creation of S4 Capital in 2018 and the associated pivotal acquisitions of Media Monks in July 2018 (a creative digital production company) for $350 million, followed five months later by the acquisition of San-Francisco based consultancy MightyHive, a specialist in programmatic advertising, for $150 million.

These two acquisitions enabled S4 to offer full service digital marketing from creative work to media planning and buying campaign advertising space.

2019 was an important year for S4 and acquisitions played a critical role in expanding the group’s scale and scope. These included Media Monks’ purchase of Caramel Pictures, whose clients included Heineken and KFC alongside consumer goods companies such as Coca-Cola, Nestle and Unilever (ULVR).

CEMENTING RELATIONSHIPS WITH BIG TECH

A desire to foster deeper relationships with Google, Facebook, Amazon, Adobe and other companies within the technology sector (which accounts for just under 50% of S4 Capital’s revenues) has been the motivating factor behind several of S4’s acquisitions, capitalising on existing relationships between the targets and the big tech clients.

HOW S4 SNARES ITS TARGETS

The success of S4 Capital’s acquisition strategy has been linked to the remuneration structure available to the owners of companies acquired by the group.

Rather than offering the usual earn-out model (a contingent payment that the seller only receives from the buyer when specific performance targets are met), S4 Capital offers a cash and equity model, albeit with time locks.

This enables S4 Capital to immediately integrate the acquired entities. Conversely, the vendors receive a cash element upfront and in accepting equity in S4 Capital, are also able to participate in the future success of the combined entity.

CAN WPP CLOSE THE DIGITAL DIVIDE?

Arguably WPP’s larger size and associated sprawling and disparate culture may have contributed to its inability to fully embrace the rapid transition to digital.

To redress this digital divide, WPP has this year pursued two separate strategic initiatives. The first has involved some relatively modest acquisitions.

In March, WPP acquired NN4M, a mobile commerce platform for global brands. The group partners with names including Wetherspoon, River Island, Nestle and Selfridges to create mobile solutions.

In August, WPP announced the acquisition of artificial intelligence specialist Satalia. While the numbers surrounding the deal were kept under wraps, it has been suggested that WPP paid £75 million.

Satalia is a fast growing UK technology company and uses machine learning tools to help firms to enhance their efficiency.

The firms’ algorithms can determine how to optimise schedules and allocate tasks. The deal is aligned with WPP’s strategy of expanding into the growth areas of commerce and technology.

NEW DATA COMPANY CHOREOGRAPH

The second move WPP has pursued has involved the creation of Choreograph, which is focused on helping brands activate new customer experiences by turning data into intelligence.

Choreograph combines the first party data management capabilities of two of its existing business: Wunderman Thompson (part creative agency, part consultancy and part technology company) and advertising technology platform Group M, which enjoys first party data insights, which is the information collected directly from audiences or customers.

MARKET REACTION

S4 Capital has since its inception in 2018 advocated a ‘holy trinity’ model of first party data, digital content and programmatic advertising.  The rationale for the creation of WPP’s Choreograph looks similar but it is obviously trailing in S4’s wake given the latter’s first mover advantage.

 The share price reaction to the news that WPP had acquired artificial intelligence specialist Satalia was decidedly muted. This may be indicative of the sub-scale and unfocused nature of WPP’s recent acquisitions.

EARNINGS TRAJECTORY AND VALUATION

The table in this article outlines several key insights with respects to WPP. First, the forecasts for both organic and reported growth in 2022 and 2023 are relatively pedestrian, with the former rising to 3% in 2022 before marginally declining to 2.8% in 2023.

Second, the forecasts don’t anticipate acquisitions acting as a meaningful catalyst for growth.

However, on a more positive note forecasts for both earnings and dividend growth are relatively robust with earnings growth of 15.6% in 2022 and 11.6% in 2023, driven by margin improvements, and dividend growth of 17% in 2022 and 10% in 2023.

Trading on a forward enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) ratio of 7.4, WPP is significantly cheaper than S4 Capital which trades on an EV/EBITDA of 35.7. Unlike S4, WPP also pays a healthy dividend.

Prospective investors need to determine if they prefer the more prosaic but reasonably valued WPP or are willing to pay up for the promise of more significant growth at S4.

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