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IPG Turnaround Gains Traction

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NEW YORK Industry analysts interpreted Interpublic Group's better-than-anticipated 6.6 percent organic revenue growth for the second quarter as a sign that IPG's long-awaited turnaround has finally gained traction.

In fact, many analysts consequently raised their estimates of key financial performance measures such as earnings per share and revenue for the second half of 2007.

IPG's organic growth for the quarter was nearly on par with Omnicom Group's 7.4 percent and far outpaced Publicis Groupe's 0.5 percent.

Enthusiasm about the organic growth, however, was tempered by lingering skepticism about IPG's chances of delivering on its promise of posting a double-digit operating margin by the end of 2008.

Of the eight analysts who issued reports on IPG last week, none predicted that IPG would meet its goal. Analysts including Merrill Lynch's Karl Choi and Bank of America's Joe Arns are estimating margins in the range of 8 percent to 9.9 percent for all of 2008.

"As we do not believe IPG is capable of delivering above-average revenue growth, we continue to believe its 10 percent target is aggressive," wrote Choi, in a report.

Overall revenue growth of 8 percent in Q2 (compared to the same period last year) helped boost IPG's margin for the quarter to 8.8 percent (from 5 percent in Q2 2006).

The company's year-to-day margin through June, however, stood at a meager 0.7 percent. Nevertheless, CEO Michael Roth, during a Tuesday morning conference call with analysts, did not back off his 10 percent margin target, even though he acknowledged that it would be difficult to achieve.

"In spite of our strong performance this quarter," Roth said during the call, "the client shifts and losses we've discussed today [including General Motors' GMC and Buick and Johnson & Johnson's creative business] coupled with the dynamic change in our industry represent additional challenges we must overcome."

Those additional challenges, said Roth, include the "speed at which the digital component of the business is evolving," which "requires increased levels of investment in professional development and technology." So, the No. 3 holding company chief raised a warning flag even while sticking to his guns.

A Deutsche Bank analysis suggests that there's little precedence for such margin improvement in just 18 months. Deutsche Bank analyst Paul Ginocchio combed through margin data from Omnicom, WPP Group and IPG that dated back to 1990 and similar data from Publicis Groupe back to 2000 and found that a "good incremental margin [year on year] is about 25 percent," meaning that for each dollar of revenue a holding company gained, it turned an operating profit of 25 cents.

And to meet Wall Street's consensus estimate for IPG of a 9.3 margin for 2008—which falls short of IPG's 10 percent goal—the company would have to achieve an incremental margin of 60 percent this year and 65 percent in 2008, according to Ginocchio.

"We use this analysis as a sanity check," wrote Ginocchio. "Based on IPG's [first-half] results, it looks like a 60 percent incremental margin is achievable in 2007. For 2008, delivering that incremental margin, while possible, seems to us a low probability event."

Bear Stearns & Co.'s Alexia Quadrani also remains skeptical. Despite the second-quarter improvement, Quadrani kept her 2008 margin estimate at 9.2 percent and is not expecting IPG's revenue to grow at the same clip in the second half.

That said, Quadrani told Adweek that "even the biggest skeptic has to say this was a good quarter. It looks like they were operating generally on all cylinders."

"I don't necessarily see that they'll sustain it over the year," Quadrani added. "They're definitely making progress, but it's not going to be a smooth, straight-line process."

Roth acknowledged as much during the analysts' call. "We have said that our results and our progress would not be linear from quarter to quarter. Our performance for the first three months of the year, though unplanned, led some to draw unduly negative conclusions about our prospects," said Roth. "Similarly, we would caution you against using the second quarter's very strong results to extrapolate performance for the balance of the year."

A combination of existing clients like Microsoft spending more and new client revenue kicking in (from Wal-Mart and Saturn, for example) fueled IPG's positive results last week, which led to high volume trading that by Friday's close of the market had raised the share price by $1.41 from its opening price on Monday.

Timing was another key factor that helped IPG achieve $121.5 million in net income for the quarter, a nearly three-fold increase from the same period last year. Major losses in Q2, including creative duties on nine J&J brands and the two GM brands, occurred in late June. As such, the accounts are still amid their respective 90-day hand-off periods and their estimated collective revenue of $50 million won't dry up until October at the earliest.

That's also good news for the third quarter, although costs related to laying off staffers who worked on the accounts will mostly occur in the next three months, IPG CFO Frank Mergenthaler told analysts last week. (Mergenthaler did not estimate the severance costs.) Also, IPG cannot expect another significant tax reversal like the $80 million non-cash reversal the company recorded in Q2.

IPG's share price closed Friday at $11.27, down 3 percent for the day but up 14 percent from Monday's opening price of $9.86, according to Yahoo! Finance. Friday's trading volume exceeded 7.3 million, above IPG's three-month average volume of 5.6 million but down substantially from the Tuesday and Wednesday volume swells of 16.4 million and 11.2 million, respectively. IPG released its latest results last Tuesday morning.