The Ad Holding Company Credit Crunch

As the recession worsens, debt-rating companies have been downgrading advertising holding companies' stocks, giving investors a little more bad news to react to. But stock-market analysts are not the only ones worried about ad holding companies. Recently, Fitch lowered its rating of WPP to two notches higher than junk, citing general concerns about the ad industry; Moody's lowered its debt rating of Omnicom; and Standard & Poor's downgraded both Omnicom and IPG. Adweek asked two of S&P's credit analysts—Alyse Michaelson and Heather Goodchild—to put the news in perspective.Q. At this point, just how bad are the clouds hovering over the ad industry? AM. We think the revenue visibility remains limited, and it's still uncertain when a sustained recovery could take hold. We are fairly cautious of the short-term environment because of the soft economy and the conflict in Iraq. And while there could be some pent-up demand that's unleashed once some of these concerns are alleviated, it's going to be hard for any one ad-agency company to show trends that are massively more positive than the overall spending environment, unless they are winning business left and right or gaining a huge amount of share. And that's just hard to do. The effect of this war is going to push a sustained recovery out in time.So are these downgrades mostly about the recession or more about the finances of individual agencies?AM. Our downgrades of both Omnicom and Interpublic incorporated the uncertain economic and advertising environment, but there are also some company-specific concerns. [Omnicom's corporate credit rating is "A-minus," while IPG's is "BB-plus." There is a significant difference between the two—Omnicom is investment grade, while IPG is not.] At Interpublic, the downgrade had to do with the company's recent record of weak profitability and with some of its operating challenges. Given the turnaround required at a number of the company's business units, the cash-flow growth could be restrained. Our outlook for the company is negative. Not so with Omnicom, which we've given a stable outlook. There, the downgrade has to do with our increased concerns about the economic environment, which in this case amplify the risks related to the company's concentration of short-term debt equivalents.What makes this debt riskier right now?HG. The concerns we've had have been on Omnicom's financial structure, with a concentration of debt that could come due in a single year. [The company has two short-term notes—and while it just averted a put on its $850 million note, holders of the company's $900 million note could exercise their put option in July.] One of the risks with short-term debt is that you've got to be able to roll it over when it comes due, unless your earnings are sufficient to pay it off at that time. In general, if a company can meet its maturities out of current year cash flow, it gives us a great deal more comfort than if they are relying on continuous external financing availability, as was the case here. When the operating outlook is a little unstable, it is less appropriate for a company to have such a high concentration of near-term equivalents, given the instability of funding sources.The recession aside, what is your outlook for these companies?AM. For Omnicom, despite our downgrade, our outlook is stable. That reflects our view that despite the sluggish near-term outlook, the company is expected to maintain its organic growth and discretionary cash flow. On the flip side, our outlook for Interpublic is negative. That reflects our view that margins and cash flow could remain pressured because the company is at the start of a turnaround—in fact, it needs to turn around a number of its business units—against the backdrop of an uncertain economic and advertising market. We'd like margins to get back to where they were, the operating trends be a little more positive, not to mention seeing a little organic growth. And we'd need to see that for more than just one quarter before we'd be comfortable revising the outlook from negative to stable.How will the not-so-rosy debt environment affect the ability of these companies to grow through acquisitions, as they have done in the past?AM. Both have been fairly acquisitive, and Omnicom is likely to be equally acquisitive—we expect their investments in '03 to equal those in '02. They are going after targets that already do a lot of business with their agencies' core client base. Interpublic has spent considerably less, and we'd probably expect to see some declines in their investment strategy going forward as they spend those resources internally, trying to reverse those negative organic trends. —Sarah Mahoney

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The Ad Holding Company Credit Crunch

Sarah Mahoney

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Sarah Mahoney