In the ad sector, anticipating consolidation can be profitableTrue Opportunity

Why have ad-agency shares underperformed the stock market this year? Yes, the market has not set the world ablaze since the turn of the century, but:

• The ad companies are having a pretty good year.

• The outlook is for more of the same in 2001.

• The stocks were not outrageously valued at the outset.

This underperformance is made the more painful since the market itself—depending on what index is used to stand in for “the” market—is flat to down from its level of nine and a half months ago. With the exception of Cordiant, all of the major publicly traded mainstream ad-shop shares are down, some by 20 percent or more.

Part of the reason for the stocks’ poor showing may be investor fatigue. For a stodgy old business, the ad industry has been quite frolicsome over the past five years. For example: the IPO of Young & Rubicam (and now its proposed acquisition by WPP); the split up of the old Saatchi company (and the just completed acquisition of the Saatchi agency by Publicis); the reconstitution of Foote, Cone & Belding within True North; the advent of the interactive shops.

Through it all, only two companies remain largely as they were five years ago, and those, Interpublic and Omnicom, have materially outperformed the five-year market. Given the upheavals, on the one hand, and the relatively good long-term stock-price performance on the other, the stocks’ recent breather isn’t shocking.

Investors typically assess a company’s earnings prospects when judging a stock’s suitability. And the outlook for the ad sector remains pretty good. But there’s another approach toward profiting in the stock market—trying to anticipate which companies will be taken over. The drive toward consolidation in this industry is relentless.

An investor who took a stake in “old” Saatchi just before the split into “new” Saatchi and Cordiant would have profited handsomely on “new” Saatchi’s acquisition by Publicis. And it’s a fair speculation that Cordiant, whose stock has also done well, may yet wind up on some acquisitor’s dinner plate.

We saw an interesting reaction in the shares of True North when DaimlerChrysler announced it might award all its ad business—presently shared between Omnicom’s BBDO and True North’s FCB—to one of its main shops. Shares of both companies declined following the news, but True North fell out of bed and remained there.

Is there an opportunity here?

True North shares, until this latest news, were one of the sector’s best recent stock performers, a response to management’s success at ratcheting up profit margins toward the industry’s standard. The shares, now deflated, have the added attraction of being more acquirable by one of the industry’s consolidators (which probably has a competitive car account and would have lost the Chrysler business anyhow). Or, TN just might win the entire DaimlerChrysler account, or its sharpened management skills might regain investors’ admiration.

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