Joy In Splitsville

Two weeks before Cordiant PLC’s extraordinary general meeting in London to split itself up. The top brass of its two main agencies, Saatchi & Saatchi Worldwide and Bates Worldwide, are jetting between New York and London, courting current and potential investors. Meanwhile, David Herro has arrived in New York on a brilliant autumn week to combine a little business with pleasure. The Midwest mutual fund manager will see a client while surprising his mother, who’s taking her first visit to the city. As Bates management put on their dog-and-pony show in highrise offices, Herro is hoofing it over to Broadway with his mother to see a performance of-what else?-Chicago.
Like many big Cordiant shareholders, Herro seems nonplussed by the upcoming meeting. He’s witnessed more than enough revenge drama and bloody infighting from the company in the past; on this visit, he intends to keep any theatrics on stage. By the time of the demerger meeting, he’ll be off visiting investment prospects in Asia. Most of the major Cordiant investors will skip the meeting as well, having sent in their proxies to approve the breakup weeks ago.
There is one point Herro is insistent on, however. Going forward, the new agencies must perform. He’s waited five years now through promises of improvement, rengineering and restructuring (see story, page 42). As one of the early boosters of a Cordiant turnaround, he wants the blunders of the past finally behind the agencies. “I can’t decide which was more asinine: putting Saatchi & Saatchi with Bates or Bates with Backer & Spielvogel. These were all combinations made irrespective of clients or corporate cultures,” fumes Herro. “The way this holding company was created is one of the greatest examples of corporate stupidity I’ve ever seen. In this demerger, we’re finally saying these are companies that never belonged together in the first place.”
So the flagships, Saatchi & Saatchi and Bates, will be sailing under their power again. In the 1980s, they became the manifestation of the Saatchi brothers’ vision of world marketing dominance and No. 1 stature. Now the two agencies, which have slipped out of the ranks of the ten largest global networks, enter a new life with ambition measured in simple increments and modest benchmarks. Their success, at the outset, will be determined by their ability to lift margins, revenue growth and earnings to the level of the rest of the ad industry.
For the spinoffs, the elimination of a joint holding company promises new shareholder scrutiny and pressures. If anything, Cordiant PLC at times offered a convenient scapegoat for lackluster performance at the networks. Saatchi & Saatchi blamed negative publicity at its namesake parent for hurting new business activities. Bates grumbled about its Saatchi sibling’s ties to Procter & Gamble as an impediment to bringing in accounts from P&G competitors. Both complained the holding company’s oft-crippled finances and weak share price blunted growth and acquisitions.
Those barriers, whether real or imagined, will now be gone. Herro voices support for each of the new companies and their executives, but warns there are limits: “For the first time ever, these businesses are being run as proper, professional companies. We want them to succeed. We’re patient investors, but we’re intolerant of incompetence.”
The first test of that patience may come sooner than expected if bidders emerge for Saatchi or, as many analysts and agency executives predict, Cordiant Communications Group, which will be the parent company for Bates. Saatchi has some protection with its P&G ties. The packaged-goods giant would have to bless any transaction, and its strict conflict guidelines eliminate a lot of potential acquirers. CCG, on the other hand, the owner of a much-coveted agency base in the Asia Pacific region, is widely thought to be a takeover target. WPP Group, True North Communications and Publicis are said to be interested in all or part of the Bates network. “When trading begins, we’ll look at how the market values CCG,” says one agency chief executive. “If the share premium is too high, we won’t look at it. But if it’s reasonable, we’ll take a look at it.”
Golden parachutes in the new management contracts suggest that any hostile takeover could be expensive. Ten top managers-six at Bates, four at Saatchi-have employment clauses and phantom stock that could be worth as much as $20 million if exercised. The clauses carry so-called double-trigger terms, meaning they are activated when an agency not only changes hands but its executives are fired. “These are very defensive clauses for companies going into higher-risk situations,” claims a rival agency executive who has reviewed the Cordiant demerger prospectus.
Cordiant chairman Charles Scott, who initially will serve as co-chairman of both companies, brushes aside the takeover speculation. “Since I joined this company in 1990, those rumors have been around and Bates is still here,” he says. “Bates is a strong international organization. It always has been and that in some ways makes it different from most other companies. Your typical U.S. global advertising company is strong in the U.S. and tends to be not so strong as you move east. Bates is strong in other parts of the world and not so strong in America. You don’t have to be a rocket scientist to figure out it could be a good fit for some of those other companies. Having said that, we’ve set up CCG to work well as an ongoing independent concern.”
Others at Bates are more outspoken about their desire to remain independent. Bill Whitehead, ceo of Bates North America, has heard all the chatter about his agency’s prospects and the betting that it will be sold. “Dogs are always looking for hydrants,” he says. “In this business, people find the closest hydrant they have in order to relieve themselves.”
For his part, Scott insists he also will stay on board well after the demerger. After his year as co-chairman (a non-executive position), Scott will move to one of the boards. He dismisses talk he’ll exit to join former colleague Robert Louis-Dreyfus, who has made a fortune after leaving Saatchi to be chief executive at Adidas A.G. “My commitment to shareholders of both companies is for one year and for shareholders at one of the companies for two years,” Scott says. “I haven’t decided yet which of the companies I’ll go to because I couldn’t be impartial” as co-chairman of both.
In any event, Scott will move off center stage after five trying years, a time in which the former accountant became the spark that ignited the feud with Maurice Saatchi over cost controls and agency direction. In July 1995, after the brothers had stormed out, Robert Seelert, a former General Foods executive, was recruited to help Scott manage the newly reformed Cordiant. Within a year, Seelert had decided that the stalled company needed a drastic split to get moving again.
“Last October, I convinced myself this was something we had to do,” recalls Seelert, who will become chief executive of Saatchi & Saatchi PLC. “I shared my thinking with Charlie and other top management at Cordiant.” In December 1996, they told executives at Saatchi, Bates and Zenith Media, then went public in April with the plans, retaining accounting firm KPMG to handle the delicate business of balancing the new books and brokers SBC Warburg Dillon Read and UBS Ltd. to issue the new shares. Herro was informed early on about the split, but he had little advice. “I had nothing to do with this divestiture,” he says. “They put the idea before us. I didn’t have a strong opinion either way.”
Although Herro is the most well-known Cordiant investor, other major shareholders have hung on through the years. Herro still maintains close ties to fund managers at the Wisconsin Investment Board, which has a 9.9 percent stake roughly equal to Herro’s Oakmark International Fund, and to General Electric funds that own 3.1 percent. “They’re seen as a cohesive voting block,” notes one Cordiant source. But it’s a British fund group that has emerged as the biggest single owner of Cordiant stock, and it is likely to have a strong hand in the fate of the two separate issues. Philips & Drew Fund Management Ltd. owns 24.2 percent of Cordiant shares through various pension funds it oversees, mainly for British companies and local governments.
PDFM, which has been part of UBS since 1988, quietly began buying Cordiant shares in mid-1994. It upped the stake over the next two years to reach nearly a quarter of the outstanding stock. PDFM fund managers won’t comment on the holding, but they are said to have been avid supporters of Cordiant’s managers against the Saatchi brothers, and they approve the demerger. Any potential acquirer of Bates would have to get PDFM on its side.
Another British fund manager heavily in Cordiant is M&G Investment Management, with 5.5 percent. M&G, which has $2.2 billion under management, is a “recovery fund” that invests in distressed situations. The firm has traded in and out of its position, but M&G fund manager Richard Hughes says he is eager to see the results from the demerger. He admits he was “disappointed the company’s recovery was delayed by events like client backlash to Saatchi’s departure,” and he says he’ll initially hold on to shares in both companies. “We’ve felt the people here have worked extremely hard and that’s not been recognized in the share price,” Hughes explains. “This company was composed of ill-conceived acquisitions by its former chairman. There’s lots of potential that hasn’t been recognized. We’re optimistic, particularly since freeing up the P&G conflict situation will be enormously helpful for Bates.”
Other significant Cordiant stakes are held by Toronto-based Trimark Investment Management, with 9.99 percent, and the company’s newest investor, Prince Alwaleed Bin Talal Bin Abdulaziz Al Saud, with the 3 percent stake he acquired in May. The Saudi prince, who is a Saatchi client in the Mideast, is said to have an $11 billion personal fortune. According to an aide, the Prince seeks out undervalued companies to invest in, such as Apple, TWA, Planet Hollywood and Euro Disney.
None of these investors is likely to make outlandish profits on their Cordiant stakes. Some, like Wisconsin, had bought their stock when it was still trading for the equivalent of $10-20 per U.S. ADR (each ADR is equal to three British shares, or about $6 currently). Even those who got into the stock at its lowest point, about 60 pence in London, are now sitting on shares that have simply doubled over two or three years. A solid return, but the other ad agencies have done even better, with much less anguish (and regular dividends) along the way.
Where the shareholders now hope to see a difference is in the incentive schemes set up to spur Saatchi and CCG executives. The top 70 managers in both will be asked to invest up to $240,000 of their own money in their respective new companies. Stock payouts will be tied to earnings per share (EPS) increases between 1998 and 2000. At 25% compound annual growth-which would mean EPS almost doubling over three years-the plans would pay out in full. At that rate, a manager chipping in $80,000 could receive shares worth nearly $1.3 million. The executives could also lose, however: They forfeit virtually all their stake if earnings are flat or fall. If annual EPS growth is only 5 percent, their investments come back to them without interest.
The board, at the urging of the shareholders, chose EPS as a criterion, as opposed to an increase in stock price, because management has more control over earnings. If revenue drops, for instance, agency execs can compensate through layoffs or other cuts. In selecting EPS as the yardstick, they also avoid the larger cyclical swings of the stock market.
Analysts figure the earnings yardstick is reachable with decent management of costs and revenue growth in line with continued boosts in overall media spending. SBC Warburg pegs Saatchi EPS going from a pro forma 6.30 pence for 1997 to 10.55 pence in 1999; UBS has CCG improving from a pro forma 6.0 pence in 1997 to 8.9 pence in 1999. “This isn’t such a tough deal. They’re still operating at only half of the levels of industry standards at places like WPP,” says David Chermont, a financial analyst at Merrill Lynch in London. “If they can just get margins up to average, they’ll improve way beyond the 25%.”
Nevertheless, the demerger leaves some wondering whether the companies are truly committed to change, or just committed to getting away from each other. The costs of the demerger are huge: Cordiant’s advisors will receive a fee of $27.3 million, while the new operating companies expect charges of another $4 million related to replication of services. Those amounts nearly equal all of Cordiant’s profits in 1996.
“It’s still difficult for me to understand the rationale behind this demerger,” says Chermont. “Look at the monstrous costs associated with this transaction. Yet operating overhead hasn’t changed much, and the same people are involved with the companies. I like the incentive program, but why couldn’t they have enacted that in the existing corporate structure?”
The demerger proponents reply, of course, that the separate companies will be more accountable and more committed to their businesses. “We tried to create equivalent companies,” says Charlie Scott. “The whole intent is to send out two solidly-based companies that can flourish independently of one another.” Their expected annual revenues are similar, $611 million for Saatchi & Saatchi and $539 million at CCG. On the balance sheets, Saatchi assumes more debt, $171 million compared to CCG’s $35 million. That breakdown recognizes Bates’ higher cash levels in overseas markets, pending tax payments and CCG’s assumption of lease obligations, like Saatchi & Saatchi PLC’s former headquarters in posh Berkeley Square. “Bates has more cash, but it also has more obligations,” remarks Scott.
In the end, the verdict on the demerger will be decided by the performance of the new agencies for their clients. “The issue is not what didn’t work for us,” concludes Ted Levitt, a long-time Cordiant board member whose 1983 Harvard Business Review article on globalization helped inspire Maurice Saatchi’s world ambition. “The issue is what might work better now,” he sighs. “What I have written, what Maurice did, and what he feels are three separate things. I’m not responsible for the conclusions other people draw from my writing.”
For David Herro, the other American who leaves his fingerprints on the history of Cordiant, his biggest wish for the future is exactly what most observers don’t associate him with. “Our future role in the new companies? I’d like to be a passive investor,” he says. “That’s always been our practice here. When we intervened, we did so because we were coaxed by the senior management and board members. We generally don’t like to get our hands dirty like that.” The questions ahead are when, how and at what price Herro and other key shareholders will decide to wash their hands of the new shares.