Roth Finally Tempers Financial Expectations

NEW YORK Michael Roth has finally come back down to earth.

For 20 months, the Interpublic CEO has repeatedly vowed to deliver peer-level growth and a double-digit operating margin by the end of 2008. And while IPG has shown improvement with organic growth, the No. 3 holding company’s margin has been consistently stuck in the low- to mid-single digit range. (For the third quarter, it stood at 3.3 percent and for the first nine months of this year, it was 1.6 percent).

Industry analysts have been skeptical of the margin target, calling it a “stretch” a year ago and, just three months ago, “a low probability event.” But as recently as mid-September, Roth was still sticking to his guns. On Thursday, however—upon the release of IPG’s third-quarter results—he finally backed down from his lofty goal, lowering his target to between 8.5 percent and 9 percent.

Reaction to the adjustment was muted because few analysts expected IPG to hit the target. Also, IPG lowered expectations in recent months. For instance, in August, Roth said that “client shifts and losses” and “dynamic change in our industry represent additional challenges.”

“No one really believed [the margin target] to begin with,” said Alexia Quadrani, of Bear Stearns & Co., which had projected margins in the 8 percent to 9 percent range during the past year and on Thursday lowered its current estimate to 8.5 percent from 8.8 percent. Even on the sell side, “nobody was at 10 percent any more,” Quadrani added.

For some, it was just a matter of time before IPG recalibrated. “Given investor skepticism about prior targets, we see the new margin targets as to some degree expected and still a material improvement, particularly compared to 2006,” wrote JP Morgan’s Fred Searby, in a report he issued after the release of Thursday’s numbers.

Although “you can’t give them a completely free pass” for setting what turned out to be a unrealistic goal, said Quadrani, “the way [IPG executives] handled it was OK.”

During a call with analysts last Thursday morning, Roth explained that margins were being squeezed by investments in digital talent and resources and severance costs, which soared as DraftFCB and Lowe laid off staffers in the wake of losing Verizon and General Motors (GMC and Saab), respectively. In addition, IPG is in the midst of agency financial planning for 2008, which tempered the CEO’s expectations.

“Looking forward, it’s clear that we must continue to accelerate the speed at which we embed digital skill and capabilities into every one of our agencies,” Roth told analysts. “This will require increased levels of investment, particularly in talent, professional development and technology and to a much lesser degree in targeted M&A activity.

“These investments will be important in building on our current top-line momentum and will help to ensure our long-term growth. But they also will affect our ability to achieve the full measure of the aggressive margin objectives we set for next year.”

Roth added that the major client losses triggered “remedial actions that will have financial ramifications for the next two quarters. These developments have also put our margin objectives under additional pressure.”

Roth’s downshift on the margin goal was offset somewhat by encouraging news on the revenue side. IPG achieved organic revenue growth of 5.7 percent and 4.7 percent in Q3 and the first nine months, respectively, and gross revenue for the quarter rose 7 percent, to 1.56 billion, from $1.45 billion in Q3 2006. Roth is sticking with his promise of peer-level growth next year, although analysts expect bumps in the road.

Since becoming CEO of IPG in January 2005, Roth has warned analysts that the $6.1 billion company’s turnaround is going to be “non-linear.” Last week’s bottom-line results for the third quarter—a net loss of $21.9 million, compared to net income of $3.7 million in Q3 2006—certainly illustrated that, especially coming on the heels of a profitable second quarter.

“While this is clearly not a straight-line turnaround, we see good evidence of progress being made,” Quadrani wrote in a report.

An unusually high tax rate, non-cash expenses and rising operating costs all contributed to the Q3 loss. Salary and related expenses, for example, grew nearly 8 percent in the quarter, to $1.03 billion, as the company hired digital talent, IPG said. Severance expenses also grew, again primarily due to DraftFCB’s layoffs.

For the first nine months, IPG also suffered a net loss of $10.8 million, though it represented an improvement from last year’s net loss of $100.8 million.

Entering Q4, Lowe appears to be under a microscope again, given recent losses here, where the top clients are Johnson & Johnson and Got Milk? The GM loss resulted in severance costs of $5 million for Q3, and another $8 million in restructuring expenses are expected globally in the next two quarters, according to IPG CFO Frank Mergenthaler.