By Alessandro Orsini
Traditional media has been one of the most profoundly impacted sectors with the internet boom and all that followed. Indeed, one of the big changes is the shift from traditional to digital media, where people's attention is most commonly found now. This has led to the successful advertising business models that make Facebook (FB), Google (GOOG), and, partly, Amazon (AMZN) so successful. One consequence of this is that small businesses that were able to harness the power of these platforms were able to drive a lot of growth. The drop-shipping Shopify (SHOP) phenomenon is one of the results. However, these strategies have eventually eroded, with many of the online marketing gurus piloting them now putting courses on how to do the same on sale. One reason is that the platforms that make businesses money change, with high ROI campaigns being possible on untapped platforms. Where Facebook was once the go-to platform, now others are able to offer more.
Despite the decline in traditional advertising mediums to make room for online platforms, these traditional mediums still have a durable place in the ecosystem as proven by the value of outdoor advertising for example. Moreover, within digital marketing, upstart platforms eventually mature to make way for new platforms where high marketing ROI might be offered. Now, the upstart gurus and small advertising consultancies that initially eroded the position of traditional ad agencies like Omnicom (OMC) are beginning to run into the same challenges of adaptation. With a leveled playing field and a legacy in excellent content creation and copy, along with the cognizance that data analytics is the way forward, traditional ad agencies look poised for a comeback. With Omnicom, in particular, being a well-managed and low operating leverage business, we think it could be attractive even in the COVID-19 environment due to its secular decline multiple and decent and sustainable dividend yield.
Smart Money is Still In Outdoor
One of the best cases to be made for the continued value that traditional advertising mediums can offer is the outdoor advertising space. Companies like Lamar Advertising (LAMR) provide substantial value for enterprises, getting visibility to untold numbers when located strategically. This is reflected in the high multiples for their assets. Indeed, acquisitions in a period of boom for companies like Facebook have still been remarkably successful in outdoor. Consider Cieslok Media, a company sold to Bell Media by mid-market PE fund Clairvest (CVTGF) netted a 94% IRR and 8.4x multiple on initial investment over the period 2013-2017. Their assets are on Yonge-Dundas Square in Toronto, affordable mainly by large brands with brand equity. The foot traffic and transit in the square must have afforded advertisers ample value for the EBITDA to have been growing substantially.
Big Tech Not A Direct Threat
Another important thing is to realise that big tech is not a direct threat to ad agencies like Omnicom. While media conglomerates like Time Warner might have more to worry about with Facebook, Google, Amazon, and myriad others providing great ad mediums, Omnicom still has its book of customers that it will try to satisfy with high-performing campaigns on any medium.
It is better to consider big tech as a source of flux, where ad agencies need to adjust their strategy and offerings to be on top of the markets and provide a compelling proposition to their clients, not unlike investment managers. A recent example of how the changing winds in big tech affect a company like Omnicom is the rapid growth in Amazon as a target for ad spend. With people holding an implicit belief that Amazon will have any product they are looking for, time spent pre-purchase in Google search is less. Hence, being able to command an effective marketplace on Amazon will be a critical part of brand strategies moving forward, with increasing relevance compared to SEO for many retail businesses. Omnicom is consulting many of its retail clients in this change. Another example is Omnicom's award of business from Riot Games concerning the League of Legends Championship, an entirely online event.
The good thing is that regardless of platform, skill in content creation and copy will always be a value-add. Although platforms do compete somewhat with ad agencies in the data analytics they provide, which might be enough for drop-shippers, bigger brands will still contract ad agencies to write the copy and build the ads, unless they have internal teams that do this. A lot of the value nowadays is in the creative copy, where the data analytics for targeting have become more commoditised.
On COVID-19 and Final Remarks
So far, the business has managed to maintain rather strong resilience.
(Source: 2020 Q1 OMC Pres)
However, management expects based on discussions with the group's clients that real pullbacks in ad spend are likely to be the most intense in the Q2. However, if consumer confidence resumes with greater force than expected, as it seems to be doing in Europe, perhaps these pullbacks in spending won't be necessary, with the real economy holding up. Regardless of what happens though, Omnicom benefits from low operating leverage, with perhaps as much as 75% of its cost structure being actionable in cost-cutting measures with the salary and service cost line. This means that Omnicom will be able to avoid massive cash destruction, and due to its presence in European geographies as well, will be able to do it while limiting the number of explicit layoffs.
There are risks, however, with contracts with clients being rather short term and more easily pulled. In addition to this meaning weaker resilience right now, it also indicates a more persistent level of high competitive pressure across the industry. But given that it trades at the same low multiple with less leverage and seasonal volatility than peers like Interpublic Group (IPG), it is still definitely worth considering in our book.
(Source: Valkyrie Research and relevant FY 2019 Disclosures for financial statistics)
Overall, Omnicom rests in an industry that still has use of them, despite the inevitable changes we'll see in the digital marketing space. With great FCF yields at around 10%, with cash value protected by low operating leverage and ample liquidity to weather the storm in the many COVID-19 eventualities, Omnicom and its 4.7% dividend yield seem to offer both value and income worthy of a diversified portfolio.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.