Reports that The Engine Group may be back on the fund-raising circuit suggest not only that chief executive Peter Scott might wish to be able to take advantage of the recession to make a few global acquisitions at appealing prices but also that the group may be seeking some additional permanent share capital to replace or augment some of its existing borrowings.
First there were reports that Engine had retained two corporate finance specialists Ingenious Media and Jefferies International to help find some more money. Then this weekend there were reports that the group was contemplating a stock market flotation (or “initial public offering” as it is now commonly called). It’s hardly the best time for either, and the whole exercise begs two questions: why the hurry and why isn’t the previous private equity backer - the AIM listed Guernsey-based Loudwater Trust - interested in putting up some more cash until market conditions improve?
Part of the answer may rest with Loudwater’s declared policy of investing in companies which are expected to achieve an IPO or a sale within a short term time horizon. Having invested £8 million of extra share capital in 2007, perhaps Loudwater is yearning for a profitable exit rather than wanting to pump in more cash. Michael Spencer’s Incap Finance may also be eager to realise some or all of its near 10% stake.
But, equally likely, both Engine and its financiers may be worrying about its profit performance. Although the group has not filed its 2008 accounts, a press release acknowledged that it lost money last year after moving offices and writing off some lease-related costs.
Engine’s bank facility was increased to £37 million by the Bank of Ireland in February 2008 which added about £24 million to the level of borrowings available on top of those actually utilised at that date. Out of those additional funds the company has spent an estimated £20 million in cash on subsequent acquisitions and its office move. That would have been fine if the group had generated lots of cash from its trading operations during the period, as might have been expected, but after announcing a loss is this still likely to have been so? Responding to this question Engine said that its debt at the end of 2008 was £23.2 million. "We are well within our borrowing capacity", finance director Ian Day added. That's fortunate because now is not the easiest time to increase borrowings, however cheap new money may be.
Some of the factors that would-be lenders might take into account include the extent to which profits cover interest charges, the ratio of borrowings to cash flow, and the ratio of borrowings to shareholders’ funds (in other words the proportion of financial risk being born by shareholders by comparison with that of bankers).
Engine’s 2007 accounts implied that the Bank of Ireland's original facility agreement in November 2005 imposed only one specific financial constraint which is not precisely the same as any of the three referred to above. According to the company, it had to ensure that borrowings did not exceed 2.5 times "rolling 12 months EBITDA". EBITDA normally means profit before interest, tax, depreciation and amortisation, but the Bank of Ireland may have taken a more generous view. Certainly the revised facility agreement made in February 2008 defined EBITDA as also excluding share incentive charges and empty property costs.
Engine reported that its borrowings in 2007 were 1.7 times “rolling” EBITDA and therefore well within its bank covenant at that time. In its press statement this week it claimed to have achieved a similar ratio at the end of 2008. But even if there is no explicit requirement to earn sufficient profits to cover interest charges and more, the out-turn for 2008 will not have been very comforting. Indeed last year’s loss means that, while the bank’s investment has been increasing, the investment from shareholders has been eroding. Taken together, these factors would provide a powerful motive for raising more permanent share capital.
Engine will have to publish its 2008 accounts by the end of October. The sooner that happens, the sooner a full - and hopefully reassuring - picture will emerge.
© Fintellect Ltd
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When Aegis Group chief executive John Napier announced in March that he expected to produce a "resilient performance in more difficult markets in 2009", did he mean that the group might make a loss for the first half at least (see Napier ambiguous about Aegis profit prospects for 2009)? That would have been an unlikely interpretation.
Yet for the half year to 30 June Aegis lost £2.1 million after excluding minority interests, despite a modest 3.5% increase in gross income (revenues less bought in direct costs).
Without favourable foreign exchange movements, revenues would have fallen by 9.2% and operating profits would have fallen by 62.2%. Thanks to those currency benefits operating profits actually fell by 55.9% (although that 6.3% difference is hard to reconcile with a statement today that operating profits actually benefited by as much as £10.7 million from currency movements). The operating profit margin on gross income slid to 4.2%.
So what did Napier mean in March? Clearly he had hoped to report a better first half than was actually achieved. The company now concedes that "although a market downturn was assumed, and action was taken to reduce the cost base of both businesses and central costs, the market decline was greater than was expected".
The Synovate research business has proved to be something of a problem - what Aegis attributes to "severe market conditions and the complexity of its business". It failed to cut costs as quickly as revenue declined, resulting in a small loss in the first half.
Aegis is not expecting any upturn in revenues during the rest of the year but hopes that extra cost-cutting measures will produce a better result than in the first half. At least the group still believes it will achieve a profit of some sort for the full year "in line with current market expectations" whatever they might be.
Net borrowings at 30 June increased to £362 million while shareholders' funds stood at £355 million, putting Aegis among the more highly geared of the sector with a debt/equity ratio of 1:1. Last December the debt/equity ratio was a far more tolerable 0.64:1. Nevertheless Aegis said today that it remained "comfortably within banking covenants" and that the undrawn headroom on committed lending facilities had increased slightly to £178.3m at 30 June. But undrawn facilities remain subject to meeting the bankers' covenants and so it may not be prudent to draw on them too enthusiastically.
Operating profits of international public relations group Huntsworth fell by 80% to £2.5 million in the first half of 2009 after spending £5.3 million on rationalisation and "other non-recurring" items.
Group revenues held up well against the chill winds of the economy, falling by a modest 4.9%. But normal operating costs were not contained in line with that rate of decline, even before spending £4.3 million on severance costs and another £1 million on property rationalisation. The position would have been worse if exchange rate movements had not boosted profits by £1.3 million during the period.
Profit after tax available to Huntsworth shareholders fell to just £193,000.
Against this backcloth Huntsworth announced today that it has hired another heavy hitting non-executive Michael Birkin to join John Farrell who was appointed last month. Both have extensive senior management experience in global groups - Birkin in Omnicom and Farrell in Publicis - but it is not yet clear whether Huntsworth plans to engage these people in new strategic developments that could involve broadening its offering. At the very least they should be able to advise on how to maximise the resources already owned by the group.
Huntsworth also announced its intention to continue buying in shares despite having net debt of £40 million at 30 June. Huntsworth said that its current borrowings were "well within the group's £90 million debt facilities" although it made no comment on whether its bankers would be content to lend that much money on the back of a half year profit of £193,000.
Huntsworth had £250 million of intangible assets like goodwill in its balance sheet at 30 June, the value of which is doubtless dependent on being able to generate steady and healthy future profit streams somewhat larger than those reported for the latest half year. Those assets were financed by £180 million of shareholders' funds, supplemented by bank borrowings and ordinary creditors. Provided no big goodwill write-offs become necessary, the group's current net borrowings of £40 million will remain modest relative to what shareholders have invested in the business. That offers some comfort.
AIM listed Media Square today predicted that it would achieve a “small operating profit” for the full year to February 2010. The company made the announcement after its annual meeting but did not elaborate on whether interest charges and other costs were likely to cancel out any such operating profit. It seems almost certain that this will be so.
The group said it had experienced reductions in revenue in keeping with the current industry trend which, when combined with one-off costs of agency restructuring, was expected to result in an operating loss for the first six months to 31 August.
To the company's obvious delight, the agitating 21.5% shareholder Prime Active Capital (“PAC”) had withdrawn a proposal to appoint its chairman Peter Lynch to the Media Square board at today’s meeting (see Media Square: in a bit of an Irish Stew). No explanation had been offered, but it should not necessarily be assumed that Media Square has seen the last of him.
However, unless Lynch has ambitions to make an outright bid, he may seek to take a lower profile initiative in collaboration with one or two other shareholders in an attempt to build the value of the group to a level that at least would enable him to recover the £6.8 million that PAC has invested in Media Square shares so far. Today Media Square as a whole is valued at less than £6 million.
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As anticipated, WPP Group’s results for the first half of 2009 tell a sorry tale with profits earned for shareholders slashed by almost 50% by comparison with the same period last year despite revenue growth of over 28% fuelled by the acquisition of Taylor Nelson Sofres (see WPP's half year results critical to confidence in the sector).
Excluding acquisitions and currency movements, revenues actually fell by 8.3%. Profit margins in all divisions were hit badly as the group struggled in vain to reduce staff and other costs to match the decline in revenues. Staff costs were exacerbated by severance expenses and absorbed 62.1% of revenues.
For the group as a whole the operating profit margin slumped to just 5% from almost 12% in the same period last year. If goodwill amortisation and impairment charges are excluded, the margin for the latest period was 6.2% compared with 13.4% last time. This performance comes from a company that vowed not so long ago that it would steadily improve its operating margin as each year passed.
The price being paid for the group’s massive expansion of its research capability (what WPP now chooses to call “consumer insight”) is most vividly reflected by the fact that, while revenues from that division grew by 131% with the help of Taylor Nelson for the first time, operating profits improved by a mere 39%. Research is renowned for problems in achieving respectable profit margins and that is no more clearly demonstrated than in today’s results. Post-acquisition restructuring will not have helped the bottom line either.
Net debt increased during the six month period to £3.5 billion while shareholders’ funds declined to £5.2 billion, resulting in a debt/equity ratio of 0.66:1.
Finance costs were cushioned not only by lower interest rates but also by a one-off credit arising from unravelling hedge accounting arrangements on repayment of Taylor Nelson debt. Even so, shareholders were left with only £108 million of post-tax profit from the period compared with £208 million reported for the same period last year. Not a lot of dosh from a lot of global activity.
Today the company said there was “little evidence” of stronger order books, but expected the second half to show a “marked improvement” in profitability.
It is no small achievement to achieve world domination as the biggest marketing group measured by revenues, but it has come at a price. As noted here last November when Sir Martin observed that WPP’s budgeting exercise for 2009 did not reflect the Armageddon predicted by the fall in stock prices: “There’s enough to worry about without Armageddon.”
Chime Communications brought a little summer cheer to the stock market this morning when it announced a modest growth in profit for the six months to 30 June despite the economic gloom. Profit after tax attributable to Chime shareholders for the period was almost £5.8 million - up 9% on the same period last year. Its operating profit margin of 16.1% remained healthy albeit lower than the 16.8% reported for the same period last year.
An increasingly large portion of group income was earned abroad. In the latest half year, nearly half the group's operating income came from international work - with a sizeable proportion of that thought to come from the Middle East - compared with 34% in the same period last year.
A chunky 20.4% of the group's total income is now derived from two clients although Chime emphasised that these pieces of business are broken down into a number of smaller contractual relationships.
The only other slightly cautioning component of an otherwise encouraging result was the group's heavy reliance on short-term credit to fund its long-term assets. At 30 June its short-term obligations exceeded its readily realisable assets by £21 million. Admittedly the group has unused bank facilities of £32 million, but it has never been regarded as a particularly prudent practice to fund long-term assets out of short-term liabilities even if the mighty WPP Group does so much of the time.
Presumably debt-free Chime is happy relying on short-term bank borrowings when the need arises. Or maybe it is waiting for better market conditions before asking shareholders for a little more long-term capital.
Digital agency Profero was able to minimise its loss for the year to 31 March 2008 by including a windfall additional profit from the sale of its 33% shareholding in digital production company Inventa Productions in the previous year.
Despite this windfall gain of £90,835, the group still reported a loss after tax of £18,037. Its operating loss before including the gain was £37,525.
Since that year end the group has appointed a new chief financial officer Chris Adamson, as well as reorganised its board under the non-executive chairmanship of Lord Puttnam.
Profero’s business development strategy has been based on starting up new ventures in a number of locations around the world, ranging through Italy, Spain, Australia, Singapore, Hong Kong, China, Japan and - more recently - the United States. All of this has been done on a modest capital base and has yet to produce a significant financial payback.
Fortunately the nature of Profero’s business - which includes an element of digital media buying and prepaid services - generates plenty of cash in the short-term, but virtually all of that is destined to pay suppliers and other creditors. More worrying, while turnover remained almost unchanged in the year to March 2008, the group had greater difficulty in collecting its debts and so its cash inflow from operations declined by about £2 million during the period.
Under the watchful eye of its strengthened financial management and non-executive board members, perhaps Profero will soon start earning a serious financial return from its ambitious globe-trotting initiatives.
Yesterday private equity house ISIS EP announced it had acquired a further tranche of shares in WIN, the AIM-listed technology facilitator of mobile phone content, bringing its stake to 19.2% - closer to the 30% threshold at which it could be obliged to make an outright bid.
Whether an outright bid is intended remains uncertain as neither ISIS nor WIN has made any public announcement relating to the stake building that has been going on throughout this year, primarily through several Baronsmead venture capital trust funds that ISIS manages. For some of that period WIN was in talks with an unnamed potential bidder, but these were terminated in April. Even a 20% stake would give ISIS considerable potential influence over future developments, particularly if it could carry the support of institutional shareholders like AXA with it.
In an apparently unrelated development two months ago, WIN announced a strategic alliance with the publicly listed Indian technology specialist Tech Mahindra that owns an internet value added services operation called CanvasM. Under the agreement, Tech Mahindra will work with WIN to develop the company's next generation mobile platform. The move was described as “a first step in a broader strategic alliance” under which the two companies will also look to develop “joint go-to-market strategies in key territories, notably Tech Mahindra's strong Asian market”. Is ISIS anticipating or even encouraging a closer tie-up between the two companies?
The latest share purchase increased the ISIS holding from the 12.8% level built up previously (see ISIS stake in WIN reaches 12.8%). The shares are likely to have been acquired from Dalton Strategic Partnership, a relatively new fund manager that confirmed it had disposed of its 6.5% holding on Wednesday.
WIN’s shares have been wallowing below 60p since the company reported a £364,000 loss last year after writing down the value of acquisitions and other assets by nearly £1.4 million. More recently chairman Richard Joyce said the group was profitable with an excellent customer base and a strong cash position.
Three directors have left AIM listed internet technology specialist cScape Group within the last year as it struggles to make a profit. Two non-executive directors - James Andrews and Timothy Childs left in June - and the third person to go was the former managing director Andrew Gannon who left in December 2008.
Gannon received 200,000 shares on his departure - hardly of great value at a price of about 3p each. Another former employee Karen Johnson was given an ex gratia 50,000 shares on her departure last year.
The departures resulted in a very small board comprising just its executive chairman and 57% shareholder Keith Young and finance director Geoff Griggs, so they have now been joined by the chief executive of the group's main subsidiary Robert Killick. The purpose of the changes is to "focus the business on growth and expansion", the company claimed. The moves may also represent an attempt to regain investor confidence after making modest losses throughout the last 10 years. The group lost £331,000 in the six months to 31 December 2008. Its latest full year ended on 30 June and an announcement of its preliminary results is awaited.
Short-term creditors exceeded readily realisable assets by £1 million last December. But the group remained comfortably within its overdraft facilities at the period end, according to Young.
Seemingly as part of its cost-saving drive, the audit was put out to tender late last year with the result that Baker Tilly was replaced by Thorne Lancaster Parker.
As some observers make their first very tentative noises about economic recovery being on the horizon, most players in the marketing services sector are still looking for tangible evidence.
Traditionally the stock market tends to anticipate the ups and downs of the economy by at least six months and so we might draw some encouragement from the rise in the FTSE All Share Index since the turn of the year. But, at the same time, history shows that the economy and the stock market almost invariably have at least one false dawn before steady growth re-establishes itself.
On this occasion the marketing services sector should not only beware of a false dawn but also recognise that this relatively small segment of the economy is in the midst of radical change. Media is becoming even more fragmented and less reliable in delivering anything like a predictable response to advertisers. Technological change, however evolutionary and exciting, has added another layer of complexity.
Small wonder that many of the marketing groups that ventured on to the stock market in recent years are at best being treated with scepticism and at worst being totally avoided by investors. As a result the MSFI Index of marketing sector shares listed on the stock market has slumped to a much larger extent than public company shares as a whole. Admittedly the MSFI Index recovered by 15% between 12 January and 12 August this year (see chart) while the FTSE All-Share Index improved by a more modest 8.9%. But that's deceptive because the gap between the sector index and the FTSE All Share Index had become so wide that even the slightest improvement in the sector index would appear big in percentage terms.
The situation has not been helped by the fact that there are not many marketing companies listed on the London stock market. Most are relatively small in size and a few of them have been built more on the back of optimistic ambition than on substantial and successful businesses. So shares in the weaker businesses have slumped and several have subsequently withdrawn from the market.
Equally worrying is the performance of some of the bigger players. Their growth depends on being acquisitive as well as on building existing businesses. Without a constant stream of new acquisitions such groups run the risk of stagnation, especially if previously acquired businesses lose momentum after their entrepreneurial founders have retired with their lumpy swag bags. Sometimes the insatiable desire to feed shareholder expectations prompts big deals that rely on lots of borrowed money. And sometimes those big deals fail to deliver the anticipated rewards or take longer to do so than expected
Fear of under-delivery and consequent financial stress is probably the biggest cloud hanging over WPP Group today as the market awaits its half-year results to be announced later this month (see WPP's half year results critical to confidence in the sector).
As it digests not just Taylor Nelson Sofres but other chunky acquisitions like 24/7 Real Media before that, the group needs to generate enough profit and cash to fund its acquisition costs, to offset declines in other more mature subsidiaries and - never to be overlooked - to enhance shareholder returns. While the recession continues, that may prove quite difficult.
Cossette, the Canadian listed marketing group under siege from a company lead by its former vice chairman François Duffar, has formerly instructed financial adviser BMO Capital Markets to expeditiously solicit proposals from other parties interested in acquiring the Company. A change of ownership now seems almost inevitable.
The move was announced yesterday as being "in the best interests of the company and its shareholders and will facilitate offers reflecting the full and fair value of Cossette".
At the same time Cossette described the proposal it had received from Duffar's company Cosmos Capital as "highly opportunistic, highly conditional, and financially inadequate" (see Major shareholder and former vice chairman makes $80m bid for Cossette). No formal offer has yet been put to Cossette shareholders.
Cossette's UK operations include Miles Calcraft Briginshaw Duffy, Elvis Communications, Band and Brown, Dare and Identica.
Creston's private placing of an additional £3.3 million of share capital last month has proved well justified, bearing in mind the 6% decline in like-for-like revenue reported this morning for the four months to 31 July.
The group raised the extra capital (before expenses) two weeks after it was noted here that the group "might benefit from being rather less dependent on relatively short-term borrowings" (see Creston reports modest revenue growth, better profits and stable balance sheet). At the time Creston expected to be able to meet the cash component of its short-term earnout liabilities and related commitments out of a mixture of its existing bank facilities and normal operating cash flows, but the question was raised here of whether this would be so unless Creston continued to prosper during the recession without serious loss of business.
Today Creston maintained that "trading overall remains in line with management's expectations", adding that July's fund-raising had provided additional working capital and would also allow for investment to boost organic growth. Maybe working capital needs will be taking greater priority in the wake of the revenue downturn actually experienced.
The Toronto Stock Exchange has told the Canadian listed marketing group Cossette that any shares obtained by the triggering of the company's recently introduced shareholder rights plan cannot be publicly traded until the Ontario Securities Commission is satisfied that the plan is not a type of defensive tactic that would warrant its intervention. This is a normal holding announcement that applies to any such share plan introduced by a public company in Canada and does not of itself imply anything unusual in this case. However, the Securities Commission review will almost certainly have been prompted by representations from a prospective bidder.
Cossette introduced the new plan last week in an attempt to thwart any attempt to gain "creeping" control of the group following the takeover offer from Cosmos Capital lead by Cossette's former vice chairman François Duffar (see Cossette under siege after being hit by $18m loss). The plan had the potential to devalue the price at which small shareholdings could change hands unless in response to an offer made for the company as a whole.
Pending the Ontario Securities Commission's decision, the Toronto Stock Exchange's action does not affect the legal status of the plan. The plan would expire next year unless ratified by shareholders at Cossette's 2010 annual meeting.
Anyone who might have hoped the arrival of Roger Parry as part-time executive chairman at AIM listed Media Square would bring about a period of equanimity will be disturbed by the latest developments.
In about two week's time shareholders will be asked to decide whether or not to appoint the Irish financier Peter Lynch to Media Square's board. According to the almost hysterical reaction reflected in the bundle of documents sent out with the notice of Media Square's annual meeting, Lynch is a small-time operator with no relevant experience who refuses to discuss how he could run the business better than Roger Parry is doing at present.
Readers of this blog will also know that Lynch's company Prime Active Capital ("PAC") has already had to write off losses of around £5 million incurred in buying 21.5% of Media Square's shares during the last two years. So his judgement may not be entirely impeccable.
Parry seems to have gone to great lengths to demonstrate just how much the board resents Lynch's approach. For example, he has produced a letter from 24 of his senior managers saying how wonderfully Parry has reorganised the business and how divisive it would be if someone like Lynch were to join the board.
Parry also appears to be paranoid about conspiracies. He has identified links between PAC and another more recent shareholder Anthony Gill who bought a 16% stake in April this year (see Yorkshire entrepreneur buys 16% of Media Square). He reckons Lynch wants to gain control of Media Square (which might make his own role somewhat superfluous). He is also troubled by the thought that Lynch may have plans to reintroduce the group's former chief executive Jeremy Middleton in some undefined role, although Middleton is adamant that he hasn't the slightest desire to cross the Media Square threshold ever again.
Why should Parry be worried? Hasn't he turned Media Square round into a profitable group again? Well not quite, but he hopes to do so in the second half of the current year. Does Lynch offer a better future for shareholders? Not if PAC's track record is anything to go by, as it has run up losses of about £6 million over the last two years.
Clearly there are risks to Parry's own job security if shareholders like Gill, Lynch and others want to gang up on the current management team. And it is fair to question whether boardroom warfare is likely to be in the best interests of anyone. And it is certainly reasonable to question whether Lynch has any really relevant skills to offer, bearing in mind PAC's predominantly unfulfilled aim of acquiring "companies where value can be achieved through improving and reinvigorating management teams". Being an Irish chartered accountant and former finance director of several companies outside the marketing sector may not prove sufficiently compelling.
The danger with Parry's current stance is that he will be seen to protest too much and the legitimacy of his arguments will carry less weight as a result.
IT consultancy Sapient Corporation’s purchase of the Nitro advertising agency network last July (see Nitro: something of a Chinese puzzle) had better prove itself in strategic terms as the financial arithmetic is hardly appealing.
According to figures filed at the US Securities and Exchange Commission last week, Sapient paid $45.8 million for a business with net liabilities of $7 million. So the difference between those two figures of about $53 million is all highly intangible and has been attributed to items like goodwill, the trade name and client lists.
Only $25.3 million of the $45.8 million purchase price was paid in cash so the immediate dent in Sapient’s massive $174 million cash pile will hardly be noticed. The balance of the purchase price was settled in Sapient shares.
Sapient remains silent about the profit stream it expects to obtain from the deal although it will be incurring costs of nearly £8 million over the next few years arising from the Sapient share incentive scheme offered to Nitro executives. Much of Nitro's business was based in China, Hong Kong and Australia. Hopefully it is full of Eastern promise and will earn lots of profit - or at least enough to cover the incentive scheme.
BOB WILLOTT
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