Magic Formula Stock Review: Omnicom Group (OMC)
Omnicom Group (OMC) is the largest advertising and marketing services company in the world by revenues. The firm is structured as a holding company, consisting of three global marketing networks: BBDO, DDB, and TBWA . Each of these networks consist of numerous individual agencies. The lines of business are loosely grouped into four segments. Traditional media advertising comprised 43% of fiscal 2007 revenues - these are your television, print, and radio ads. Other groups include customer relationship management (36%), specialty/niche advertising (10%), and public relations services (10%). Omnicom also has a wide geographic reach and diverse customer base, operating in over 100 countries and servicing over 5,000 clients. Almost half of revenues are generated outside the United States, mainly in Europe.
It's instructive to give an example of how a large integrated marketing firm provides value to a customer. Take one of Omnicom's campaigns, the highly successful "I'm Lovin' It" campaign developed and implemented for McDonald's (MCD). Omnicom's services here cover a wide variety of topics. First, McDonald's would have consulted with the company in the theme and brand positioning development to come up with the ideas in the first place. Then, Omnicom's agencies would then develop a pilot campaign and test it against focus groups. Once it was determined to be successful, the full rollout of "I'm Lovin' It" can begin, with Omnicom developing television, print, Internet, radio, and various other ad materials, and making the strategic buys for placing them. Omnicom would have also identified attractive sponsorship events for McDonald's, such as the 2008 Olympics. The firm's services are so broad that they could conceivably also assisted in designing window and panel marketing inside the McDonald's locations themselves, as well as container designs for the food items! As you can see, such an integrated set of services adds a lot of value, especially for big firms rolling out large marketing campaigns. Some of Omnicom's large clients include FedEx (FDX), Clorox (CLX), even marketing giant Proctor & Gamble (PG).
Let's measure Omnicom against the "three pillars" of investment: growth, financial health, and moat. First, growth. This is one where Omnicom has succeeded in the past, growing sales at about 10% annually over the past 5 years, while earnings per share growth has exceeded 10% annually. Like most firms in marketing, growth comes mainly through the acquisition of new agencies to broaden both service offerings and geographic reach. Some market analysts believe there is a general trend in big firms toward Omnicom's brand of integrated marketing, which would drive organic growth. In fact, Omnicom has done well at creating organic growth from within, mainly through additional services to existing clients. Of course, growth by acquisition is less profitable then internal growth. Growth potential is at least average here.
Financial health doesn't look like a major problem, but there are a few things that could cause headaches. Omnicom holds about $1.1 billion in cash, against about $3.1 billion in total debt. About $2 billion of that figure is in what are known as "putable bonds", where holders can demand redemption before maturity. With about $1.3 billion becoming redeemable over the next year, large redemption demand would force Omnicom to empty some of their cash or issue additional debt. Overall though, there does not seem to be any large short term concerns. MFI return on capital is excellent at over 160%, but since much of Omnicom's growth has come from acquisition, adding back in goodwill shows a much more pedestrian 13% nominal ROIC. Free cash flow margin has been right around 10%. Omnicom is in decent financial shape, nothing to be concerned about.
Lastly, moat. Omnicom's size and diverse offerings give it a huge leg up in winning large contracts against smaller competitors. However, it does face competition against similar large firms like WPP Group (WPPGY), Publicis Group S.A. (PUB), and recent Magic Formula stock Interpublic (IPG). There are really few built in moat advantages. Switching costs are relatively minor, and of course there are no regulatory barriers or unique assets that deter the competition. Omnicom's main advantages are it's size, talent (it's agencies dominate industry awards), and track record. Also, management has been very successful in identifying and integrating acquisitions, something it's competition (notably Interpublic) has failed to pull off.
So, considering all of this, I do not advocate against Omnicom for your MFI portfolio. It does not make the MagicDiligence Top Buys list, however. There are a few reasons for this. First are the less-than-durable competitive advantages mentioned above. Also, relying on acquisition to grow, however successful in the past, is quite expensive and risky. Interpublic has decimated it's business over the past 10 years through poorly integrated and overpriced acquisitions. Last, and most importantly, advertising and marketing are changing. Newspaper and radio ads, in particular, have experienced massive drop offs in volume and pricing, while the Internet is emerging as a very important conduit. Omnicom has to evolve or risk being left behind. Evolving requires capital expenditures and business reorganizations that can be expensive and risky. Consider that the company's return on capital was well over 20% for most of the 1990's, and has fallen into the low teen's today.
Still, Omnicom is a proven firm operating in a field that will always have demand. It is a good choice for MFI investors.