Upmarket advertising agency M&C Saatchi (LON:SAA) suffered a near halving of its share price today as a trading update today revealed that profits were to be below expectations and that results of a prior accounting review would affect both current and previous results.
The share price took a battering and has not recovered since:
Given how accounting reviews often mean very bad news, we can surmise that the lack of trust going forward may be responsible for such a large loss in share price.
The name Saatchi is synonymous with advertising in the UK having been behind some memorable ad campaigns. The shares have been listed since 2004 and up until now have produced some good returns for longer-term holders. The share price went as low as 26p back in 2009 at the end of the last global financial crisis, but over the next 10 years would deliver a 10-fold increase in price.
The fall has been quite staggering: as late as July this year, the shares were trading at 355p, so the company has lost approximately 75% of its value in less than half a year. The main catalyst has been an ongoing accounting review relating to the statement of certain items on the accounts.
What’s gone wrong at M&C Saatchi?
The bad news comes in a morning RNS. When the title reads ‘Accounting Review’ it almost certainly is going to be bad. The only crumb of comfort is that we get straight to the points. The accounting review:
M&C Saatchi today announces that, following the findings of an independent review by PwC, the Company will make adjustments of £11.6 million to its results, to be apportioned between its 2018 and 2019 financial results. The Company also provides an update on the actions that have been taken to strengthen its financial systems and controls.
This accounting review is nothing new and was referred to in the August update, but the level of adjustments has risen to the £11.6m we see today. This is also a very expensive affair for the company, as £1m of legal costs will be booked as exceptional expenses.
We also have a warning on profits for this year:
As announced in the Company’s interim results, a very significant proportion of the Company’s profit arises in the final quarter of the year. However, the Company’s underlying profit before tax, before taking into consideration exceptional costs, (including restatements arising from the PwC review noted above), is now expected to be significantly lower than expected at the time of the interim results announcement. Furthermore, the Company has incurred significant additional central costs in its UK business.
This figure is quantified as 22-27% below 2018 on a like-for-like basis. We also have news of further expenses for this year:
The Company also announces that it is restructuring its UK office. Management estimates that the restructuring will result in an exceptional charge of £2.5m for the financial year ending 31 December 2019, but is expected to generate annual savings of approximately £6m in 2020 and onwards.
Even this is jam tomorrow: the exceptional charges are presumably concrete in that people have to be laid off, whereas the savings may or may not materialise at this level. As RNS’s go, this could not have been much worse.
M&C Saatchi: A delicate balancing act
Despite the business model there appears to be a lot going on at Saatchi. On initial thought, one might think that this type of business is more suited to being a private partnership rather than a private listed entity. Much of the main competitive advantage are in the people, and they can be signed up by other companies.
One of the justifications is that being on the market allows companies to tap the markets for cash, and that is what has happened here. Much like rivals WPP (LON:WPP) we can see that a global network has helped them perform their activities, and this has been made much easier by acquiring stakes in other companies.
Turnover here has rocketed in the past 5 years although profits have not exactly followed:
As we can see average margins have declined over the years. That said, there was little for shareholders to whinge about: the business generated cash, most of which was paid out as a increasing dividend. The last year’s totalled 11p, but it seems unlikely that this will be held. Dividends have been the biggest expense, totalling £8m over the past year.
A significant event which happened last year was a disposal of an associated (Walker Media) for a £25m cash consideration. This has allowed the business to move back into a net cash position, although the structure is curious.with approximately £50m of cash outweighing £41m of borrowings. From their explanation in the profit warning, the cash appears to be that spread around its subsidiary undertakings.
Net tangible assets are positive, as are net current assets over liabilities, but this can be said with less conviction than for other shares: a great deal of the assets are receivables, the veracity of it is under question. Additionally much of the cash may not be truly accessible to cover a central cost.
Are M&C Saatchi shares good value?
Even prior to a profit warning earlier this year, one might have sensed that a global slowdown would badly affect SAA, and in the last recession they fared very badly. Today we appear to arrive at the low point under a different set of circumstances. The accounting issues sound worrying and although things may turn out to be just fine and an isolated problem, one cannot be totally sure if this may end up being another Patisserie Valerie. The adjustments are large, relative to profits: this isn’t a small case. There is also plenty of scope for more pain:
Receivables have grown sharply to £145m. As a proportion of revenue this has not grown, but can it be trusted?
A poor scenario may materialise that once the issues are cleared up, the underlying business isn’t very good without the overstatements. Stockopedia shows margins running between 2-3% for the last couple of years, so it may well be that the ad campaigns are flash but as a business it is not. With a raft of exceptional costs to be piled up, it looks as if this year and the next will be lean ones for M&C Saatchi. If a global recession hits the business itself could be at stake.
On the flip side, directors have plenty of skin in the game. We also have a ship here with plenty of meat on it. The group has almost 2,600 staff and wages are the biggest expense, totalling £175m. With margins as thin as they are it might not take much cutting here to deliver a meaningful upside, and the mooted £6m saving from reorganising the London office looks highly significant.
I see no real reason to invest here at present, and there is a chance that it could be a fragile deck of cards as there are quite a few unknowns at this period in time. That being said, I don’t view it as a total basket-case either, but that isn’t with enough conviction to invest. 2/5.