OMC + IPG

OmnicomGroup (OMC) and The Interpublic Group of Companies (IPG) are merging into an entity that – in my perfect dreamworld – would generate 15-20% IRR over the next four years (8% bear case, 35% bull).

I might be disappointed in that expectation, but I doubt I lose money over time.

At present prices, I’m paying a single-digit multiple of normalized free cash flow for a predictable business that, 1) generates a lot of cash with minimal capex and negative working capital, 2) could see efficiencies with AI, and 3) is targeting $750M cost savings post-merger.

In my view the market is under-appreciating the earnings power and durability of these businesses due to limited growth in a time where growth and narrative are all that people care about.

What They Do

Omnicom and Interpublic own a bunch of advertising, marketing and public relations agencies. And they’re merging to create the biggest bunch of advertising, marketing and public relations agencies.

If someone wants to create an advertisement, launch a social media campaign, get positive press coverage, or understand its customers better, they hire a company like Omnicom or Interpublic. Besides making ads, they specialize in figuring out the best place to put them, buying the ad space, using data to figure out if it’s working and then calibrate the strategy as needed.

Basically, if a company wants to market or communicate anything to the world, they use some myriad of services from an ad agency. 

While companies like Google have certainly eaten some of the traditional ad agencies lunch, it’s been far from a death blow. In more than thirty years, OMC has only seen their per share cash generation decline twice — GFC and COVID-19.

The Deal

OMC and IPG are merging in an all-stock transaction. IPG shareholders get 0.344 shares of OMC common stock for each IPG share owned.

You'll find all the good stuff in the S-4 here.

The deal is waiting on Mexico and the EU for final regulatory approval and is expected to close by the end of 2025.

The Opportunity

I’ve watched the ad agencies for years and have always thought they were cheap. But, if you look, OMC and IPG have basically been flat for the last decade.

In that time, per share profitability has increased and multiples have compressed to their lowest point outside of extreme economic conditions such as the great financial crisis and COVID-19.

Plus, the combined entity is targeting $750M cost synergies by YE2029. I know, synergies aren’t anything to hold your breath over. But if they succeed, it’d be difficult to imagine the share price not reacting to at least maintain the current multiple being assigned.

As for AI, it’s a tailwind. There’s a lot of efficiencies to be had integrating AI into content creation, media buying and analytics — and management is already implementing them. 

While the companies require minimal tangible assets and have negative working capital requirements — all of which is why you see high ROTA, ROIC, ROE et al. — it is a human capital intensive business.

OMC brings in $200k revenue per employee, but only $20k profit.

For context,

• J.P. Morgan earns $184k per employee
• Coca-cola earns $153k per employee
• META earns $842k per employee

If AI is everything people expect it to be, I’d expect per employee income to increase over time — but to what degree I have no idea.

Some Numbers

Regardless, I think OMC is cheap now and IPG is cheap now.

There’s two ways to “value” companies. One is you try to predict what others will pay for it. The other is to decide what you would pay for it. I do both, but for this specific situation I’m talking about the latter. I have no idea if people will care about this company.

But it's a great business. It's simple – even if the implementation and services themselves are data intensive – and necessary. It produces high return on tangible assets. The financials are clean and predictable. The annual reports are short.

I don’t know why Berkshire Hathaway or some private equity firm hasn’t gone after them, but I would if I could.

OMC generates more than $9 per share of cash. And, as I said, in more than thirty years, they’ve only had per share cash generation decline twice.

Against that $9 per share, the stock trades at $78 and has $15 per share of net debt.

Along with IPG, if I lowball their runrate FCF at $2.5B, I think the combined company is worth $103 per share.

At $3B — which I think is closer to their actual normalized earnings power — I think the company is worth $127.

Applying $750M of synergies by YE29 on top of that and I get $138-162 per share.

That’s 15-20% IRR excluding dividends or buybacks.

Three fundamental levers drive returns over time

1. Dividend yield
2. EPS growth (including buybacks)
3. Multiple expansion / contraction 

Taking $2.5B runrate and assuming no growth or synergies, I expect around 6-8% shareholder return per year in dividends and buybacks.

With the stocks trading around the cheapest multiples in history outside extreme cases, I think at some point some people will again prefer predictability over growth and the multiple will rise.

Summary

I don't expect these types of boring businesses to catch much interest. For me, the simplicity, predictability and valuation of OMC and IPG required little effort to conclude wanting to buy. Whether it’s pattern recognition or bias or hope, in my experience companies like this don’t trade at depressed multiples indefinitely.

I own shares of OMC. There's no real return benefit to owning IPG and if the deal falls through, I'd rather own OMC anyways.

The most likely worst case is this turns out to be a mediocre investment. People seem more concerned earning mediocre returns than actually losing money, but I’m content clipping dividends and giving this time to work out.

It's also possible RFK Jr. creates headwinds with pharmaceutical ad limitations. Though, for me, even if pharmaceutical revenue theoretically went to zero the company would still be cheap(ish). That's not to say the stock price wouldn't get punished. But, putting on my 'what would I pay for the entire business' hat, when I stress test the numbers it'd still be attractive – to me at least. To each their own.