The Mission Marketing Group (TMMG): High growth, low P/E

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A wise man once told me: “Never recommend a stock to anyone. You’re bound to loose. If it rises, they’re brilliant. If it tumbles, you’re an idiot.” In length, I emphasize that the following write-up is not a recommendation. It’s merely a collection of reflections that document my reasoning behind my investment decisions, hence allowing me to go back and learn from my mistakes and successes.

The Mission Marketing Group (TMMG) is a British holding company offering marketing and advertising services. Top of mind, it seems to be undervalued by Mr. Market, since the business’ free cash flows have compounded at a rate of 29.6% for the past 7.5 years, but its priced like a zero-growth company using a 10% discount rate.

Business and Background
The Mission Marketing Group characterizes itself as an Agency Group. The company is a holding company comprised of 16 marketing and advertising agencies spread across the UK, US and Asia. The UK market accounts for the majority of the company’s operating income, namely 89.4%. The remaining 11.6% is distributed equally between the other two regions.

TMMG assists its clients – which includes i.e. Fiat, Ferrero, Barclays, Velux and Mars – with branding and advertising services (78.7% of operating income), media purchase (5.2%), events and learning (6.8%) as well as PR (9.3%).

A merger of several agencies resulted in the listing of TMMG in 2006 at a price of £1.25. The company’s capital structure was – like so many others in these years – extremely toxic. Its debt burden was overwhelming and there was serious doubt about whether or not TMMG could service its obligations when the financial crisis broke out. A concern that resulted in a 94% drop in the share price (from £1.50 to £0.09) between 2007 to 2010.

The board determined to wipe the slate clean in 2010 when it appointed David Morgan as CEO. His most important task was to restructure the company by improving profitability (primarily through cost cutting) as well as focusing on the core business and thus putting acquisitions on ice for a while for the benefit of reducing debt. David & Co.’s simple strategy proved fruitful. Today, TMMG’s balance is in balance, which has enabled the company to make acquisitions, pay dividends and develop the core business. The numbers below indicate that David has led a successful turn-around. Between 2010 and June 2018, TMMG’s ..

• .. revenue grew from £90 million to £155 million, equivalent to 7.5% p.a..
• .. operating income increased from £5 million to £9 million, corresponding to 8.2% p.a.
• .. net profit grew from £1 million to £5 million, corresponding to 23.9% p.a.
• .. free cash flow grew from £1 million. to £7 million, corresponding to 29.6% p.a.

Top of mind, TMMG appears to be a well-greased machine. But is it a bargain?

The Stock
TMMG is currently trading at £0.55, which is just about the highest level the share has seen over the last 12 months. The latest 12% increase between the 18^th and 19^th of September was caused by the announcement that the second half year’s dividend payment will increase by 27% to £0.070 per share. The share’s price spike exceeds the amount of the dividend, but Mr. Market must have considered this announcement as a award-worthy sign of the business’ health.

With 82.91 million outstanding shares at a price of £0.55, TMMG’s market value is around £46 million. It currently trades at a..

• P/E of 7.3
• P/CF of 7
• P/S of 0.3
• Dividend yield of 3.6%

It was these metrics that caught my attention. In my view, there seems to be a mismatch between the above impressive historic growth and these low price-to-fundamentals. An observation that the company itself emphasizes: “Our shares trade at a significant valuation discount to our peer group.” This statement is backed up when you compare TMMG to its competitors’ key valuation metrics (cf. WPP, Next Fifteen Communications Group and Huntsworth).

Why is the stock trading at such a seemingly cheap price? I have not been able to answer that question, which, of course, worries me! Perhaps it’s just the low market capitalization that ensures TMMG a spot in the shadow? Perhaps there are concerns about TMMG’s future given how extremely competitive the advertising sector is? Fear of a recession? Brexit? Perhaps I have overlooked certain challenges that keep the stock price down?

Nevertheless, despite these doubts, let’s try to estimate TMMG’s intrinsic value to assess if Mr. Market truly has overlooked an opportunity.

Intrinsic Value Assessment
In the introduction, I mentioned that Mr. Market considers TMMG as a zero-growth business based on a discounted cash flow (DCF) nalysis. The method is outlined in the post How much is LEGO worth?, but let me flesh it out quickly.

You may have heard Warren Buffet say: “Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.” A DCF calculation aims to determine just that. The model seeks to estimate a company’s present value based on the future free cash flows of the business (into perpetuity). In essence, free cash flow (FCF) is the profits that are left after spending the money needed to maintain the operational assets (e.g. property, plant and equipment). Hence, the free cash flow is simply operating cash flow – capital expenditures. FCF is significant, as it represents 1) the cash you could pocket if you owned the entire business, and/or 2) the cash the company can allocate as it sees fit, e.g. reinvest in the business’ growth, pay dividends or share buyback programs. Once we’ve made our projections as to the growth rate of these free cash flows, we need to settle on an appropriate discount rate based on the investment’s risks. Finally, we subtract the business’ long-term liabilities and add its cash position.

According to page 13 of the latest interim report, TMMG has the following debt obligations: £13,852,000 in bank loans; £3,084,000 in short-term liabilities related to acquisitions; £7,889,000 in long-term liabilities related to acquisitions. In total, TMMG’s obligations amount to £24,825 million. The company sits on £6,102,000 in cash. The free cash flow for the past 12 months comes in at £6.526,000. If we plot these numbers into the DCF model and assumes that TMMG’s free cash flow flatlines (0%) forever, an intrinsic value estimate of £0.561 to £0.649 with a 9% and 10% discount rate is returned. There are thus no growth expectations baked into today’s price (if you consider ~ 10% an appropriate discount rate).

Of course, it will be utopic to believe that TMMG can maintain a ~30% growth rate in free cash flows as it has done for the past 7.5 years. I would rather adopt a bit more conservative stance and assume that TMMG grows at the same rate as the economy’s historical rate of 3%. Feeding the model with these assumptions return an intrinsic value span of £0.93-1.1 using a 9-10% discount rate. If one believes in these assumptions, there is an upside potential of 69-103%, see below.

We could also try to value the business using the P/E model. Let’s assume that the current net income of £5,338,000 grows at 7.5% per annum for the next five years (7.5% is 1/3 of the past 7.5 years’ average income growth). In this scenario, TMMG would present a net income figure of £7,483,969 in 2023. If we divide that by the 82.91 million outstanding shares, we arrive at an EPS of £0.0903. If we multiply that EPS by the latest 5 years’ average P/E multiple of 9.5, we can speculate that TMMG is trading around £0.858 in 2023. If we further assume that TMMG continues to pay out 24.8% in dividends, the investor would collect £0.160 in dividends across the five year period. The investor would thus cash-in a return of £0.468 per share (future sales price of £0.858 + £0.160 in dividends = £1.018 – purchase price of £0.55 = £0.468). This translates into a respectable annual return of 13.15%.

Again, whether or not these assumptions are utopic or realistic must be up to the reader to evaluate. It should, for instance, be underscored that these intrinsic value calculations are based on growth. What would happen if we once again face a global recession? This would obviously affect all stocks, but advertising is often the first victim of companies’ cost-cutting initiatives, which is bad news for TMMG – a risk that TMMG acknowledges on page 30 of the 2017 annual report.

Nevertheless, let’s discuss how TMMG can be expected to operate going forward and thus hopefully drive the stock price towards my estimates of TMMG’s intrinsic value of £1.

Strategy
Taking a point of departure in the 2017 annual report, it seems TMMG’ key focus areas are 1) organic growth of the 16 agencies in their portfolio; 2) acquisitions of well-driven businesses (TMMG focuses on acquiring businesses with proven management teams) that can add new marketing disciplines to the portfolio or improve existing services; 3) launching their own start-ups.

In terms of the first objective, TMMG has demonstrated strength within one of the key areas of the advertising business: customer retention. In a sector marked by low switching costs, being able to retain one’s customer’s is alfa-omega. TMMG states that 80% of their operating income is considered recurring. In addition, TMMG’s 16 agencies focus on different industries, geographical areas and/or services, ranging from an agency servicing real estate agents (thinkbdw), a web agency in Asia (Splash Interactive), an agency who caters for the health and wellness industry (mongoose), a center for customer research (Ethologoy) and much more. In addition, TMMG’s customer portfolio count more than 1,000 clients ranging from conglomerates to boutiques. In other words, TMMG seems to possess a well-diversified portfolio of uncorrelated bureaus and clients- That TMMG is growing organically is evident in its consistently growing operating income (see above). According to the latest half-year report, TMMG’s operating income grew by  5% when excluding acquisitions.

For objectives 2) and 3), TMMG seems to have focused on acquiring businesses that could add ‘newness’ in the shape of either customer types, technologies, competencies and geographies. In my view, TMMG seems to have been successful in this regard, as they own aforementioned well-diversified portfolio of agencies. I suppose corporate management’s satisfaction with said portfolio is why they prioritize organic growth above all else going forward.

Management states that acquisitions have been financed with an appropriate mix of equity and debt to ensure shareholders get the benefits of financial leverage without exposing the business to financial risks. If corporate management spots more acquisition candidates that adhere to their stringent requirements for adding additional value and high returns on invested capital, they’ll still be interested. However, the primary focus is, as mentioned, on organic growth as well as bringing down debt and maximizing margins.

In length of the above sections, TMMGs capital-light business model and (hopeful!) continued organic growth in FCF seems to be an ideal foundation to narrowing the gap between the stock price and my estimate of the business’ intrinsic value by 1) reducing debt, 3) share buybacks, 3) dividend payments, 4) acquisitions of value-adding agencies, and/or good ol’ fashioned organic growth.

Risks
In my worried mind, it doesn’t seem like TMMG possess a competitive advantage (or moat). Sure, they own a strong portfolio of agencies and (large) clients, but most competitors would be able to boast of such.

The advertising industry is, as mentioned, extremely competitive and the switching costs are low. If Mars, Velux or Fiat get a stronger strategy, creative output or the like from a competitor, it is quite easy to replace TMMG with X. TMMG has attempted to mitigate this risk by ensuring that a single client cannot account for more than 10% of the operating income. In addition, TMMG boasts of high customer loyalty/retention (see above).

Earlier in this post, I mentioned that a recession would be especially hurtful to the advertising sector. Management acknowledges this fact cf. the half-year report: knows about the semi-annual statement: “Under such circumstances, advertising costs are highly likely to be cut, which will reduce profitability across the sector, thereby reducing the free cash flows available to reduce acquisition and debt liabilities”

Sure, TMMG has grown organically, but a major driver of the company’s historic growth has been acquisitions. As corporate management now focuses on organic growth and ensuring a more robust balance sheet, the expectations to the core business increases. If it fails to live up to these expectations, e.g. because clients shift agency, key personal change jobs (an important factor in a relationship-driven sector), a recession or the like, this failure to grow could cause the P/E multiple to stay low or go even lower than the historic level of 9-10.

Finally, it should be mentioned that TMMG’s management could misallocate capital, i.e. if the  agencies are acquired at too high a price, if the acquired business’ operations deteriorate post-purchase, the talents within said agency changes jobs etc. Unless the acquisitions add shareholder value, it will hurt the business’ finances and with it, the stock.

Conclusion
I don’t neglect the above-mentioned risks, but in my view, the company seems to be mindful in terms of mitigating these risks’ effect on the business. For instance, the high customer loyalty/retention, the diversification of agencies and clients as well as management’s performance in terms of growth and profitability, testify that TMMG is a well-run company with a lot of runway to grow. Despite a handful of serious risks and my conviction that TMMG doesn’t possess a moat per se, I choose to invest in the stock based on its historic performance as well as the seemingly large margin of safety (the gap between the price and my estimate of its intrinsic value).