• by Steve McClellan  @mp_mcclellan, April 13, 2015

Brian Wieser, the senior analyst at Pivotal Research, has downgraded all four of the biggest agency holding companies -- urging investors to sell WPP, Omnicom and Publicis while urging stockholders in Interpublic Group to Hold their position.

“Stock prices on each company were already pushing the boundaries of prior ratings, but emerging concerns among marketers around different forms of agency rebates in the United States causes us to partially (if slightly) re-assess some of our views on long-term holding company growth,” Wieser writes in a report issued early Monday. “With a drumbeat of negativity to come from marketers only now learning about the issue, we recommend investors move to sidelines or exit the sector for the time being.”

This is how Wieser explained his dramatic reassessment of the agency business: “Behind our favorable long-term view on agencies over the years was the notion that fragmentation and reliance on digital advertising helps agencies -- especially those with heavy exposure to media trading -- given the reliance on labor required for digital media, and value-added services such as branded content production, barter and programmatic trading. All of this would, we thought, elevate organic growth despite relentless client pressure on fees.”

“However, we have reassessed our view in recent weeks with growing awareness of the topic of undisclosed agency rebates (aka “kickbacks”) in the United States.”

Wieser added: “The volume and specificity of allegations by aggrieved media owners, former agency executives and marketers are difficult to ignore. Rightly or wrongly, there is a growing perception among marketers that agencies have been misleading, transferring value associated with media volumes without clients’ full understanding or support. (Note we distinguish “support” from “authorization,” which we don’t doubt agencies pursue at every turn.)

Between cash rebates, consulting arrangements, vendor-funded staffing or services, inventory banks, equity provided for spending volumes, shifting of inventory from one entity to another and all of the above practices involving volumes in one country shifted in exchange for benefits in another, few marketer-clients in the U.S. fully understand the specific arrangements their agencies undertake with media owners.”

Wieser has repeatedly noted that WPP, at least, is transparent about its lack of transparency.

“We note that among our coverage, WPP is probably the most ‘immunized’ from problems that may follow in this area as its management has been most vocal in defending the notion that agencies deserve to get paid, and that they have the right to be ‘transparent about being non-transparent,’ he said. "This is an appropriate position to take, even if under-paying clients don’t like to hear it.”

But, Wieser added, “unfortunately, other than WPP, none of our coverage disclose gross revenue versus revenues net of media trading. None break out revenue from barter, cash rebates, consulting or media agency “research” fees, the book of business from media inventory banks nor trading with equity investees.

Consequently, it is difficult for the companies’ clients -- or investors –- to identify the degree to which different agencies’ historical growth rates have been supported by the aforementioned activities, which may impact benchmarks for future growth.”

“More tangibly,” Wieser added, “for investors to consider is that clients’ scrutiny of fees and relationships with media owners will surely expand as trading practices are explored in greater depth, pressuring organic revenue growth and / or margins more than has been the case in recent years. For reference, media agency groups represent 15%-20% of revenues at each of the holding companies and have been growing by low double digits organically with margins typically exceeding 20%.

"While agencies are always capable of finding new revenue streams from new business lines (such as IT consulting associated with marketing technologies), it’s hard to imagine that new pressure on the media business won’t impact long-term holding company growth versus. what previous assumptions. Put differently, it may be too optimistic to think that larger agencies can escape the gravity of clients’ businesses and concerns.”

Wieser said it was hard to estimate “how much of a haircut to growth might follow” for holding companies.” It is “subjective, not least as we don’t know the scale of revenues and cash flows at risk. For now, we are reducing long-term growth by 0.5% for each of WPP, Publicis and Omnicom as our expectations for their dependence on media was higher than for IPG, whose position in media was weaker to begin with. (We also previously incorporated our lowest long-term growth rate among holding companies for IPG, and reduce growth for them by 0.25%).

"All of this may ultimately cause only an imperceptible difference in growth, but as marketers become more vocal about undisclosed rebates and more specific allegations come to light, a drumbeat of negativity will build around the sector over the course of this year. Given this risk, we’d recommend that investors move to the sidelines or exit the sector altogether while it all plays out.”