30 June 2008
Advertising Agencies
Global ad market slowdown is
knocking at the door
Matt Chesler, CFA
Research Analyst
(1) 212 250 6170
matthew.chesler@db.com
Transferring coverage: Downgrade IPG to Hold, Maintain Hold on OMC
Of the five sub-sectors that we cover, we like the agencies well ahead of the
others (marketing services, magazines, yellow pages, and newspapers) due to its
strong structural tailwinds. We are downgrading IPG from a Buy to Hold, as we
are concerned that an ad market slowdown may delay its timeline to achieve peerlevel
margins, and maintaining our Hold rating on OMC while we look for a more
attractive entry point. Our UK-based analyst Patrick Kirby has a Buy rating on
Aegis, a Hold rating on Publicis and Havas and is restricted on WPP.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Transferring Coverage
Top picks
Interpublic Group (IPG.N),USD8.74 Hold
Omnicom (OMC.N),USD45.05 Hold
Companies featured
Interpublic Group (IPG.N),USD8.74 Hold
2007A 2008E 2009E
EPS (USD) 0.08 0.48 0.68
P/E (x) 140.6 18.2 12.9
EV/EBITDA adj (x) 7.6 3.9 3.4
Omnicom (OMC.N),USD45.05 Hold
2007A 2008E 2009E
EPS (USD) 2.97 3.32 3.59
P/E (x) 17.2 13.6 12.5
EV/EBITDA adj (x) 9.4 7.7 7.3
Global Markets Research Company
Global ad market downturn not here yet, but likely coming
Cyclically, agencies are typically the last to see an economic slowdown in their
results as agency growth lags movements in the underlying advertising market by
six to nine months. We believe the chances of a slowdown in 2H08, if not 2009,
are increasingly likely. This deceleration sets the stage for disappointing agency
performance in the coming quarters, and therefore limited upside in the shares.
Tough for IPG to work in an ad market slowdown
While IPG has achieved peer-level organic growth and is on its way to performing
like a “normal” agency, we think a slowing ad market will delay its ability to get to
peer-level margins. Unless the market sees a pathway to bridging the margin gap
within a reasonable timeframe, we do not think it will pay a premium for the
opportunity. We continue to believe the margin opportunity will reward very
patient investors, but we prefer to invest closer to the payoff. We downgrade the
stock from a Buy to a Hold, and lower our price target from $13.50 to $10.00.
Stocks are fairly valued for the near-term risk of slower growth
The agencies may be moving into a period of slower growth in part due to the
cyclical headwinds, and we think this is fully reflected in the current multiples.
Overall, OMC is trading on a 7.6x ’08 EV/EBITDA and 13.5x P/E multiple, a 4%
discount to the S&P 500 at 14.0 versus a historical relationship of par to a 10%
discount typically in periods of slowing growth. IPG is at 6.3x ’08 EV/EBITDA, a
deserved discount to the peers at 6.8x, but at a P/E premium at 18.0x versus 11.2x
for the peers. See full valuation section beginning on page 11.
Biggest upside risk: less-than-expected organic growth deceleration
The major upside risk to our Hold recommendations on IPG and OMC is organic
growth not decelerating as much as expected, which would most likely be due to
marketing services or digital acceleration. Also, even if ad spend does decelerate
in 2H08, there is a risk that the stocks may still rise if the market sees signs of
improvement in the economy and believes that spending will rebound in 2009.
Downside risks include an economic slowdown that is more severe than currently
expected, loss of key clients due to reviews or mergers, loss of key personnel to
other agencies or start-ups, and restrictive government regulation on ads.

Investment thesis
Interpublic Group (IPG) – Hold rated, $10 price target
Give management credit. CEO Michael Roth and CFO Frank Mergenthaler have done much
to turn the business around, including patching up the financial systems, bolstering talent and
restoring the competitiveness of the media offerings. For their efforts IPG has achieved peerlevel
organic growth, and while peer-level profitability has been an elusive goal, 8.5-9.0%
EBIT margins in ’08 (and improving cash flow) is headed in the right direction and a
substantial improvement from where they started. IPG may not yet be able to claim that it is
a “normal” advertising agency, but it is well on its way.
The problem for IPG is the ad market, or at least our view that a second half slowdown is
increasingly likely. Simply put, we don’t think the stock can work in an ad recession. IPG has
exceptional margin improvement opportunity, but a slowdown in spending by clients (new
business is only slightly positive this year, and there are fewer pitches) could make it that
much harder to leverage new hires. Unless the market sees a pathway to bridging the margin
gap within a reasonable timeframe, we don’t think it will pay a premium for the opportunity.
Based on our valuation work, we think the market is still factoring in high-single digit margins
at least through 2009. IPG shareholders are afforded some downside protection by the
potential takeout of IPG by private equity or a strategic bidder, namely Publicis, which we
believe puts a floor on the stock not far below current levels.
Downside risks for IPG: (1) elusive margin expansion due to higher-than-expected staff costs
or not enough new business wins to leverage new hires, and longer-than-expected time to
reduce professional fees, (2) larger-than-expected revenue deceleration in 2H08 due to
economic slowdown, and (3) account losses or decreased spending at major clients like GM
(due to market share losses and spending shift to digital or new marketing channels).
Omnicom (OMC) – Hold rated, $46 price target
OMC is the best-of-breed operator in the agency space that consistently delivers peer-leading
organic top line growth and reliable, peer-level margins. The company has led the industry in
diversifying out of traditional creative and media and into the faster growing marketing
services disciplines, which should enable it to monetize the structural shift in spending from
traditional mass to non-traditional targeted media, and to outgrow its peers. The only knock
on OMC is that it is not as levered to emerging markets as WPP, Publicis, or even IPG, so it
may need to spend more via acquisitions to build larger positions in those geographies.
Unfortunately, OMC’s strong operational performance makes it a universally loved company,
which in our view makes super-normal returns from the stock difficult unless investors are
willing to invest during recessionary periods or when the stock takes a hit for some
temporary, non-structural reason (i.e. worries about accounting). But given our view that
consensus expectations for 2008 are too high, we think the upside/downside risk is skewed
downward until concerns about the consumer subside. We continue to wait for a better
risk/reward entry point on OMC, which may be when market expectations more fully reflect
the ad market slowdown or that the top line deceleration is not as much as expected.
Downside risks for OMC: (1) an economic slowdown that is more severe and prolonged than
expected, leading to ad budget cuts, (2) loss of key accounts due to review (eg., potentially
VISA), merger or personnel departures, (3) margin pressure due to lower earnings at clients,
and (4) overpaying for acquisitions as OMC builds out its marketing services and international
offerings.