Publicis bids $3.7bn for Sapient Inc. – how to buy ‘organic growth’

Finding a marriage of ‘equals’ with Omnicom was not to its tastes, Publicis is back to what it does best; hoovering up smaller digital marketing operations. When you are not a Wonga client and can borrow at only 2.6%, then buying in a business on an operating profit yield of approx 5.5% before synergies and 7.0% proforma post synergies also makes a lot short term sense in terms of short term EPS accretion, particularly when it enhances your own flagging organic revenue growth and you can step-up the proportion of claimed digital component from 40% to 50%.  EPS accretion however does not equate to value enhance in these QE distorted markets

So what is Publicis buying here? Sapient is essentially a consultancy business focusing on digital marketing solution for range of both commercial and government clients. Revenues are substantially generated from fees (usually time +costs) and as with all consultancies, compensation is the major cost. At almost 72% of revenues however it is considerably higher than the approx 60% ratio for most larger marketing agencies, notwithstanding that 66% of Sapient’s staff are located in India. In terms of historic revenue growth, Sapient’s performance  has been good at >+10% pa, albeit with limited operational leverage to margins that remain at under 11%.

  The valuation

Historically, Sapient has traded in a growth rating range of +3.8%/+6.8% and a mean average of +5.2% against an average revenue growth rate range between +5%/+25% and +14% average.  Applying a growth rating range of +5.6/+5.8% on prospective operating FCF, the valuation for the stand alone enterprise comes in at approx. $19/$21 per share vs the $25.0 ps cash offer being made this morning by Publicis

Sapient worth $19-21 ps pre-synergies

Mapping the WYT npv calculator into a chart (below) suggests that the shares had not been running ahead of their growth delivery in the run up to this offer

Post acquisition synergies take the valuation range to $25-$26 per share

Publicis is a past master in eking out cost savings from its acquisitions without imploding  the acquired growth.  For Sapient, Publicis expects to extract cost synergies of $50m/$60m pa which is probably an under-estimate on past performance. Adjust Sapient’s earnings for this to derive a proforma operating FCF and see what happens to the valuation in the table and chart below.

proforma incl €50m savings

Include an adjusted chart history and presto!

Proforma