Creston — Update 13 June 2016

Creston is a marketing communications and consultancy business. It consists of a group of specialist agencies that between them provide a full service offering. Each has its own corporate identity and approach, but all have a common branding through the use of the Unlimited suffix, introduced across the group during the last year. The agencies have a distinct data and technology backing. Creston has a strong and diverse client list, with unusually long (for the marketing service industry) tenures and has specific expertise in the health sector. The group’s growth strategy is a combination of organic progression (winning clients, adding incremental business), acquisition and start-ups to add capabilities, alongside partnership agreements with like-minded companies to fill in either complementary offerings or geographies.

Following a period of recovery earlier last year, the shares have drifted back down over the last eight months from a high of 162p, with the current share price only a little off the one-year low. This reflects market disappointment that the promise of a good record of winning new business and tighter control of overheads has yet to translate into growth in earnings per share. By delivering a set of results that have more than met market expectations, a level may have been set from which a recovery can launch, not only for the earnings but also for the share price. Applying a peer group multiple, and allowing for a 10% discount to reflect the record, results in a valuation of c 150p. Similarly the DCF, using a WACC of 10% and conservative assumptions, supports a valuation in excess of the current share price.

Our revenue and profit forecasts for FY17e are unchanged on publication of the FY16 results, which were slightly ahead of our prior expectations. We have instigated FY18 forecasts, which are inevitably provisional, but which show 3% growth at the revenue level and 5% progress at pre-tax to £11.0m. Forecast growth at the earnings per share level is slightly lower due to a higher proportion of US earnings raising the expected blended tax charge. Creston has very good cash conversion characteristics and had net cash of £1.4m at end March, with no debt on the balance sheet and no further outstanding acquisition consideration liabilities.

The broader market backdrop shows expectations for premium growth in advertising spend in both the UK and US, well ahead of growth in GDP. This is still driven by digital, and mobile in particular, but corporate confidence remains very fragile and campaigns and projects continue to be subject to delays and cancellations. Specific market segments, such as retail, are particularly nervous ahead of geo-political uncertainties, while the backdrop to the Health segment is continuing corporate realignment. The group has an impressive record of tenure at its substantial clients, but nothing is guaranteed and while the increased use of procurement officers is reducing the impact of personal relationships with CMOs, unanticipated shake-ups in the supplier base could impact client retention. The increase in overseas-derived earnings is increasing the specific currency risk, where the group’s costs are sterling-based.

Creston is a marketing communications group. It operates through a number of agencies, unified under the ‘Unlimited’ suffix branding, delivering digital and technology-based marketing solutions to a broad range of global clients across many different sector verticals. Its offer includes social, multi-channel creative and digital solutions, often integrated with more ‘traditional’ approaches. The agencies making up the group fall into two broad groupings: Communications & Insight and Health (under the Health Unlimited banner). The offer as presented to clients can be categorised as covering communications and consultancy, with the individual agencies offering the required disciplines either singly, or, increasingly, in combination. Digital capability and delivery is a given in all areas of the business and is no longer separately identified. Having different branded agencies helps to manage the inevitable client conflicts. A new executive leadership team in place as of FY15 has instigated a clear and coherent five-year growth strategy, of which the second year has just been completed, although the rewards are yet to be fully reaped.

The group was founded in 2001, when Don Elgie (CEO until his retirement in 2014) backed Synergie Consulting into London Stock Exchange-listed cash shell, Creston. The group then pursued a buy-and-build strategy, building a portfolio of broadly complementary marketing services agencies, rather than focusing on a single discipline. Instead of driving profitability by stripping down overheads, the majority of managing directors of groups sold to Creston have remained in place. Over subsequent reporting periods, the emphasis became more balanced between acquisition and start-up, adding additional capabilities and skill sets to the group’s offer. With inherently strong cash generation, the group has been able to accelerate this expansionary phase with the recent acquisition of Splendid and with strategic partnerships, such as that put in place with Serviceplan Gruppe in November 2014. Further partnerships have been forged with Future Foundation (Global Consumer Trends), Propeller Communications (Digital Healthcare Communications in the US) and a ‘close working relationship’ established with Hakuhodo in Japan where another partnership covering media is in discussion. These arrangements give Creston a low-risk option to extend its geographic reach. There has been no consideration paid or equity swapped in respect of these relationships, simply agreements to look after each other’s clients in respective territories, eg with Creston responsible for the UK and US markets and Serviceplan responsible across Europe, effectively allowing both parties to offer pan-European coverage as is demanded by some international clients.

The group employs around 900 people in the UK and the US, based around hubs in London, Bristol, Richmond (Surrey) and New York. There are nine client-facing brands in Comms & Insight, all with identifiable specialisms and eight within the Health operations, all now with the Unlimited suffix.

As a group, Creston has a broad and loyal client base. The top 20 clients make up 51% (FY15: 54%) of revenue and nine of the top 20 are now served by two or more group agencies; 12 of the top 50 clients by three or more. The average fee generated by these top 20 clients is £2.2m, up over 10% on the prior year, which itself reflects the success in introducing other group agencies to existing clients and joint pitches for new business.

The group’s new business continues to perform well, and these results show that the group’s propositions were holding sway with new clients as well as those who have been with Creston a while, with brands new to the roster accounting for 63% of annualised new business wins. CRM and data strategy have been particularly strong areas, with their data element making those clients likely to be more ‘sticky’ as historical reserves of relevant information build. New CRM customers include Asda, British Airways, Vodafone, Costa Coffee and Weetabix. British Airways and Mitsubishi are among new clients placing business with more than one group agency.

FY16 was the second year of the implementation of management’s five-year plan which identified five core strategies in order to drive both top line and margin growth within the company. Progress has been made on all five criteria, as outlined below:

Branding & Advertising

CRM & Loyalty

Social & Content

Technology & Innovation

Local & Experiential

PR & Comms

Media & Performance

Data & Insight

The consultancy offer currently tackles the following:

  Digital transformation

  Service design

  Product innovation

  Market optimisation

  Digital optimisation

  New market opportunities

The main board changed considerably in 2014, with the appointment of former CFO Barrie Brien as CEO and the appointment of Kathryn Herrick as CFO. Since then, the line-up of non-executive directors has also been refreshed, with Chairman Richard Huntingford stepping down in March 2016, replaced on a temporary basis by senior non-exec Nigel Lingwood while a replacement is sought. Kate Burns (Bebo, AOL, Google) joined as a non-executive and chair of the remuneration committee, while Nigel Lingwood (FD of Diploma) joined in July 2015. Iain Ferguson (ex-Havas) was appointed to the board in February 2016 to represent the interests of DBAY Advisors, which holds a 28.05% equity stake.

Both Barrie and Kathryn sit on the operational board, alongside Tim Bonnet, who chairs the Communications & Insight operations and Nicky Walsby, who runs Health Unlimited. They are joined by Richard Marshall and Paul Tullo, the M and the T of TMW Unlimited. The average tenure of the executive management team is approaching 14 years.

There is an unsurprising and clear correlation between the condition of the global economy and the amount that is spent on advertising. The additional volatility of the ad spend cycle over the last 20 years is also immediately apparent from Exhibit 4, above. There are two particular points of note about the interrelationship. First, there is no lag (or lead) between the two economic indicators. Second, projections over the three years 2016-18 show the continuing influence of the faster growth of digital and mobile ad spend. There is, though, still a tendency for clients to adopt a cautious stance and judge success on short-term horizons, rather than focusing on long-term investment and on building their brands. For two of Creston’s core markets, the UK and the US, the indications are for further outperformance of the overall economy over the next three years, with a more marked projected outperformance in the UK.

Within the specific healthcare and pharmaceutical markets, the period of intense corporate activity among the major companies as they sought growth and built on their strongest areas of influence has slackened off. What is clear is that drug companies need to get smarter at driving demand from both the procurement layer and stimulating the demand pull from the ultimate consumers. This applies across products to address medical needs and those designed to promote wellness, which is bringing a new swathe of potential clients into the arena. The need for professional marketing communications and services is clearly established, as is the growing willingness for pharma companies to work in partnership to outsource expertise.

In both areas of the business, the need for an understanding of the data generated has become integral and it is no longer sufficient simply to put promotional material in front of an audience. The technical demands of delivering an integrated, multi-channel campaign and measuring its impact in real time are considerable, but when agencies do it well, clients will allocate a larger proportion of their dedicated budgets and should be less likely to chop and change suppliers.

Creston’s financial performance will be affected by external economic and industry factors, as well as by its own actions. These can be broadly summarised as follows:

We monitor the pricing and valuation of a range of smaller agency stocks, as well as the marketing services holding companies. Creston’s peer group is clearly the former.

The share price has retreated from a high of 162p at the beginning of October 2015 as progress on the trading front hesitated. A further mark down followed the cutting of forecasts in January when it became clear that the poorer trading in H216 would not be recouped in the financial year.

At current prices on a 2016 annualised EV/EBITDA basis, there is a wide divergence of valuations within the peers, with Creston, The Mission Marketing Group and SpaceandPeople all valued by the market at similar levels, at a substantial discount to the sector average. Excluding WPP from that average (on grounds of scale and complexity) brings the average in to 7.8x. Applying a 10% discount to reflect the limited liquidity and a mixed long-term historical record, the multiple equates to a share price for Creston of 150p, as shown below. This is over 50% ahead of the current level (c 95p). The dividend yield is the most generous amongst the peer group.

We have also looked at the valuation using a DCF method under varying assumptions, which return valuations considerably above the current share price, backing up the peer valuation basis. For example, as summarised in Exhibit 9, using a terminal growth rate of 2% and a 10% WACC generates a value of 125p per share.

On all of these measures, the current share price of 95p is well below the less generous end of the range. As the route to acceleration in the rate of earnings growth looks smoother, there is clear potential upside to the share price.

The full year results came in a little ahead of expectations as recalibrated in January.

The setback earlier in the year was primarily attributable to weakness in business in the retail and consumer technology segments (see our notes of January and April), with client delays and cancellations and general volatility in spending patterns.

For the full year to March, overall revenues were ahead by 8% to £82.6m, with like-for-like, constant currency broadly flat at £76.5m (currency added 1-2%, with the benefit of the strength of the US dollar offset by the impact of the weakness of the euro). The net currency impact in the period is assessed at a cost of £0.4m at both the revenue and profit levels. The acquisition of How Splendid, now Splendid Unlimited, added £5.9m into the top line and £1.6m to the PBIT level.

Given the weakness in the two key sectors identified above, the group acted quickly to protect its margin at the operating company and at the group level. Headline PBIT of £10.1m and PBT of £9.9m were 4% ahead of our revised numbers, showing the positive impact of headcount reductions. The group had staffed up earlier in the financial year following a very successful run of new business wins, which had to be reversed in the second half as existing revenue streams came under pressure. The benefit of this overhead reduction will be reflected in the FY17e figures. The long-term record shows the steady progression in revenue, which has not as yet translated into growth in earnings per share. However, the group’s strong underlying cash conversion has enabled good growth in dividends since 2010.

Looking at the group figures masks the disparate performance of the two reporting segments, shown below. Comms & Insight recorded top line growth of 12% in the year to March 2016, whilst Health declined by 5%.

The priority across the group is to grow the operating margin from the group level of 12.2% in FY16 through growing margin at the operating level and keeping head office costs as low as is practicable. An annualised £1.2m has been taken out of non-client facing operating costs, split £0.7m to Comms & Insight and £0.5m within Health removing the regional management structure. The effect of this can be seen in Exhibit 14 below. Health margins are still ahead of those in the rest of the business, but are not at optimal levels. Health has also seen a concentration in its client base in the larger accounts and a marked tail off in the business from the long tail of clients, leading to the overall reduction in divisional revenue of 5% (8% on a like-for-like basis).

The headline tax charge of 20.5% reflects the decrease in the rate of UK corporation tax and we expect the rate to tick up as the proportion of earnings generated in the US increases.

The results included a non-cash exceptional impairment charge of £15.2m taken on the book value of ICM Unlimited and DJM PAN Unlimited, allocated £10.7m to the former and £4.5m to the latter. An exceptional item of £2.0m had been identified at the half year stage as the cost of withdrawal from FieldWork UK at ICM, part of the Insight operations, following structural shifts in the market. This further write-down is on the goodwill carried on the balance sheet in regard to more conservative estimates of what the business is capable of earning in future years. A similar appraisal exercise identified a further discrepancy in the carrying value of DJM PAN Unlimited, two of the Health agencies that had been merged.

Other headline items totalling £2.2m were also indicated, the largest element (£1.3m) relating to acquisition, accounting and deal related costs, alongside restructuring and closure related costs of £0.5m and start-up related net losses of £0.4m.

Creston has naturally strong cash conversion, with little requirement for capital expenditure. For the year just reported, operating cash flow of £10.6m equated to a conversion of 111% against reported EBITDA, giving a five-year average cash conversion figure of 92%. The group’s working capital position is well controlled, with an improvement in the position over the year despite the Splendid acquisition.

The group now has no outstanding deferred consideration on earlier acquisitions. There are call options over a further 24% of the equity of Splendid (51%-owned) but actioning the option is entirely at Creston’s discretion. The last payments for Cooney Walters and DJM PAN were made in FY16 (£1.4m).

As at end March, the balance sheet showed a net cash position of £1.4m and our model shows this increasing to £4.2m at end FY17 and £7.0m the year after. There is no debt. However, there are facilities in place of a revolving credit arrangement of £25.0m (including a £5.0m overdraft) and an optional accordion of £10.0m. Further share buybacks are a possibility but a decision on this will wait until the short-term market worries have subsided.