Ebiquity — Improving growth profile

Ebiquity’s revenues increased by 4.6% to £87.4m, of which 3.4% of growth is accounted for by currency movements and 0.4% from the September acquisition of Australian digital analytics business, Digital Balance (for up to A$5m subject to performance hurdles to 31 December 2021). The mix of revenue growth is consistent with the first half; a strong performance from the MVM practice outside the US was offset by the US MCA and US media business, with MI stable overall. Like-for-like constant currency growth of 0.8% signifies a better underlying growth rate in the second half.

EBITA margins decreased by 2pp to 13.8%, in part a result of the group’s strategy to invest an increasing share of revenues in enabling its consultants with market-leading technology, and in part owing to continued weakness from its US businesses. Consequently, normalised PBT decreased by 7% to £11.0m. Reported PBT of £4.5m includes £6.5m of one-off or non-cash items. These relate to acquisitions and restructuring costs (£3.8m), deferred consideration and share-based payments (£0.7m), and amortisation of acquired intangibles (£1.9m).

Underlying cash conversion from operating profits remains strong at 93% and the board is proposing a dividend of 0.71p (+10% y-o-y). Year-end net debt remained broadly stable at £28.9m, 2.1x EBITDA.

In February, Michael Higgins, chairman for 12 years, announced his retirement with effect from 9 May 2018. He will be replaced by Rob Woodward, who has significant experience in the TMT industry. Rob was CEO of STV Group for 11 years to January 2018, prior to which he was commercial director at Channel 4 Television. Earlier in his career he was MD with UBS Corporate Finance and the lead partner for Deloitte’s TMT industry group in Europe. Rob is also non-executive chairman at AIM-listed Blancco Technology Group.

Excluding the MI division, which contains the soon to be divested AdIntel business, like-for-like revenue growth was 5.5% in H217, compared to 2.3% across the year.

MPO (15% group revenues, 20% FY18 pro forma revenues): total revenues decreased 2.3% y-o-y (7.7% like-for-like) and the weakness in MCA had a material impact on margins, which decreased to 12.9% (FY16: 28.7%).

MVM (59% group revenues, 80% FY18 pro forma revenues): revenues increased by 9.3% (5.2% like-for-like) with an operating margin of 27.3% broadly as expected. In a continuation of the trend seen in H1, the contract compliance division, FirmDecisions, performed very well, benefiting from the visible step-up in the group’s marketing efforts and the industry’s increased engagement on the issue of media transparency. The media benchmarking business outside the US also performed well, but the US business continues to be under pressure from lower overall media spend and the trend towards zero-based budgeting. During Q417 and Q118 a new leadership team was recruited to re-energise the US Media practice.

MI (26% group revenues, 0% FY18 pro forma revenues): revenues decreased by 0.9% (3.1% like-for-like), reflecting stability in the AdIntel business and continued declines in the project-based reputation business, which now accounts for only £1.3m of revenues. This reputation business has subsequently been divested.

In February EBQ announced the proposed sale of its Advertising Intelligence business (AdIntel) to Nielsen for £26m in cash before taxes and transaction costs. The transaction is expected to complete during Q218. However, as CMA approval is required, this could be delayed to Q4 should it require a more detailed Phase 2 investigation.

The AdIntel business accounted for the majority of EBQ’s MI division, comprising £21m revenues and £4.4m EBITA (before central overhead allocation).

In 2016 management presented its plan to accelerate growth, principally by investing in the faster growing MVM and MPO practices. The proposed divestment of AdIntel is entirely consistent with this strategy, leaving a more focused group with the balance sheet flexibility to accelerate growth opportunistically:

Faster growth profile: over the last few years, the AdIntel division has struggled in the face of pricing pressure and the rapid rise in digital advertising. An upgrade to the Portfolio platform was introduced last year and, to complement its services in traditional media, in H117 it launched its Digital platform. Although this has helped stabilise divisional revenues, the growth outlook remains inferior to MPO and MVM, as do the operating margins (see Exhibits 2 and 3 below).

Streamlined business: the divestment would enable a simpler group structure, focused on the higher-growth consulting services, which operate similar relationship-based business models. As well as simplifying the overall business model, management sees the potential to reduce central overheads by up to £0.7m over time. Reflecting the more aligned structure, EBQ is rebranding its divisions as Ebiquity Media (MVM), Ebiquity Analytics (MPO) and Ebiquity Tech.

Strengthened balance sheet: the pro forma net debt to EBITDA gearing of the group would reduce from 2.0x at December 2017 to 1.0x, providing flexibility to invest to accelerate growth in MVM and MPO; in particular in terms of its data science capabilities.

Much of the 3pp revenue shortfall compared to our forecasts came through the MPO division. While the US MCA issues knocked growth off course during 2017, the client losses appear fairly isolated, action has been taken to bring the US back on track and the performance of the division outside the US remains strong. We rebase our forecasts for FY17 results, but maintain our 10% revenue growth forecast in this division in FY18 and 7% in MVM. Net of small changes to tax (24%) and finance costs, we reduce our FY18 adjusted diluted EPS forecast by 5% to 8.9p. We also introduce forecasts for FY19, which assume a similar growth rate in revenues and margins.

Given the uncertainty on timing of the divestment of the AdIntel business, at this stage we have not carved it out of our forecasts, but present FY18 and FY19 pro forma figures in Exhibit 4 to demonstrate the shape of the business assuming it is divested as of 1 January 2018.

On a pro forma basis, the sale of AdIntel translates to a c 2pp uplift to our revenue growth rate in each year. In our pro forma operating margins, we assume that a full £0.7m of savings is achieved by 2019. Despite this saving, allocating higher central costs to a smaller business means that we believe pro forma operating margins of c 11.6% are achievable in 2019, approximately 1pp below our forecast for the ongoing business.

The difficult trading environment in the US, paired with a declining margin, has weighed on the shares’ performance over the last year and the shares now trade at a c 25% discount to small-cap agency peers. However, we believe this rating undervalues the MPO and MVM practices, where we forecast a pick-up in like-for-like revenue growth in FY18. Should the divestment of the slower growing, lower-margin AdIntel division proceed as proposed, we expect the overall growth profile of the group to improve, in which case an in-line rating may be more appropriate. A 10x EV/EBIT multiple (broadly in line with the peer average) applied to FY18e pro forma earnings would suggest a share value of c 90p.