Can The Roll-Up Strategy At MDC Partners Keep Rolling?

If you snooze in a bull market, you lose. I had intended to look into MDC Partners (MDCA) back in the summer and didn't get around to it. The stock is up about 100% since then, which makes that a pretty expensive delay.

Although I don't think MDC Partners is going to double again over the next six months, I do think this stock has room to rise from here. I expect the company to continue to post organic growth well ahead of the industry average and identify acquisition opportunities outside North America that can expand the business further. The advertising industry has its ups and downs and this company remains on the outside of the ruling oligarchy, but competitive wins and a focus on interactive marketing could make it a more serious challenger in the coming years.

Top Ten … And Growing

MDC Partners has bought and built its way into the top 10 of advertising agencies (eighth, by most accounts). Like other large advertising and marketing services companies, including WPP (WPPGY) and Interpublic Group (IPG), MDC Partners is basically a holding company of numerous agencies - MDC owns all or most of approximately 50 agencies spread across North America and Europe.

Investors are right to be nervous about roll-up situations where companies just keep buying and buying to stoke growth. That's particularly true in cases like MDC Partners (and advertising in general) where those acquired agencies are generally kept relatively independent and separate from each other.

There are good reasons for this approach, though. First, the best advertising people tend to be creative and independent, and trying to consolidate everybody into a tightly-run, uniform system doesn't usually work so well. With a looser holding company structure, agencies can benefit from shared infrastructure (like MDC Partners' agency trading desk) and best practices while still being free to maintain their own style and approach.

Second, the holding company structure creates options. There would be reasonable concerns about conflicts of interest in having the same agency running ad/marketing campaigns for two companies in the same industry, but different agencies under the same advertising company umbrella could manage that without the conflicts. Likewise, if a client is unhappy with a particular agency there is a chance to move the account to another agency and keep that business "in house".

Last and not least, a portfolio of agencies has a smoothing effect on the overall results of the company - some will be growing well, some will be underperforming.

Not Just An Acquisition Growth Story

Although MDC Partners does get a boost to its growth rate from acquisitions, it's not the dominant source of growth in recent periods. Instead of buying large, well-established agencies, MDCA management looks for small firms that they believe are "on the cusp" of significant growth.

MDC Partners has been posting organic growth around two to three times the industry average recently. Some of this is a question of scale. About 60% to 70% of the advertising market is controlled by the largest firms (including WPP, Interpublic Group, and Omnicom (OMC)) and growth is a little easier to come by when you're one-tenth the size of your largest competitors.

I don't want to dismiss real progress at the company, though. The company has won awards for work it has done for BMW, Samsung, and Fiat, and won accounts like Charles Schwab and Microsoft from Havas and Interpublic. Moreover, the company is heavily weighted toward digital and interactive, not only one of the fastest-growing areas of advertising, but one where established agencies at rival firms are less competitive and certainly less entrenched.

MDC Partners has also been able to broaden its business and recruit more large accounts while simultaneously being less dependent on large accounts. MDC Partners now counts about 40% of the Fortune 100 among their clients, against about 5% seven years ago, but those major clients are individually a smaller part of the company's revenue.

Can MDC Partners Unlock The Leverage?

There is a lot that is going right for MDC Partners. The company is only just starting to go after international business in countries like China, and the company's media planning and buying segment is seeing very good growth.

It looks like the company is really starting to tap into its operating leverage possibilities, as EBITDA margins have moved into the double digits. Importantly, MDC Partners is seeing strong double-digit organic growth from its Strategic Marketing Services segment, which produces roughly double the EBITDA margins of the more analytics-focused Performance Marketing Services segment.

I'm not looking for MDC to blow away the industry with its top-line growth, as I'm looking for long-term growth in the neighborhood of 6%. I am looking for strong operating leverage, though, and for EBTIDA margins to move from the low teens and up through the mid teens as the company increasing leverages its existing infrastructure and internal investments.

Speaking of leverage, MDC Partners does have a lot of debt and has a net deficit in lieu of positive shareholders equity. This certainly ratchets up the risk if the economy sours or MDC Partners' agencies lose their touch. Management is looking to reduce its leverage ratio, but won't refuse a promising acquisition to do so.

The Bottom Line

Combining my growth and operating leverage assumptions, I come up with a DCF-based fair value of about $31 for these shares. MDC Partners currently trades at around 10x 2014 EBITDA, which is neither all that high relative to its peers/competitors, nor its likely EBITDA growth rate over the next three years.

As I said, I don't expect MDC Partners to double again right away. I do think, though, that there's a case to be made that this is a stock that could outperform the market by a comfortable margin over the next year or two.

Source: Can The Roll-Up Strategy At MDC Partners Keep Rolling?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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