Ida Axling
Jul 27, 2022

Growing ‘too quickly’ and risk of ‘talent exodus’: analysts' verdict on S4 share slump

Sir Martin Sorrell's S4 Capital is determined to prove it 'still is a very strong company'

Growing ‘too quickly’ and risk of ‘talent exodus’: analysts' verdict on S4 share slump

Analysts have stated that S4 Capital has “grown too quickly” and warned of a potential problem in retaining talent, following the company’s profit warning on 21 July.

In a trading update on the London Stock Exchange, S4 Capital warned staff costs were rising faster than revenue (known as gross profit) in its content practice and promised “significant cost reduction measures, including a brake on hiring”.

S4 Capital’s share price almost halved on the day to 120p, to end 86% below where it was at its highest point of 870p in September last year.

The business, which was set up in 2018 by Sir Martin Sorrell, said it was confident in hitting its 25% top-line growth expectations for the year ending 31 December, but admitted that its bottom line would be hit.  

S4 Capital stated it would prefer to lower expectations for its target Ebitda for the full year to about £120m, noting that analysts had previously forecasted Ebitda in the range of £154m-165m.

The company had unnerved investors earlier in the year when it twice postponed the publication of its 2021 annual results due to an audit delay. “Control weaknesses, staff turnover and lack of detailed documentation” were all issues at S4 Capital, the company told investors in May.

The profit warning in July was a fresh blow. 

Stock market analysts' view

The “lack of central controls appears to be worse that expected”, caused by the content division “hiring aggressively based on revenue forecasts that central management deems too high”, according to analysts at Barclays, which suggested that the company had "grown too quickly".

They continued: “Investors now face a simple question with a difficult answer. Does this represent the last problem the company faces (in which case 25% top line growth for 8x P/E [share price to earnings multiple] would appear very good value)? Or will central management asserting control on individual companies and a low share price lead to a talent exodus resulting in the top line slowing?”

Barclays analysts stated that they were “leaning towards the former”, but added: “We admit that our confidence has been knocked by the successive issues of the delays to the accounts and now this profit warning. We reduce our price target to 360p from 550p owing to lower forecasts.”

S4 Capital has grown rapidly through acquisition since it was launched, having merged with more than two dozen purchased businesses, including MediaMonks, Mighty Hive and Firewood.

Barclays analysts warned that entrepreneurs who sold their businesses to S4 Capital and were paid 50% in shares may be disappointed by the current share price.

“Potentially, then, this might lead them to leave S4C when their earn-outs are paid. A talent exodus could lead to lower organic and possibly another future profit warning,” they continued.  

Barclays analysts highlighted though that the positive view is that management is “intensely focused” on addressing these issues.

More disruption ahead?

Meanwhile, analysts at Numis Securities also highlighted that S4 Capital has grown fast and warned that its internal structure has “not developed fast enough”.

“Whether this is a more fundamental content management or control issue is unclear but amounts to the same; S4 must beef up budgeting, cost scrutiny and financial controls,” Numis analysts said.

They further expressed concern about more disruption before the right controls are in place, and questioned what extra controls would cost.

In a similar vein to Barclays, Numis analysts also pointed to talent retention as a potential issue for the company. 

However, they concluded that their recommendation remains to buy S4 Capital shares, adding: “While bruised, we see a well-positioned digital agency needing near-term control upgrades. This is a risk but arguably discounted, given SP [share price] falls.”

Analysts at Peel Hunt noted that the profit warning was “disappointing”, given that market expectations on margins have pulled back several times since last year.

They commented: “Before today, we were under the impression that accounting issues were behind us and control functions were on the mend. Added to this is the positive news from S4’s peers over the last two days, pointing to a better than expected environment for client marketing spend. 

“While S4 has been a darling until the back end of last year, the series of events since 3Q [2021 when the company first said profit margins would take a hit] has massively impacted the share price, which is down 86% since the highs of last year.

“We think the shares are cheap even post the downgrade and controls are being improved, but it may take some time to regain investor confidence. We move our target price to under review.”

The company’s earlier difficulties, including the audit delay, had already prompted S4 Capital to axe annual bonuses for Sir Martin Sorrell and the other executive directors for the 2021 financial year.

S4 Capital’s response

Speaking to Campaign, S4 Capital’s chief growth officer Scott Spirit admitted that there was definitely something in the growing pains mentioned by several analysts. 

He said: “We’re a high growth company – we grew our topline 44% last year and we’re continuing to project strong growth this year, at 25%. Those are growth rates that are way beyond what other agencies are doing. It’s true that growing at that rate can cause problems.”

Spirit added that the company’s profit, or Ebitda, is “very second half weighted”, which he noted was typical for the industry. 

“What happened from our perspective is following visibility of our first half year numbers the board felt it was cautious to rein in the profit projections that analysts had for the company,” he continued.

“That was based on the fact that we had invested heavily in additional talent in the first half of the year, particularly in our content division to drive further growth in the second half.”

Asked about the dramatic drop in S4 Capital’s share price, Spirit stated that it was “disappointing”, adding that it, combined with the audit delays earlier in the year, presented the company with challenges.

“It’s incumbent on us to deliver,” he said. “There’s a real focus and a lot of ambition in the company that we are creating a new business and we’re creating something different and something that is a high growth company. 

“We’re very committed to reaching that target. It’s important for us as a company now to deliver on our targets to win back that investor confidence.”

However, contrary to analysts, he did not believe the situation would have an impact on staff retention. 

Spirit, who used to work with Sorrell at WPP, concluded: “Our management team are owners of the company, so we’re all incentivised to turn this situation around, to reach those targets and to prove to investors that this still is a very strong company. 

“We’ve spent a lot of time talking to our people about this internally. There’s a real sense of determination to prove ourselves and confidence that we can.”

When S4 Capital launched in 2018, it created special incentive shares for management, including Sorrell and Spirit, which, hypothetically, would give them a 15% share of the uplift in the company’s value, if it hits 6% annual compound growth over a five-year period to 2023.

S4 Capital is currently valued at about £700m. The company has raised about £450m from investors, plus it has issued a significant number of extra shares to fund acquisitions.

Campaign India

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