Engine breakup: who’ll buy its divisions and how will it impact its value?
One-stop shop Engine is facing a breakup as its owner Lake Capital puts it up for auction. Tristan Rice, who leads SI Partners’ European M&A practice, considers who will buy its divisions and how will it impact the value of its business.
Who might want to buy each of Engine's divisions and what are the implications for the value of the business?
To understand what’s happening with Engine today, you have to go back to its origins.
Engine – formerly The Engine Group – was conceived in a different era. Those who remember the likes of Loewy and Photon will recall that there was great excitement around the concept of buying up agencies of all shapes and sizes and sticking them under a group umbrella. The idea being that the whole would be more valuable than the sum of its parts. Of course, there were nicely crafted propositions and narratives on how this would add value to clients and offer a better alternative to the global holding companies, but at their core these were strategies driven more by financial engineering than client need.
Engine probably had the most compelling proposition among its peers: an integrated business with no earn-outs, everyone aligned to a common goal, collaborating and cohabiting in chic Noho offices. And it appeared to be a winning strategy, with plenty of agency owners willing to exchange ownership for a chunk of cash and some Engine shares on the promise of further gains from a future sale of the group.
But there were a few problems.
The model attracted mature businesses that did not expect significant further growth. Why else would you sell for a one-off price with a limited and uncertain future upside, rather than with an earn-out where strong growth over three or four years can deliver a substantially higher price over which you have more direct control?
A lack of real integration – with agency founders fiercely defending the importance of their brand and culture – made for a confusing patchwork quilt of sub-brands, inhibited cross-selling and created inefficiencies that suppressed margin.
Engine’s focus on the fundamentals of each business it acquired (management, scale, margin, client base etc), over and above the quality of fit with the overall proposition, exacerbated this. By 2013, Engine had a lot of talented people and did a lot of things for a lot of clients, but what tied it all together in terms of a go-to-market strategy? What did it stand for?
It also focused heavily on the UK market, where there was a lot of low-hanging M&A fruit. But in the meantime, clients were thinking much more globally and Engine started to look overweight in one territory.
Contrast that with today’s clutch of consolidators – S4 Capital, Dept, Jellyfish et al – and you’ll note that each is driven by a core, client-centric proposition that defines the parameters of their increasingly global service offer. In today’s market, specialist and global trumps generalist and local every time.
The incursion of management consultancies into the marcoms sector a decade ago raised the possibility that Engine could be a tempting way to establish a bridgehead in the UK market. But even Accenture – by far the most adventurous consultancy to enter the market – recognized the importance of limiting the scope of services it offered, to fit with its overall proposition – in its case, based around customer experience on a global scale. A UK-based generalist was never going to be on its agenda.
Engine’s fraught sale to Lake Capital in 2014 was not the exit the shareholders had hoped for, but it did pave the way for a much-needed restructure. The ’merger’ with Trailer Park and ORC International to create a more global business was never really credible as their offers and sector expertise were just too different. Engine was still fundamentally a UK business. But bringing in professional management, reorganizing the UK business into distinct, integrated divisions and dropping most of the sub-brands (easier to do once many of their founders had left), started to transform the UK business from a patchwork quilt into something resembling a pinstriped suit.
But Lake still has a problem to solve in terms of creating an exit from the business. Engine’s scale and diversity within a geographic niche mean there are few (if any) obvious industry buyers for the whole business.
Creating separate divisions, each with its own chief exec and management team, was clearly designed to maximize its strategic options. Industry commentators are already predicting a breakup as the most likely option.
But the questions remain, who might want to buy each of these divisions and what are the implications for the value of the business?
If they are sold to three different buyers, the Engine brand will have to be dropped by at least two of them, which carries some risk that might impact value. Value could also be eroded through the loss of clients that prefer the current, integrated model.
Ironically, the whole might now be worth less than the sum of its parts.
There will be some interested trade buyers, but private equity seems the most likely option and there is certainly plenty of appetite and cash available in the market. But with so many new PE-backed platforms emerging, is there really room for more?
In a few years’ time, when many are looking to sell, it may be a buyer’s market, so they have to look at IPOs. UK stock markets have not been kind to second tier marcoms groups in the past, with many ending up back in private equity hands, but perhaps the meteoric rise of S4 Capital’s share price will change investor perceptions of the sector.
As for Lake Capital, any champagne corks popped at the conclusion of this latest attempt to exit will likely be more out of relief than celebration.
Tristan Rice leads SI Partners’ European M&A practice.