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Challenger groups could define the year in agency M&A

By Matt Lacey | Director

January 9, 2023 | 11 min read

The growth strategies employed by advertising’s contender class of agencies could shape the industry for years to come, argues Matt Lacey of Waypoint.

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The last 12 months have been busy ones for mergers and acquisitions (M&A) and at the heart of that activity is a cohort of ambitious, fast-growing agencies, collectively described as ’challengers’. Their headcounts range from 500 to around 13,000. Stagwell, the largest, is still a minnow compared to WPP, at over 109,000 employees.

In 2022, they accounted for roughly over half of transactions. Looking forward to 2023, why should we focus in on these challengers? Well, most come at things from the digital activation end of the market and are heavily tech-enabled. While they’re not immune to headwinds facing the industry, they’re likely to be more resilient than those operating in other areas. And with the majority well-funded via public markets or financial investors, M&A is – and is likely to remain – a core growth pillar in 2023, meaning we can predict with a good deal of certainty that they’ll account for a significant chunk of M&A in the sector.

The core group we track is around 30 strong and they’re unified by a focus on the modern marketing brief, building best-in-class specialist capabilities.

Besides the familiar names, there are still relatively unknown but sizeable players such as Plus Company, PMG and Sideshow, which are building quietly in the background. Names like Wpromote, Power Digital and MiQ all made moves last year via secondary private equity deals to continue their expansion paths. In time, and with investment to drive growth by acquisition, agencies such as Goat may also make it on to this list.

Making their presence felt

A combination of ambition, scale and skillset means the challengers are increasingly winning significant global client briefs. Earlier in the year, PMG secured a key share of Nike’s $1bn media account and Known, with a headcount of around 500 and pitching itself as “the new operating system for modern marketing”, fought off the larger networks to become the global media agency of record for AMC Networks.

US-based Bounteous, with a headcount of 2,000 people and investment from New Mountain Capital, describes itself as “the digital innovation partner to the world’s most ambitious brands” and its clients include Coca-Cola and Domino’s. Notably, Brian Whipple, the former Accenture Interactive CEO, recently joined the agency’s board of directors.

And he’s not the only one to move over to the challengers. Jo Wallace jumped ship from Wunderman Thompson to become executive creative director at Media.Monks and Jon King joined Croud as group general manager after roles at WPP and Publicis-owned agencies.

The challenger group approach to M&A

The challengers acquire with a steely focus on best-in-class specialist capability for the fast-evolving client brief. What emerges is a genuine specialism but with a broad enough skillset to deliver for multinational, multi-territory remits. Activation, performance, data and digitally focused skills usually sit at the heart of the offer, operating at the sharp, ROI-led end of marketing.

This focus on quality means they need to be well-funded premium acquirers. Earlier in 2022, Stagwell bought a little-known e-commerce specialist, BNG, for an estimated £54m, hot on the heels of its acquisition of independent media agency Good Stuff. Over the usually quiet summer, Dept bought ShopTalk and Two Bulls (and most recently Melon, marking acquisition number seven in 2022), and Waterland-backed Sideshow added 230 heads in October with the acquisitions of Nomensa and More2. And we eagerly await an update on the outcome of the BrandTech-Jellyfish talks.

Yet growth by acquisition depends on a reliable source of high-quality targets and competition in a finite market of scaled targets will remain a difficulty for this cohort to address. Larger groups that are pursuing growth hard may look to acquire the smaller, fast-growing challengers and in time take the IPO route.

And that makes sense – why buy and attempt to integrate 10 different companies when, if you have the capital and the structure in place, you can snap up something the size of a BrainLabs for a step change in momentum?

That’s a very real option for an outfit like PMG. It may have yet to create headlines here in the UK, but given its ambitions, there’s every chance it could bid for BrainLabs or even Croud, where Livingbridge and LDC have been invested for three and a half and almost three years respectively.

Alternatively, some of the smaller challengers may come together through private equity backing to drive scale fast.

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The challenges facing the challengers

Rapid scaling comes with its own set of growing pains. Some of these highly ambitious players are looking to triple in size. Identifying acquisition targets is key, but those targets need to be increasingly larger businesses in order to drive the pace of growth that’s being set.

Smaller groups on this kind of trajectory will have to grapple with acute pressure on leadership abilities and structures. Because of the nature of their backstories (they may be run by practitioners or young, dynamic founders), a rapidly increasing headcount and new companies to integrate will be novel challenges for some of these leaders. Establishing enterprise governance and adding in more infrastructure, process and operational excellence is a must.

Yet no matter how big the business, it needs to carefully consider the supporting structures that are required at each stage of growth. You only need to see how S4 Capital’s reporting issues earlier this year led to changes in how its finance department is run.

What it’s like to be acquired into a challenger group

For businesses and senior teams that are hungry and ambitious and see a sale event as the next step in their growth journey rather than the endgame, the challenger groups present an increasingly attractive option. To varying degrees, they can be instrumental in helping drive growth within their new home and having a say in future direction, particularly in the smaller challengers. There are certainly parallels to be drawn between the buzz around management consultancies when they first came on the scene and the ’white space’ they can offer to grow a practice area.

They might integrate immediately or they might operate as a standalone. Whichever of the two, it’s likely to feel very cohesive and that’s because of the challenger modus operandi, acquiring and building out complementary skills from a specialist core or acquiring the same capability in different markets to create a modern take on the full-service model.

It also avoids those who have been acquired finding themselves side-lined or competing with others like them within the organization.

No surprise then that this is supported by a more innovative and flexible mindset when it comes to deal structures, with the traditional, profit-based earn-out element often absent in many transactions so that the path to cohesion is obstacle-free.

Valuation prospects

It would be naive to ignore the pressures building in the market. But as yet, there appears to be little change in what have been fairly strong valuations in recent years. Big transformational deals are still being chased by challenger acquirers as this article is being written, with valuations north of 15 times EBITDA; all cash and no conditions. Because of the lack of quality targets of scale, competition for best-in-class assets will continue.

Valuation expectations among the top-performing, high-quality groups and platforms are likely to remain because they are at the sharpest end of the market and growing fastest (double digit) relative to others or relative to the market that they sit in (single digit).

Large global private equity players or financial investors will continue to be drawn to them. And let’s not forget that marketers tend to opt for a clear ROI on their spend when the outlook is tough, which favors performance over other disciplines.

For larger platforms reaching the end of their private equity hold, who at other times would have been planning an IPO, there may be some sort of contingency planning. Once capital markets improve, an exit via IPO could be back on the table.

In cases where acquisitions fail to deliver and hold back overall value, given the relative pace of growth, groups may be quick to quietly re-engineer in the background. They re-organize talent and structures as part of a streamlining and cohesion exercise to optimize future progress.

Certainly, the market overall will slow to a degree, given increases in the cost of borrowing and public market dynamics. At the very least, we can expect to see more focused and detailed diligence being done, leading to slightly longer processes for buyers, banks, private equity and other funding stakeholders as positions become more difficult to call.

The experience of the pandemic may hint at what’s likely to play out in the potentially tricky months ahead. Average businesses may not easily find a home among this cohort and even elsewhere they might be looking at reduced valuations.

Matt Lacey is a partner at Waypoint.

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