S4 Capital: shares nosedive as rising overheads weigh heavily

Hitting an occasional air pocket on flights can jolt the most seasoned traveller. Repeated occurrences affect the plane crew as well.

On Thursday, founder Martin Sorrell’s S4 Capital revised down its outlook for full-year ebitda by about a quarter. Oxygen masks dropped from above shareholders’ heads as its share price lost nearly half its value on the day. This looks very bad for an agency that depends on its share price as an acquisition currency.

Never mind that only five weeks ago, the digital advertising and marketing agency reiterated its guidance for full-year profits at its annual general meeting. Put aside the fact that S4 had already had an embarrassing delay to those annual results because its auditor would not initially sign off on these — which knocked 35 per cent off its value at the end of March. This downgrade of full-year ebitda to £120mn — from the analyst average consensus of £160mn — begs questions of the owner-operated, integrated model at S4, a change from the holding company structure at Sorrell’s old shop WPP.

Whereas at WPP any acquired businesses existed separately, with an operational management overlay, S4 is run by a team of owners who are more than willing to disagree. It appears that the captain and his crew did not take the same view on what was on the horizon. Sorrell seems to have taken the view that hiring by the more optimistic content team, responsible for more than two-thirds of gross profits, had inflated the group’s cost base too quickly. As founder, he would have every right to raise concerns about the macro outlook for S4’s business.

The fallout is bad news for a group that acquires smaller agencies with cash and shares, with later earnouts based on performance. These were estimated at more than £52mn this year by Citi. But the shares have fallen 85 per cent since peaking in October. While the share proportions will vary, it is safe to say that keeping any earnout promises will result in more share dilution than previously hoped.

S4’s previous high earnings growth is not possible without more acquisitions. That requires a steadily rising stock price. Brace position, please.