(By David Sterman) Even though we all track a select group of stocks on a regular basis, we still need to keep one eye on everything else happening in the investing sphere. Actions at another company may help to support -- or erode -- our confidence in a stock we've been tracking.
For example, in the throes of the European crisis a few weeks ago, it might have been easy to overlook an important acquisition. On June 21, Paris-based WPP (Pink Sheets: WPPGY), the world's largest advertising company, announced plans to acquire AKQA, one of the leading independent ad shops in the field of digital marketing. The $540 million purchase price was pretty stiff, equating to around 2.5 times projected 2012 revenue and around 13 times EBITDA.
Connect the dots, and you can see why I am enamored with rival MDC Partners (Nasdaq: MDCA), which I added to my $100,000 Real-Money Portfolio three months ago.
As I noted back then, shares had been steadily falling in value, putting them at a strong discount to rival stocks such as Interpublic (NYSE: IPG) and Omnicom (NYSE: OMC). Shares initially slumped in tandem with a falling market, but since June 21, they're up more than 20%.
Notice that date -- June 21? That's when WPP bought AKQA.
Investors aren't suddenly embracing this stock because it will be the next buyout play in this consolidating sector. Instead, they've received a clear sense of just how cheap this stock became, at least compared to WPP's purchase of AKQA.
Analysts at Albert Fried, who follow all of the ad agencies, suggest MDCA would be worth $33 a share, based on comparable EBITDA multiples. This might seem like an unrealistic assessment, considering it is roughly 200% above the current stock price. But the Fried analysts note that:
• MDC has a broader, more diversified client base than AKQA
• MDC is more weighted to the healthier North American market (while AKQA has a more European focus)
• MDC's larger size should enable it to yield greater synergies than AKQA
• The deal may force rivals to snap up their own digital-focused ad agency -- such as MDC -- in a bid to keep up in terms of skill sets.
I quibble with these analysts in one key respect. MDC, with roughly $1 billion in revenue, is a much bigger fish than AKQA, which makes an acquisition that much more unlikely. They suggest Japan's Dentsu would be the most logical acquirer.
As I noted in April, MDC "has been rightly criticized for neglecting free cash flow in the past as it invests in acquired businesses and extends its broad sales platform. Management's 2012 free cash flow targets show that it gets the message. Assuming few new major acquisitions this year, you should expect to see free cash flow surge even higher in 2013 as the era of internal investments winds down."
That makes the upcoming quarterly report, due in late July, so important. MDC has spent several years focusing on building sales without any major profit payoff. If cash flow looks solid in the quarter ended June, then shares could easily move up into the mid-teens. It may take a number of quarters of solid cash flow generation for shares to eventually reach $20.
Risks to Consider: As is the case with all ad agencies, MDC is quite sensitive to economic growth. If the U.S. economy slumps badly in the second half of this year, then all ad agency stocks would move lower. MDC, as the cheapest stock in the group, has more limited downside.
Action to Take --> Frankly, I don't see this stock going much past $20, which would value it at eight times EBITDA, on an enterprise value basis. Still, at just $11, that would be almost double. Simply put, this stock is far too cheap.
-- David Sterman
David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.
This article originally appeared on StreetAuthority
Author: David Sterman