S4 Capital: The Only Media Stock You Need to Buy

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We previously wrote about concept stocks and today we discuss why S4 Capital (SFOR.L) is the undiscovered high-growth concept stock that you’re looking for. Flying under the radar in the advertising world dominated by Publicis (PUB.PA), Omnicom (OMC) and WPP (WPP.L), S4 Capital is a pure digital advertising company. Consequently, it was founded in 2018 by Sir Martin Sorrell, who also happens to be the founder of the advertising giant WPP plc.

Advertising has come a long way. With technology today, broad-based targeting ads are now being replaced by personalised ads you see today across all social media. In fact, we continue to experience the shift from traditional towards digital advertising. Consequently, the global digital ad spending top $333 billion in 2019, more than half of global ad spending!

Introduction to S4 Capital

S4 Capital is a digital disrupter in the advertising space. A one-stop shop, it offers first-party data, digital content and programmatic marketing services. An inorganic growth strategy, it builds its business via acquisition of tech-savvy digital-enabled ad agencies that can grow exponentially when merged.

Specifically, S4 Capital offers:

First-party data analysis: First party data refers to data collected directly from your targeted audience. S4C uses its proprietary tools to help clients analyse, strategise and produce effective datasets.

Digital content creation: Responsible for creating and developing high-quality digital content with emphasis on building first-class UX. In addition, it is supplemented with data-driven analytics that creates digital designs that are targeted and flexible.

Programmatic advertising: This is the use of software to buy digital advertising. This differs from traditional methods that includes proposals, tenders, negotiation etc. Programmatic leverages machines to buy ad space. It also provides solutions to enhance media buying, tracking and targeting. It further enhances its offering leveraging on its unique dataset and cost efficiency tools.

Summary

Digital-only, not first, S4 Capital is a media company fully dedicated to the digital advertising segment. Founded in 2018 by Sir Martin, S4C operates across the digital advertising value chain. A highly incentivised management team, S4C stands to benefit from the secular growth of the industry.

S4 capital financial data
S4 Capital key financial data. Source: Company report.
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    Digital trends of 2020

    Before we jump into why we think S4 Capital is an excellent investment and its key drivers, let's remind of ourselves how COVID-19 accelerated digital trends so far in 2020.

    Post COVID-19 digital trends. Source: Company presentation.
    Post COVID-19 digital trends. Source: Company presentation.

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    Key drivers of S4 Capital

    S4 Capital's business model is straightforward. They’re paid for products and services provided. In addition, given its focus on growth, the key drivers of the company are primarily its revenue drivers. The overriding driver is global advertising spent. Clearly, this is a function of global economic activity.

    world gdp and global advertising spending
    Source: World Bank data and Statista.

    The table points towards a positive correlation (albeit small sample size) between the two variables. Intuitively, this make sense because greater economic activity tend to imply higher marketing budget and hence the need for greater brand awareness.

    The second key driver would be progressive shift towards digital advertising channels. This is critical because S4C is pure digital focus. For this reason, the percentage of digital ad spending is actually more important than the global ad spending. According to eMarketer’s projections, while digital ad spending are projected to slow, its contribution to the total media ad spending is increasing steadily.

    digital ad spending trends latest
    Note: includes advertising that appears on desktop and laptop computers as well as mobile phones, tables and other internet-connected devices, and includes all the various formats of advertising on those platforms; excludes SMS, MMS and P2P messaging-based advertising. Source: eMarketer, February 2019.

    Despite the industry being dominated by juggernauts like Google and Facebook, the data continue to suggest that there is enough pie to go around for everyone.

    Why we are excited about the stock today?

    COVID-19 accelerated digital transformation

    S4 Capital benefits from the accelerated shift in trends to the digital channel. The lockdown undoubtedly changed the many aspects of our daily lives. For example, according to Mintel, a market intelligence agency, UK online grocery shopping is now forecasted to grow by 33% 2020 (vs 2.9% in 2019), as a result of the lockdown. Consequently, the increased need for digital media buying and planning.

    Unlike its larger competitors who are driven by legacy traditional advertising channels, S4’s product suite means it can generate greater sales lead from new clients emerging from the crisis.

    Organic growth opportunity: Cross-sell potential

    Perhaps the key part of why S4 Capital is an attractive investment is its cross-selling potential. To understand this better, we need explore the building blocks of the group.

    Founded in 2018, S4 Capital started through numerous M&A.

    S4 capital share price
    Timeline of S4 Capital's journey so far. Source: Company reports, Yahoo finance.

    Uniquely, the acquisitions are mutually exclusive in most cases. In other words, acquired businesses don’t typically share the same clientele.

    For this reason, its cross-selling opportunities across businesses are enormous. A simplistic example to illustrate the point. Assume you have 3 distinctive businesses with different fee structures and each business has 5 independent clients.

    Acquired company Clients Fees Total
    Company A 5 $3 5 x $3 = $15
    Company B 5 $4 5 x $4 = $20
    Company C 5 $5 5 x $5 = $25
    $15 + $20 + $25 = $60

    Now, if we assume all three companies reached its full cross-selling potential. The table will look like this.

    Acquired company Clients Fees Total
    Company A 15 $3 15 x $3 = $45
    Company B 15 $4 15 x $4 = $60
    Company C 15 $5 15 x $5 = $75
    $45 + $60 + $75 = $180

    From this simple example, the company increased its fee revenues by 300% having maximised its cross-selling potential. With Sir Martin Sorrell’s leadership evident during his tenure in WPP plc, there is little reason to doubt its cross-selling potential at S4 Capital.

    Skin in the game: highly incentivised management team

    The best stocks to invest are those where senior management team has a significant stake in the company. At the time of writing, senior management team (including Board members) owns a total of 34% of the company. In particular, Sir Martin Sorrell owns just over 10% of S4 Capital.

    According to the annual report, Sir Martin has also been issued with B shares which provides him enhanced control rights. I’ll leave it for readers to dig through if required (Page 53 of 2019 AR). What’s interesting about this is the clause attaching to the B shares.

    An excerpt from the latest annual report:

    The B Share will lose the B Share Rights if it is transferred by Sir Martin and also:

    • in any event after 14 years from 28 September 2018 (being the date on which the B share was issued), or, if earlier, the date on which Sir Martin retires or dies; or
    • if Sir Martin sells any of the Ordinary Shares that he acquired on 28 September 2018 (other than in order to pay tax arising in connection with his holding of such shares).

    Consequently, B shares are frequently issued in tech start-ups in order to preserve control. Leaving retiring or death aside, the second clause means that Sir Martin will have to give up his rights should he decide to sell down his stake acquired in 2018.

    Finally, remember how the we talk about how S4 Capital is built through M&As? The deal are structured on an earn-out basis. In simple terms, this means that a portion of the acquisition costs are paid in the future upon hitting a certain (no disclosure) financial target.

    According to the latest annual report, this amounts to ~£54m. In short, management team are extremely incentivised to deliver its financial targets, further reinforcing the phrase “skin in the game”.

    What this all mean is that S4 Capital has absolute conviction and confidence of their business outlook and execution strategy.

    Key risks

    Firstly, one of the key risk is a prolonged global recession. Ultimately, a global recession implies a lower global advertising budget, possibly hampering the growth ambition of S4 Capital.

    Secondly, execution risks. S4 Capital is practically built on acquisitions, which introduces significant execution risks. While the group is extremely experienced, the amount of cross-selling and synergy are yet to be realised, albeit early days.

    Lastly, the known unknown – regulation. With the rise of targeted digital adverts, there is an equivalent awareness about privacy. For example, the introduction of General Data Protection Regulation (GDPR) in Europe and the California Consumer Privacy Act (CCPA) in California, US. With increased regulations, this could imply higher operating cost, hence, leading to lower margin.

    ZagInvestor's perspective

    S4 Capital is a new-age digital advertising company with a highly reputable management team. In addition, it has fundamentally sound business operating in an environment supplemented with structural tailwinds.

    With a market cap of ~£1 billion, this stock doesn’t not come close to most institutional investors’ screening criteria, which makes it even more attractive today. While shares has since recovered partially, investing in S4C provides an alternative play to the structural growth of Big Tech.

    S4C’s continues to offer a skewed risk-reward profile. Interestingly, if we factor in its organic growth opportunities, S4C trades at a significant discount (>50%) on its PEG ratio relative peers.

    A growth machine, headed by the industry’s finest with an enviable track record, S4C is suitable for medium term investors who seek capital appreciation potential.

    How often do you come across a stock that offers robust growth prospect, structural tailwinds and an insider ownership of ~35%?

    What do you think about S4 Capital? If you're interested in understanding our idea generation process, you don't want to miss our recent article!

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