RE: S4 Capital: Bargain Buy For The Digital Economy7 Jun 2023 08:48
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It remains to be seen whether the business model here really can generate sizeable profits in the long run. One additional concern I have is the lack of director buying. No directors have bought this year, including Sir Martin and Scott Spirit, both of whom were previously buying at a much higher share price.
Clearly, then, there are risks here. The chart above is a not a pretty sight.
Strong business momentum
Set against that, though, is the growth we have seen at S4. The accounting delays leading to a share price tumble meant that the company became less willing to use its stock as currency for M&A, which had been a key growth driver for the firm. Even without the benefit of M&A, though, organic growth rates are strong.
S4 is clearly going gangbusters. My key concern financially is the losses and debt. The company expects net debt to rise this year, as it pays compensation for historical M&A. But next year, that ought to fall away. Alongside an improved operational model, I therefore hope that ongoing strong revenue growth ought to see losses fall back next year and perhaps even turn into a profit.
S4’s business model has been covered in depth before on SA (starting with A Rising Star In Online Media: S4 Capital, since when the basic model has remained unchanged). I think what we see now is that the model is delivering when it comes to revenue growth. Revenue last year topped £1bn for the first time (against a current market cap of £760m).
Ongoing sales growth sets the foundation for long-term success: what is needed now is conversion to profitability. Declining merger payments, economies of scale and tighter cost control ought to enable that, in my view.
Bargain Price
For all of that, I think the current share price looks like a bargain. While the Trade Desk isn’t an exact comparator as a business, it comes close. Whereas S4’s price-to-sales ratio last year was 0.7, The Trade Desk’s was 23. Sir Martin’s track record at WPP ought to give S4 a premium if anything (arguably in 2020-21 it did, but not now). But even ignoring that, and allowing for racier tech valuations Stateside than in the London market, that suggests that S4 is an absolute bargain relative to its peers. (Indeed, many S4 shareholders have suggested that simply gaining a U.S. listing could immediately unlock substantial value at the firm, which does the majority of its business in North America).
What will it take to unlock this? Great revenue growth has not been enough so far. Maybe a clearer path to profit is needed. Certainly, confidence about both Sir Martin’s health and robust succession planning could both help. The ad outlook isn’t helping and S4 may continue in a rut for a while. Ultimately, though, I think today’s price is a deep bargain for the long-term investor.
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