Whenever you hear that a company is a
"growth-through-acquisition story," you should be cautious.
Investors tend to shun these types of stocks, as acquisitions bring
plenty of risk. The acquired company may not generate the revenue
growth that management had been banking on, or hoped-for cost cuts
or other synergies may simply never materialize.
But a knee-jerk dismissal of these types of companies is a mistake,
and investors instead need to differentiate between the two types
[block:block=16]Some companies do deals just to grow larger, while
others do them to fill holes in theirbusiness model . It's this
latter focus that actually canyield major gains, and where you
should be focusing.
Filling in the gaps in its platform has been the key driver for
MDC Partners (Nasdaq:
, North America's third-largest advertising agency behind
Omnicom (NYSE: OMC
. Publicis, WPP and Havas are also larger than MDC, but are
domiciled in Europe. (Please note that many investors mistakenly
MDC Holdings (NYSE:
, which is a home builder.)
MDC Partners went through a solid growth spurt before theeconomy
headed south in 2009. (Sales rose from $247 million in 2004 to $583
million in 2008.) The company was able to snag a number of key
accounts from the industry's bigger players by a tight focus on
online media advertising. Yet management realized that further
gains would be hard to come by as MDC lacked several key services
and offerings that clients expect from an ad agency. MDC has
recently completed several small deals to round its platform, but
those deals have soured investors who shun deal-making companies.
Yet MDC is now in a position to again take share from rivals and
also generate more sales from existing customers. The company is on
track for more than $1 billion in sales this year, which finally
puts its name in discussions whenFortune 500 companies are looking
to award major accounts.
Despite the company's newfound heft,shares are off 22% in the past
six months, even as Interpublic and Omnicom's stocks have risen
more than 35% in that time frame.
As a result, MDC is now the most inexpensive stock in the group --
but it is also the fastest-growing. While Interpublic and Omnicom
are expected to boost sales 3% this year, MDC's sales are expected
to rise in the low teens to around $1.06 billion.
Sure, the company has done some minor acquisitions in the last few
quarters (and just announced another one this week), but the bulk
of that growth is coming from new client wins. In just the first
quarter of 2012, MDC landed new accounts with Arby's and
Applebee's, as well as
grocery business. Equally important, the company's broadened suite
of offerings is enabling MDC to move deeper into client account
relationships, which is boosting pricing andprofit margins.
The company expects to generate 10.5%profit margins in 2012,
roughly 100 basis points higher than in 2011. That's leading to an
estimated $1.45 a share infree cash flow , which works out to afree
cash flow yield of more than 13% ($1.45FCF / $11 stock price =
This helps support an annualdividend of $0.56 per share (good for a
5.4%dividend yield ).
I had been waiting to see how MDC's quarterly results looked, but
management just pre-announced solid projections for the first
quarter and the full year. Look for first-quarter sales to rise
roughly 7% from a year-ago to around $233 million, and full-year
sales to rise more than 10% to around $1.06 billion. Though the
company is expected to be unprofitable on aGAAP basis due to a high
level ofamortization ,cash flow should be quite strong, as noted
Strong top and bottom-line momentum, a robustdividend , and low
valuations help explain why I'm adding this company to my
$100,000 Real-Money Portfolio
The Downside Protection -->
Ad agencies derive a high degree of recurring revenue thanks to
multi-year contracts, so a fall-off in business is unlikely unless
the U.S.economy hits a bigair pocket . Meanwhile,shares are washed
out, trading near a two-year low and sporting a double-digitfree
cash flow yield . It's hard to see this stock falling much below
Upside Triggers -->
Management understands that the recent spate of acquisitions must
help bolster thebottom line as well as the top line. The company
has been rightly criticized for neglectingfree 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
This is also a play onGDP growth. As the U.S.economy creates
200,000 jobs each month, corporations will respond by boosting
spending on advertising. A handy rule of thumb is that ad spending
moves at two to three times the direction ofGDP growth, so MDC
should see a 5% to 10% boost to growth, even before assuming any
furthermarket share gains that come from the company's recently
expanded service offerings.
Action to Take -->
I will buy 500shares (or roughly $5,500 worth) of MDC
roughly 48 hours after you read this.
I also suggest investors put in astop-loss order at $9.50, in the
event amarket rout sucks this stock down with the pack.Shares can
be bought under $14.
-- 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.
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