The Investment Column: Digital division is the key to future success at Aegis

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The Independent Online

After Publicis and WPP abandoned plans to buy Aegis, this column struggled to find a reason for holding the shares of the media-buying agency and advised readers to avoid the stock. But in light of a well-argued note from Deutsche Bank yesterday, which sent Aegis 4 per cent higher to 128.5p, this assessment looks to have been too harsh.

The German broker's stance is quite simple. It believes City forecasts for earnings at Aegis in the years to come will have to be upgraded in a big way as the media group's management, led by the new chief executive Robert Lerwill, starts to improve profit margins.

So what is going to drive this improvement? Deutsche says securing better prices for future acquisitions is key, as is enhancing the general operating efficiency of the business. There certainly seems to be room for improvement. Historically, Aegis has achieved a 5 to 6.7 per cent return on capital compared with an 8 to 9 per cent cost of capital.

Meanwhile, Deutsche expects sales at the group to be boosted by improving trading conditions in Europe and strong growth at Isobar, Aegis's digital advertising division.

The media sector is in the middle of a structural shift away from traditional advertising formats - newspapers, billboards and television - to digital alternatives. Internet advertising is estimated to have grown 28 per cent in 2005 and by 2008 is likely to account for 6 per cent of global advertising spending - in line with that spent on outdoor advertising.

And Aegis is particularly well placed to benefit from it. In Deutsche's words: "Aegis has one of the most well-developed, comprehensive digital offerings of all the agencies." The broker has a point. Isobar is in 32 countries and can boast of being one of a few fully global digital businesses. Deutsche sees the division as easily being able to grow sales at 15 to 20 per cent a year.

Given these factors, it believes there is a good chance Aegis profit margins can rise from 16 per cent to about 20 per cent. Such a scenario should boost earnings significantly and could leave Aegis trading on a rating of 11 times forecast earnings.

Meanwhile, a takeover of the company remains a distinct possibility. It is the last remaining independent media-buying agency and it received three bid offers last year. The presence of the French corporate raider, Vincent Bolloré, with a 25 per cent shareholding, only makes the company more vulnerable to takeover.

In the autumn, the French rival Publicis offered 140p a share for Aegis but later walked away. Deutsche believes the shares can hit 145p on their own accord and believes a predator will have to pay up to 168p if it is to win the company. Investors would do well to add the stock to their portfolio.

No jams ahead for Trafficmaster

Things seem to be looking up at the vehicle navigation specialist Trafficmaster. At the start of the week it indicated it was on course to make an operating profit of about £1.8m, and yesterday it secured yet another contract win for its Smartnav satellite navigation system.

Smartnav is to be standard issue in Isuzu's new Rodeo Denver Max pick-up truck. The car maker is one of nine international car groups to fit Trafficmaster technology in new models and, importantly, offer customers a one-year subscription to the real-time traffic information service the navigation firm offers. The hope for Trafficmaster is that after a year's free trial, users will find the technology indispensable and subscribe to it on a long-term basis, thereby generating recurring revenues.

In this way the group makes money by selling Smartnav to car manufacturers and also by selling information about traffic jams across the UK's motorways and trunk roads.

The third string to Trafficmaster's bow is its Teletrac fleet management division which allows the likes of distribution companies and taxi firms to keep tabs on their drivers. The business has grown rapidly in recent years. It registered 24 per cent sales growth in 2005 and now accounts for half of the group's sales and a significant proportion of its profits.

Although group revenues for the year just gone will come in slightly below expectations, this will be more than made up for by cost cuts. A recently completed strategic review by Tony Eales, Trafficmaster's new chief executive, is tipped to produce savings of £2m in 2006 because of headcount reductions, call centre savings and a more streamlined sales process.

Trafficmaster rose 3.25p to 42.5p yesterday in response to the Isuzu deal. At this level, the shares trade at 10 times forecast earnings for 2006, which is not expensive particularly given the ratings enjoyed by some of its peers. @Road Inc, a Nasdaq-listed group which competes directly with Teletrac, trades at a whopping 50 times earnings, while the London-listed traffic information player Itis Holdings stands at 17 times.

Given the growing momentum at Trafficmaster, this discount is unjustified and makes the stock a buy at current levels.