James Moore: Governance issue puts me off taking a punt on WPP

Investment View: The company's reward packages present a genuine investment problem
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The Independent Online

Our view Hold

Share price 744.5p

How good is the investment case for WPP? That has been rather obscured by the recent heated debate over the eye-popping, £12.9m pay package handed to Sir Martin Sorrell, who founded and still runs the company.

The latter simply cannot be ignored, but let's set it aside for a moment. On Wednesday, WPP issued an upbeat update (surprise, surprise).

Cynicism aside, the company reported revenue growth (on a like-for-like basis excluding recent acquisitions) of 4 per cent. The UK and Europe were a bit slower, and the US was a lot slower, but the company gets a third of its profits from faster-growing parts of the world and they're going like the proverbial train. Operating profit was also said to be above "budget" while margin growth was on target.

WPP also continues to work on improving co-ordination between its multitude of different operating companies, so no more Argentinian agencies creating hullabaloos by secretly filming athletes running all over memorials in the Falklands?

This year, of course, ought to be good. There's an Olympics, a European football championship and a US presidential election, all of which generate business for WPP's ad agencies, PR companies and lobbyists.

Next year will be tougher, though. And the new president will have to tackle the US budget deficit. There's still the problem of the eurozone to contend with too, and WPP's global reach will only partially insulate it if things get really nasty.

Still, overall, things look good. And the valuation is also starting to look compelling. WPP shares have been on the slide in recent weeks. It now trades on just over 10 times this year's forecast earnings while offering a healthy enough prospective yield of 3.5 per cent.

That compares well with international rivals. The French Publicis group sits on just under 11 times forecast earnings with a prospective yield of 2.4 per cent. The latter is about the same as what Omnicom, from the US, offers, although it trades on nearly 13 times earnings.

Another salient point is that WPP offers the best exposure to faster-growing economies in Asia, Africa and Latin America. So the shares look keenly priced.

Which is all very well, but the issue of governance cannot be ignored.

The co mpany's chairman has said talk of reforming Sir Martin's package is "premature", offering only "meetings" with investors.

More needs to be done, because the company's reward packages present a genuine investment problem. Much has been made by Sir Martin of his own investments in the company, which is welcome.

But under WPP's leadership equity acquisition plan, the company matches personal investments on a five-for-one basis, which is quite extraordinary and provided Sir Martin with conditional matching shares valued at 1,810 per cent of his base salary, according to an analysis by Pirc, the corporate governance watchdog.

The latter is also unhappy about the performance targets that the "conditional" applies to. It has further highlighted the "poor acquisition record of WPP", which it said "shows that the company has been better at enriching the shareholders of the companies and partnerships it has bought, rather than the shareholders of WPP".

And the evidence? Write-offs of goodwill and acquisition-related intangibles in total of £1.3bn, representing 20 per cent of shareholder equity. This doesn't matter too much to management because the reward structure means that rather than being rewarded from their own holdings or share price performance of awards from the past, management are continually given huge tranches of new shares each year.

Sir Martin has countered that a shareholder who had stayed with the group from the 1980s, when it was founded, would have done really quite well. But past performance is not necessarily a good guide to future performance, and big companies grow a lot more slowly than little ones.

I'd be a buyer without the governance concerns, because the shares look fairly priced. But the governance concerns, and Pirc's point about the acquisitions, puts me off. I'd want a lower multiple before buying any more shares, although I would be a holder at the current level.

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