- Why Agencies and Private Equity Are a Strategic Fit - September 17, 2019
Deconstructing Phoenix Equity’s M&A deal with 1000heads
Phoenix Equity Partners’ multi-million-pound investment in London-based agency 1000heads is one of the latest in a recent run of high-profile marketing and advertising M&As. Here, Jim Houghton, Partner, Waypoint Partners, who led the deal, outlines the rationale for the investment. He also investigates the emergence of private equity as a leading force in marketing industry M&As.
For the last couple of years, marketing agencies have been popular Merger & Acquisitions targets. With management consultants, agency networks, tech giants and private equity firms all competing for a piece of the pie, M&A activity in the sector was worth $33bn in 2018, up an eye-catching 144% year on year.
One M&A deal that my consultancy was involved with was private equity firm Phoenix Equity Partners’ recent investment in 1000heads, a leading international provider of social media-led data & insights, strategic consultancy and creative services to some of the world’s most famous and powerful brands. In this piece, I’ll outline what makes this a great deal, and how joining forces with a private equity firm can help agencies fulfill their ambitions.
The deal essentials
From 1000heads’ perspective, the backing from Phoenix is a way of ramping up its international footprint and services, while augmenting resources to invest in operations, infrastructure and talent. With 150 people already based in London, New York, Sydney, Dubai and Berlin, financial and Boardroom support from Phoenix will enable 1000heads to grow without derailing day-to-day activities.
As for Phoenix, there are a number of cogent reasons why it made such a substantial investment. Firstly, and foremost, the unique nature of 1000heads impressive client list, and secondly, the company’s international success, particularly in the US, which speaks volumes about the stamina and ingenuity of the team and has translated into strong organic financial performance.
Strategic investor or financial investor?
There is a historic distinction in the M&A market between strategic investors (agency, tech giant, consultancy etc) and financial investors (private equity). The implication is that the former has a strategic reason for investing, whereas the latter is focused only on ROI. The problem with this distinction is that it is entirely misleading. In my experience, ‘strategic’ M&A deals often end up with the acquired firm making compromises the leadership hadn’t anticipated during the starry-eyed adrenalin rush of doing the deal. The strategic buyer, for example, may propose that the acquisition streamlines operations with another in-house division or aligns its brand and culture with another part of its existing organization. This might only involve office relocation or sharing back office systems; but it could involve pressure to merge or to dispense with clients due to conflicts of interest or adjustments to employment practices.
None of the above are necessarily problems for entrepreneurs that view M&A as a way of taking the business to the next level or generating personal wealth. But for management teams that have a unique culture and vision for the growth of the company, the risks of a flawed strategic transaction are painfully real.
By contrast, a private equity backer is an enabler and accelerator. When it invests in a company, it is supporting an approach that it believes can unlock deal value. In this scenario, the strategy is delivered by the acquired firm, not the investor. Is private equity right for all agencies? Absolutely not, because every M&A deal is different and driven by different motivations. In good times ‘strategic’ and private equity deals can deliver handsomely for all parties, but all acquirers and investors ultimately are motivated by – and indeed have a fiduciary duty – to achieve financial results for their backers. In less good times, acquired agencies might find shelter alongside another agency in a ‘strategic’ deal, but in a private equity deal, if trading falls away, it can be a long and lonely road with less latitude. But a Financial investor can be as strategic as a Strategic investor, helping drive growth, add capabilities at speed, bolster client rosters and acquire game-changing talent. As 1000heads founder Mike Rowe notes, Phoenix will “enable us to grow rapidly while preserving our culture and identity”.
Keeping out of the spotlight
Not to be overlooked is the fact that private equity, by definition, has the unique benefit of being private funding, which means it is possible to nurture company growth away from the scrutiny of the public markets in which the ‘strategics’ operate. As such, it means transactions can be tailored for individual deal participants. This is an intriguing advantage when there’s still ample growth ahead in an agency and future equity participation can be used as a hook for talent. It’s also a consideration for founders seeking to de-risk or allow succession management into a stronger ownership position without just diluting equity. In the glare of the public markets, typically it’s a one-size-fits-all deal. That can be an excellent way to structure a destination deal, but when there’s still a new region to conquer or disciplines to build out, bespoke deals make all the difference.
Dragon’s Den – not Day-Traders
For marketing-based agencies that see the private equity route as the best way to achieve their next phase of growth, it’s important to keep in mind that this is not a free ticket to fame and fortune. The high volume of private equity deals being done should not be seen as evidence that they are like day-traders, looking to make a quick return on the whiff of market rumors.
Private equity firms are professional investors entrusted by major financial institutions with money to be invested wisely. Their sole purpose and fiduciary duty is to deliver a return – which means they absolutely have to see a compelling business plan coupled with a credible and committed management team. Like Dragons’ Den entrepreneurs, they will also expect to see client momentum and a unique, defensible market position before investing.
Likewise, it is critical you don’t just roll over at the prospect of a cash injection. Private equity funds vary considerably in terms of investment and return criteria, risk appetite and timescales. They also involve a myriad of personalities in the deal process… around the Boardroom table, post deal and at Exit. Negotiating this maze of potential partnerships and personalities isn’t easy; so, it makes sense to take your time and properly assess who you invite into your boardroom for the next 4-5 years.
Private Equity Going Forward
Historically, the professional investor community was cautious about investing in marketing services firms, primarily because of their lack of tangible assets. Marketing’s predilection for putting ‘creativity’ at the heart of its business model was seen as code for it being erratic, emotional and uncommercial. Even those who understood the value of creativity were concerned about how easily talent could join rivals or set up new shops.
More recently, however, private equity firms have got to grips with the sector.
In part, this is because agencies have become much better at measuring creative effectiveness. But it is also to do with the sector’s increasing recourse to data as the benchmark for decision-making. With AI and machine learning enabling the industry to deliver real-time, responsive consultancy advice to their clients, my expectation is that private equity investors will continue to regard strategically minded marketing services agencies as an attractive M&A option.