Australia's Mad Men16.12.2011

We mention Photon in our latest issue. It has been one of the biggest winners lately with its share price more than doubling because it has removed the massive liabilities that floated above the company, like the proverbial sword of Damocles.

Having zero debt is one thing, what's left is another.

Photon one for the brave punters
Richard Hemming
December 16, 2011 - 8:49AM
Investors in the stock market can often be “over-exuberant”, and this is definitely the case with the advertising and marketing group Photon, whose shares have doubled since early October after it announced that it had eliminated its debt, largely through the $146.5 million sale of one of its businesses.

The company might have survived, but your intrepid columnist seems to be one of the few asking, what's left?

Photon (ASX code PGA) at just under 6 cents prior to today is trading on a forecast price/earnings ratio for 2013 of 14 times. If you take out the non-cash expenses (mainly amortisation from its many acquisitions) this reduces to about 11 times. This ratio is in line with its bigger competitor STW Communications (ASX code SGN).

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Photon has been cleaned up, for sure, but in investment terms, this achievement is the equivalent of reaching South Base Camp at Mount Everest.

In 2011 Photon's revenues were $344 million producing operating earnings (EBITDA) of just over $53 million. After the fire sale that has occurred to keep the doors open, in 2013 the company should produce about $200 million at the top line and EBITDA of just over $20 million.

Takeover prospects remote

Upon analysis of the remaining businesses, any hopes of a takeover by London based giant WPP are pre-mature when you look at the task confronting the chief executive, whoever that will turn out to be.

You see, the man who won't be embarking upon the restructure is current chief, Jeremy Philips. A couple of weeks ago he announced the big deal to sell a division and save advertising executives their jobs. Then this week he said he was leaving his.

Philips, by all accounts, is one of the more cheery people in corporate Australia. He owns about 5 per cent and along with other shareholders probably believes that Photon's growth makes it a better investment than STW.

But, in the words of one industry insider, both will struggle in a country with a very small population:

“The problem with all (advertising and marketing) businesses in Australia is that they are inherently sub-scale because of the costs of a holding company type operation, which only really works off a much bigger revenue base.”

Philips came into Photon 18 months ago when it was saddled with 45 businesses and payment liabilities of $450 million. Fast forward today and the company has zero debt and 14 businesses.

A feudal overlord

He has clearly removed its financial duress, but Photon still suffers from its feudal holding structure.

What got it into trouble was that it operated as a kind of fiefdom, grabbing businesses left, right and centre. It encouraged them to come into its fold by saying the equivalent of: “keep your management, keep your systems, we won't integrate them, we just want you to be part of our group, plus we'll pay you more if you continue to perform.”

Many of these companies did perform, and Photon was on the hook to pay over $100 million in what they call earn-outs, which the company severely underestimated. This gap resulted in its shares plummeting from $1 to 10 cents in mid-June 2010 and Photon raising $100 million at 10 cents a share. It now has 1.54 billion of the suckers on issue.

What remains in Photon now is the question. We would suspect that with its nose pressed firmly against the glass, the businesses it has sold were its strongest.

In terms of integration, all the 14 businesses currently do together is pitch for the occasional job. Integration does represent a big opportunity, but it will involve massive costs. And this is at a time when the industry outlook is poor, because of the obvious constraints on its customers.

Philips is happy knowing he won't be part of this, and good luck to him. The challenge for Photon is to find someone who is genuinely happy, and able, to finish a job only half completed.

What about its competitor, STW?

STW has about 70 advertising, marketing and communications agencies that work under its structure. It also has the overlord look about it, which one insider said was an essential part of the industry:

“Feudal lords are not looking for love (from their feudal overlord) they are looking not to be annoyed.”

But the key difference between STW and Photon is that the former's back office and administration capacity is largely centralised.

STW was originally spawned from John Singleton Advertising in 1985 and is Australia's largest operator in the space. It is now operating without its old guard. Russell Tate retired at its AGM last May, while founders John Singleton and Mark Carnegie and the majority of the original board have left the company.

Some have confidence that the old guard are not necessary because STW centralised its operations further and engages in the training and cross-selling necessary to be successful in an extremely competitive and small market.

One of those is Frank Villante of Celeste Funds Management says his fund owns shares in STW, but does not consider Photon to be investment grade.

“Photon is a red-blooded punt, and if I wanted to do that I'd go to the races. If you are comfortable with the industry, STW is successful in the key metrics of customer retention and sales performance.”

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About the Author

Caroline Mark

Caroline is the publisher of Under the Radar Report. She has a diverse background, from producing financial publications, to fundraising and marketing.

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