Valuing S4 Capital Is Difficult, But Expect Further Growth (OTCMKTS:SCPPF)

After writing previously on U.K.-headquartered demand-side platform and digital marketing consolidator S4 Capital (OTCPK:SCPPF), a number of commenters have asked how high I think the shares could go. Reaching as high as 423p in mid-September, it has since retrenched somewhat to around 390p. But I have been considering the likely future share price direction and remain very bullish on the name.

Using Earnings to Value S4 Capital

Using earnings to value a tech company is not very common, while it is more common for a media company. I would put S4 in the tech sector when it comes to valuation metrics.

In its half-year results, the company announced a variety of EPS numbers – take your pick. With changes in reporting basis and rapid growth through acquisition, as well as the intangible nature of a lot of the assets in a tech business like S4, it is hard to get to a solid-feeling EPS number, especially as at just a couple of years old, the company has a short track record.

If one is willing to accept the adjustments, a caveat for most growth tech companies, then the current share price of around 390p equates to a P/E of 75x using the most recent full-year figures. If the growth seen in the first half of 2020 is replicated across the full year (which it should be at a minimum; in fact I expect the results to be better as the second half shouldn’t have the same COVID-19 impact S4 saw in March and April), annualized EPS would come out at 13p, which would give a P/E at today’s share price of 30 x.

Note that the company’s clearly stated objective is to double like-for-like revenue and gross profit over the three years from 2020 to 2022, and in its half-year results, S4 reiterated that it believes it has “an even stronger fighting chance” of so doing. If it doubles like for like, and there is bolt-on growth through acquisitions, then the actual growth will be greater than 100%.

The doubling organically target, which the company is clearly focused on as a metric and which I think its repeated confidence suggests it is determined to achieve, refers to gross profit, not EPS. If EPS were to double from the projected 2020 full-year figure I outlined above, that would mean that the P/E a today’s share price would fall to just 15x. Note, however, that that will be hard, as the number of shares in circulation has increased substantially (approximately 34% between the end of 2019 half year and end of 2020 half year) and so earnings will be distributed over more shares. I expect that to continue as the company issues shares to raise funds (as it did this summer) and also to use as currency in deals, which it has stated it prefers to fund using a combination of cash and equity.

Nonetheless, even using a P/E basis which typically doesn’t work well for early-stage tech companies, the current valuation doesn’t look crazy. On an adjusted basis, the ratio of 30x with strong earnings growth expected for years to come looks cheap compared to market peers, in fact.

Using Peer Benchmarks to Value S4 Capital

One of the challenges in valuing the company is clearly understanding what it does and what its competitive advantages are. The company often talks about its so-called “holy trinity”. That consists of first-party data, digital content and programmatic. By integrating different agencies in each of these areas and connecting the dots, the company can offer a one-stop shop for clients. Based on the growth in account numbers and size in recent months – Sir Martin Sorrell pointedly stepped out of the last earnings call to speak to a “whopper” client the company was close to securing – that proposition is attractive to clients.

Something a lot of people seem to overlook about the model is the importance of first-party data. Historically that has been less important in digital advertising, as companies can use third-party data. With growing restrictions on data use such as GPDR and Californian rules on selling personal data, first party data will become more valuable and help to strengthen S4’s moat, in my assessment.

The market for digital advertising is huge and set to continue growing. A company somewhat similar to S4 is The Trade Desk (NASDAQ:TTD), which has a market cap now approaching $23 billion. It is well covered here on Seeking Alpha, with Louis Stevens’ May note The Trade Desk: Capturing A Revolutionary Trend providing a useful overview of the value proposition. After being founded in 2009, current full-year revenues are estimated at $723M, with around 1,300 employees. S4 Capital’s first-half revenue, extrapolated for a full year, would come out at approximately $363M. In other words, it will likely have revenues half as large as The Trade Desk’s by the end of this year, despite The Trade Desk having an eight-year lead in development. Although S4 is British, its key market is the Americas, which provided 72% of gross profit in the last half.

What unites the company in valuation terms, in my view, is that the market is affording it a valuation premium based on the tailwinds in its area of operation: digital marketing is set to continue growing, and within that, the more integrated the offering the more effective the return on investment for clients should be, which will drive business. While The Trade Desk is not an exact comparator for S4 Capital, the fundamentals of the business and the value proposition are similar.

The Founder Premium

The company was set up by the erstwhile WPP (WPP, OTCPK:WPPGF) boss Sir Martin Sorrell and is clearly his baby. Indeed, if one reads the share structure and articles of association of the company, the constitution is clearly designed to protect Sir Martin’s interests – I don’t like that but can live with it as the tradeoff is benefitting from his obvious expertise.

There is a premium in the share price for Sir Martin’s involvement, I think. That doesn’t bother me. He may be in his seventies (which isn’t that old, really), but if anything, he is speeding up, not slowing down. During the lockdown, for example, the company has raised capital and continued its acquisition spree.

Arguably there is a key-man risk with Sir Martin, which would negatively affect valuation if he was no longer involved with the company. Indeed, as S4 is happy to reiterate at every opportunity, WPP’s value fell sharply since his departure. As for example:

“Sir Martin was CEO of WPP for 33 years, building it from a £1 million “shell” company in 1985 into the world’s largest advertising and marketing services company with a market capitalisation of over £16 billion on the day he left. Today its market capitalisation is less than £8 billion.”

(That version is from this month’s interim results, but a version appears in all S4 announcements as far as I have noticed, presumably Sir Martin’s vindication at the ongoing travails of WPP shareholders moderated by the fact that he remains one himself). Clearly there is champagne on ice in the S4 offices waiting for the day that its market cap matches that of WPP, and as a shareholder, I quite appreciate the drive that that gives the company.

Incidentally, it is worth noting once more that that value creation at WPP really was phenomenal. Sir Martin has an outstanding track record of value creation for shareholders. That said, I think the key-man risk for S4 is overrated, for now. Sir Martin clearly has no plans of quitting anytime soon. “I have a point to prove,” he told an interviewer from the Manchester Guardian. But the value of S4 does not depend wholly or perhaps even mainly on the ongoing involvement of its founder. WPP may have lost half its value – but it is still capitalized at nearly eight billion pounds, because Sir Martin understood how the ad agency landscape was changing and built a structure and operation to fit that. Similarly, S4 Capital has a clear point of view on digital advertising in the coming years and has collected a growing set of assets to deliver against that vision. The group has over two and a half thousand staff. So, while the founder remains important, the whole valuation of the group doesn’t rest on one man sitting in an office with his Rolodex, a BlackBerry and a grudge against WPP.

Conclusion: S4 Remains a Strong Buy

S4 has been on a tear for the past few months. 400p seems to be something of a resistance point for the share price for now, but I expect it to pass that in due course.

I had a holding in the company and substantially increased it at close to current prices in September, after I published S4 Capital: Still A Buying Opportunity In This Growth Machine and decided to follow my own advice. I continue to believe that despite its strong price appreciation, at the 400p level, the company is very attractive.

My own target price is 1,000p within five years. But I can’t easily ascribe a logic to that: we really are in the territory of how long is a piece of string? The market for what S4 does is growing and set to continue growing, its own value proposition is strong, its client roster is growing, it has industry-leading talent and proven leadership which is strongly motivated to grow fast. To some extent, therefore, ascribing an actual valuation based on business metrics at this point is a leap of faith.

The company’s shares have run up a lot this year, so may take a breather.

Source: Google Finance

However, the trendline is clear, and I expect it to continue in the same direction. 2020 has shown that the S4 business model works and is scalable. With new acquisitions and positive results, shares tend to move up a level – something that predates 2020 but has been more pronounced this year – and over the next several years, I anticipate that amounting to a lot of growth. I continue to rate the name as a strong buy.

Disclosure: I am/we are long SCPPF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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