Engine’s buyout – Have we just witnessed the birth of a significant new holding group?

1st August 2014

One of the great things about this industry – and particularly in the M&A space – is its ability to constantly surprise you. Here at Green Square, I’ve lost count of the number of times we’ve said “Nobody saw that one coming!” Life’s never dull, that’s for sure.
It happened again this week, with the private equity company group Lake Capital snapping up Engine – London’s last remaining independent of any great size – for a tasty £100m.The deal itself wasn’t a complete surprise – rumours had been circulating in the City and Adland for at least a week, and with a few days’ hindsight there seems to be a kind of inevitability about the transaction – but what is really interesting is what it represents – of which more, later. But first, let’s recap the basics of the deal, which were reported in The Drum on Wednesday afternoon and then take a quick look at the two principals.

Up until Wednesday, Engine’s key investor had been HIG Capital, an alternative investment firm specialising in private equity and growth equity, headquartered in Florida (but very active in London). HIG became involved with Engine some four years ago, when the group was looking to expand beyond its Soho base and into the US and China; as a result, a two-year, £62.5m funding deal was put in place, giving HIG a 40 per cent stake in the company.

As for Engine itself, the story itself began back in 1979, when the ad agency Wight Collins Rutherford Scott was set up by old school advertising legends Robin Wight and Peter Scott; since then – partly as a result of ambition, partly as a result of acclaimed work for brands such as Sky and BMW – it’s grown into a multimillion-pound mini-group (Engine was set up in 2005) of 13 agencies, working in most major disciplines, including advertising (WCRS); PR (Mischief), DM (Partners Andrew Aldridge), data analytics (Fuel), social media (Jam), and digital (Fantastic Thinking). Operations are still based in London, but the group’s activities – thanks in part to HIG’s funding – have reached across the globe and are now very strong in the US.

But the main thing that has long distinguished Engine is its independence and its desire to remain independent; back in 2004, WCRS, the agency upon which this little empire was built, was bought out by its management from Havas, the holding group that then owned it. Since then, the group’s leaders have resisted the offers of the big holding groups (and this is why they turned to PE, as opposed to a public float or allowing a WPP or Publicis to take a stake) to fund its expansion plans. And, as one of the very biggest independent shops still left standing, I’m guessing that Engine must have looked interesting to a Sir Martin, a Maurice or an overseas acquirer looking for scale in the UK (think Dentsu, pre-Aegis).

It’s a fundamentally sound business, with a good creative reputation, a highly-rated management team and a genuinely blue-chip client book that includes Sky, Unilever, Coke, Diageo, Santander and BMW. Last year, revenue was up 10 per cent to £100.1m, while EBITDA was up 14 per cent to £13m. Margins, however, look a bit thin, and the UK agencies are underperforming compared to the US (non-US business comprised just $29.7m or £17.6m). So there is room to not only expand, but also improve performance, particularly in the UK.

Doing this requires long-term investment and stable leadership, which is why the Lake Capital deal is an excellent outcome. HIG has now been bought out, Lake owns 85 per cent and management and staff own 15 per cent, giving the group’s top creative, planning and admin talent a reason to stay on. And of course, Engine’s cherished independence has remained intact.

But what’s most significant I think is that we have seen the birth of a new holding group. Chicago-based Lake Capital already owns Trailer Park, a hugely successful US entertainment marketing agency whose clients include CBS, Fox, HBO, Marvel, Disney and AMC, the home of Mad Men; and ORC, a research shop. These two will now be brought under the Engine Group umbrella to create a global marketing services group. Trailer Park, Engine and ORC actually fit together extremely well – Engine now has a compelling research offer with ORC (as a marketing services group, research was always oddly absent in Engine compared to its peers), and one can see a very powerful offer combining Trailer Park and Engine’s interactive digital shop Deep Focus – the first purchase Engine made following the 2010 HIG funding.

Lake Capital co-founder Terry Graunke (who, incidentally, has known Engine boss Peter Scott for years, and who actually considered helping WCRS buy itself out from Havas all those years ago) told the US trade journal AdAge this week that there was a place in the market for a new holding group player.

“Our thesis is that pre- and post- the Omnicom-Publicis merger and lack of completion, there’s a real opportunity to create a middle-market player in the space,” he said, adding that he considered “mid-market” to be an operation with $500m to $2bn in revenue. Engine, ORC and Trailer Park added together get reasonably close to that lower revenue target (I estimate a figure just north of $400m), but new additions need to be made to fulfil Graunke’s ambitions.

Graunke said that over the next 18 months, Engine would look to complete other agency deals to grow the Engine portfolio across three categories: business intelligence and data, creative services and digital content. I doubt if many of these will happen in the UK, but in fast-growing “new markets” in the APAC and “Next 11” regions, as well as the US.

So, I think we’ve witnessed the birth of a new force in advertising – and, in many ways, the birth of a new era. When HIG invested in Engine in 2010, private equity investment in advertising companies was, if not quite rare, certainly not a commonplace; it would have been far more normal for Engine to have floated, particularly given the appetite for IPO’s pre-summer. But Lake Capital’s buyout represents a huge vote of confidence, not only in Engine’s talented team, but in marcomms generally and in London as the centre of the marketing communications world.

Why? Look at this way: the big question is, what does Lake Capital want? PE typically invests in a business in order to sell on at a profit later. But the fact that Terry Graunke will be executive chairman of the enlarged group (PE firms often take non-exec roles), and that Lake already occupies a sizeable spot within the space (at least Stateside) suggests to me that they are in this for the long term and that Graunke has more than just a financial interest in marcomms. Could he be a Sorrell in the making?

If they can find the right synergies, cut the right costs, and make the right acquisitions, a business like Engine could actually provide the high margins and returns private equity firms demand.

This acquisition won’t go unnoticed by Lake Capital’s peers. PE firms have been increasingly active in this sector and we may start seeing a bigger influx of PE capital into the marcomms arena over the coming months and years as similar such investors enter the fray. Coupled with the relatively recent activity we have seen from the management consultancy community, together with continued economic growth, this can only be good news for the remaining marcomms independents of scale in the sector.

Interesting times.