Analysts have stated that S4 Capital has “grown too quickly” and warned of a potential problem in retaining talent, following the company’s profit warning last week.
In a trading update on the London Stock Exchange, S4 Capital warned staff costs were rising faster than revenue (known as gross profit) in its content practice and promised “significant cost-reduction measures, including a brake on hiring."
S4 Capital’s share price almost halved on the day to end 86% below where it was at its highest point in September of last year.
The business, which was set up in 2018 by Martin Sorrell, said it was confident in hitting its 25% top-line growth expectations for the year ending December 31, but admitted that its bottom line would be hit.
The company had unnerved investors earlier in the year when it twice postponed the publication of its 2021 annual results due to an audit delay. “Control weaknesses, staff turnover and lack of detailed documentation” were all issues at S4 Capital, the company told investors in May.
The profit warning in July was a fresh blow.
Stock market analysts' view
The “lack of central controls appears to be worse that expected," caused by the content division “hiring aggressively based on revenue forecasts that central management deems too high," according to analysts at Barclays, which suggested that the company had "grown too quickly."
Barclays analysts warned that entrepreneurs who sold their businesses to S4 Capital and were paid 50% in shares may be disappointed by the current share price.
“Potentially, then, this might lead them to leave S4C when their earn-outs are paid. A talent exodus could lead to lower organic and possibly another future profit warning,” they continued.
Barclays analysts highlighted though that the positive view is that management is “intensely focused” on addressing these issues.
More disruption ahead?
Meanwhile, analysts at Numis Securities also highlighted that S4 Capital has grown fast and warned that its internal structure has “not developed fast enough."
“Whether this is a more fundamental content management or control issue is unclear but amounts to the same; S4 must beef up budgeting, cost scrutiny and financial controls,” Numis analysts said.
They further expressed concern about more disruption before the right controls are in place, and questioned what extra controls would cost.
In a similar vein to Barclays, Numis analysts also pointed to talent retention as a potential issue for the company.
However, they concluded that their recommendation remains to buy S4 Capital shares, adding: “While bruised, we see a well-positioned digital agency needing near-term control upgrades. This is a risk but arguably discounted, given SP [share price] falls.”
Analysts at Peel Hunt noted that the profit warning was “disappointing”, given that market expectations on margins have pulled back several times since last year.
They commented: “Before today, we were under the impression that accounting issues were behind us and control functions were on the mend. Added to this is the positive news from S4’s peers over the last two days, pointing to a better than expected environment for client marketing spend.
The company’s earlier difficulties, including the audit delay, had already prompted S4 Capital to axe annual bonuses for Sorrell and the other executive directors for the 2021 financial year.
S4 Capital’s response
Speaking to Campaign, S4 Capital’s chief growth officer Scott Spirit admitted that there was definitely something in the growing pains mentioned by several analysts.
He said: “We’re a high growth company – we grew our topline 44% last year and we’re continuing to project strong growth this year, at 25%. Those are growth rates that are way beyond what other agencies are doing. It’s true that growing at that rate can cause problems.”
Spirit added that the company’s profit, or Ebitda, is “very second half weighted," which he noted was typical for the industry.
“What happened from our perspective is following visibility of our first half year numbers the board felt it was cautious to rein in the profit projections that analysts had for the company,” he continued. “That was based on the fact that we had invested heavily in additional talent in the first half of the year, particularly in our content division to drive further growth in the second half.”
Asked about the dramatic drop in S4 Capital’s share price, Spirit stated that it was “disappointing”, adding that it, combined with the audit delays earlier in the year, presented the company with challenges.
“It’s incumbent on us to deliver,” he said. “There’s a real focus and a lot of ambition in the company that we are creating a new business and we’re creating something different and something that is a high growth company.
“We’re very committed to reaching that target. It’s important for us as a company now to deliver on our targets to win back that investor confidence," he added
However, contrary to analysts, he did not believe the situation would have an impact on staff retention.
Spirit, who used to work with Sorrell at WPP, concluded: “Our management team are owners of the company, so we’re all incentivised to turn this situation around, to reach those targets and to prove to investors that this still is a very strong company."
“We’ve spent a lot of time talking to our people about this internally. There’s a real sense of determination to prove ourselves and confidence that we can," he said.
When S4 Capital launched in 2018, it created special incentive shares for management, including Sorrell and Spirit, which, hypothetically, would give them a 15% share of the uplift in the company’s value, if it hits 6% annual compound growth over a five-year period to 2023.
This story first appeared on campaignlive.co.uk.