Omnicom's Credit Crunch: a Gamble by CEO Wren That Didn't Pay Off
Omnicom has been put on Standard & Poor’s creditwatch, placing its A- credit rating in doubt. Adweek reported the news, and gave this reasoning from S&P credit analyst Heather Goodchild:
We are also concerned about Omnicom’s overall funding flexibility as a result of recent and potential debt puts.
What does that mean? The article doesn’t say. Luckily, BNET is here to offer an explanation: Essentially, CEO John Wren made some bets with acquisitions but got caught in a foreign currency trap — and now he’s got more debt than he probably wanted.
This is important because credit downgrades often presage layoffs — credit rating companies like to see companies cut their expenses to get their ratings back. We saw this already with WPP.
First, note that Omnicom had a not-great Q4.
Revenue declined 3.3 percent to $3.3 billion — that was the headline. I thought it was more significant that the company saw an actual cashflow decline of nearly $700 million. This turns out to be significant in terms of the debt Omnicom carries. Check out OMC’s Q4 statement.
Omnicom provides a “current credit picture update.” These are usually quite boring, but this one contains a couple of hand grenades.
Earnings before interest payments went up, from $1.8 billion to $1.9 billion. Usually this is a good sign. A company with increasing profits is better able to pay its debts, not, as S&P just ruled, less able.
Total debt stayed the same at $3 billion. Something here doesn’t make sense. If earnings are up and total debt is the same, why is S&P getting its knickers in a twist?
Turns out Omnicom’s debt and debt-expenses are increasing faster than its earnings, and — as I noted a couple of days ago — its actual cash-in-the-bank is decreasing. Here are the numbers:
Gross interest expense went up, from $106 million to $124 million. That’s bad (think of your mortgage interest rate adjusting upward). Whereas Omnicom once earned 17 times the cash needed to pay the interest on its debt, it now earns only 15 times that amount. But here’s the killer blow: Remember that cashflow loss of $700 million? Omnicom’s total debt minus cash-on-hand went up from $1.2 billion to $1.9 billion. Even though Omnicom is earning more on paper, it’s getting poorer in real cash terms.
More debt + less cash = trouble with the credit ratings agencies. Expect Fitch and Moody’s to follow suit.
What caused this? First, foreign currencies devalued rapidly at the end of 2008, so when all those euros and pounds were translated into dollars, Omnicom lost about $356 million. At the same time, Wren signed off on $441 million of acquisitions — that was cash out the door on shops like Yellowwood Future Architects (!) in South Africa.
So there’s your story: Wren took a risk, spending cash on companies and hoping his earnings would hold up. They did, but foreign currency didn’t, and now he’s got more debt than he thought he’d have.
Jim Edwards, a former managing editor of Adweek, has covered drug marketing at Brandweek for four years, and is a former Knight-Bagehot fellow at Columbia University's business and journalism schools. Follow him on Twitter or send him an email.
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