The Investment Case For Chime Communications

Posted on 05/12/2010


Firstly, a disclosure: Cautious Bull is a shareholder in Chime Communications plc.  Here’s the investment case that persuaded me to buy the company’s stock.

Lord Bell, Baroness Thatcher, Lord Saatchi

Chime Communications plc is a London Stock Exchange-listed holding company for a variety of public relations agencies, including Bell Pottinger, the agency founded by Lord (Tim) Bell, who rose to fame after his work for Margaret Thatcher’s Conservative Party while at the advertising agency Saatchi & Saatchi during the 1970’s and 1980’s.  Today, Chime Communications encompasses around fifty different agencies operating around the world and across the disciplines of advertising, corporate social responsibility, public relations, sports marketing, sponsorship and research.  In 2009 the company earned revenue of £301m and net profit of £12.7m.

From 2004-09 Chime grew cash flow from operations at an average annual rate of 25%, driven by geographical expansions and acquisitions of smaller competitors (costing a total of £45m, roughly 60% of cash generation).  The company began paying a dividend in 2005 and has since increased it at a rate of 27% per annum, while also making share repurchases in each year since 2006.

Recent performance has been positive with the company indicating in a recent interim management statement that they “have continued to perform ahead of expectations in 2010 and expect the second half performance to exceed that of the first half year.”  In addition, they “are feeling confident about prospects for 2011.  All of the top 30 retainer clients (48% of 2010 operating income) have renewed for 2011 or are in negotiations to renew.”  This gives me confidence that 2011 should be another positive year for the business.

Chime currently has only £0.4m of debt and £6m of cash, however, acquisition agreements usually contain earn-outs (deferred consideration) in order to retain key staff after the purchase.  Chime currently expects to pay-out £1.2m in 2011 and £0.7m in 2012, though notes that payments could be as high as £20.4m in 2013.  I would add that in the latter case the businesses in question would be performing extremely well, so this is not a liability in the normal sense, ie not a fixed amount or maturity date.  In the event the business underperforms significantly, then the earn-outs would be negligible or nil, presenting no threat to the sustainability of the company.  In addition, Chime can also decide to make the earn-out payments in cash or shares at its discretion.

The company pays out a dividend of 5.1p per share, a yield of 2.4% on the current share price.  Although this seems small, the company has also bought-back shares each year since 2006, with the payout in recent years averaging roughly 60% of the dividend, which should take the total payout to 3.7%pa.  In addition, the dividend has grown at a rate of 27%pa from FY05-09 and we would expect the dividend to continue growing, though possibly at a slower rate.  On a price/earnings basis, the company currently trades at 9.4x FY10e earnings, which I think is a relatively modest multiple for a company which has recorded free cash flow growth of 25% per annum, has just released a positive trading statement, and is likely to have a decent FY11.

Finally, the company is clearly a potential takeover target for advertising and marketing giant WPP plc.  WPP already owns 15.8% of the company, trades at a premium (13.4x earnings – so any acquisition would be EPS accretive) to Chime, can easily afford to make the purchase (WPP earned £438m in FY09), is in a closely-related market segment, and has a history of regularly making bolt-on acquisitions.

In summary, Chime Communications has shown exceptional historical earnings, free cash flow and dividend growth, has just issued a positive statement about current trading and FY11, has net cash, is a potential takeover target, and is cheap relative to earnings and cash flow.  Consequently, I feel it makes an excellent investment opportunity.

Posted in: Investment Ideas