I saw a documentary in the BBC Horizon series recently that suggested optimists live longer, healthier lives than pessimists. That’s good news, I thought, because I pride myself on my optimistic disposition. I’ve taken my knocks over the years – like any professional investor. But it was resolute optimism during periods of economic crisis that has led me to the greatest money-making opportunities I have found.
My biggest winner as a professional investor came about by taking just such a contrarian view. And I think there are very striking parallels with the situation we find ourselves in today.
This company was led by a hugely charismatic chief executive. He was a man down on his luck – his company and reputation was in mortal danger at the time. But he was fighting his way back. And by backing him we would stand to make a truly explosive return on our investment…
How debt nearly killed this giant
When you see Sir Martin Sorrell, he will strike you as very assured, confident and not short of opinions on how things should be. Whether on television from Davos or commenting on last week’s Omnicom/Publicis advertising mega-merger, he is the epitome of the global CEO.
When I first met him on 1993 though, his circumstances were different. WPP had been under financial stress during the recession and was a recovery stock rather than an international colossus. Along with a couple of colleagues, I visited him in the small boardroom of his head office in Farm Street, Mayfair. It was understated, but smart. Investor support was hard-won at the time, so we had a generous two hours in his company along with his extremely smooth floppy-haired personal assistant called Julian.
Sorrell is shorter than average and had all the pugnacious qualities associated with a smaller man up against it. That fighting spirit stood him in good stead as he battled to get his company back on track. Rather than the big-picture, grand overview which he specialises in giving nowadays, we were treated to a highly detailed discussion of what had gone wrong and how it was being fixed. His experience as a finance director came through as we went through lease reorganisations, variability in pay structures and cost/income ratios. He didn’t look down at his notes once.
Like now, the UK was beginning a weary recovery from recession back in 1993. At the time, interest rates were being kept artificially high to defend the pound in the Exchange Rate Mechanism, which we infamously exited on ‘Black Wednesday’ in the previous September. The high cost of borrowing contributed to a housing-market bust and also damaged companies which were highly indebted. One of which was advertising business WPP.
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WPP was bought into as a shell company by Martin Sorrell, former finance director of Saatchi & Saatchi, in order to embark on an acquisition spree and build a global marketing empire. He managed to acquire top quality assets including J Walter Thompson in 1987, and Ogilvy and Mather two years later. There was nothing wrong with these operating businesses; both were top-drawer. Unfortunately, there were three big problems which conspired to put WPP in mortal danger.
The first of these was the price paid. I firmly believe that the most important job of top management is to allocate capital. Done well, this means investing at the bottom of the cycle when prices are cheap and being tight with the purse strings at the top. Stock-market valuations were high when these WPP deals were done at the end of the 1980s boom; not a smart time to acquire.
The second problem was the economy. We entered into a downturn in 1990 which was sparked off by the Gulf War. Rising oil prices and deep uncertainty might have been triggers, but we also needed to digest the vast excesses of the ’80s’ boom. Historically, advertising had managed to withstand recessions, but there’s a first time for everything. Rather than holding up, clients cut back on their marketing spend, which made WPP’s newly acquired businesses much riskier than previously thought.
The final and biggest problem was debt. WPP had too much of it. And by the end of the recession, the banks were edgy. Ultimately, more equity was raised, a deal was done with the lenders and it looked like WPP should survive; but its share price had been absolutely pummelled. Sensing an opportunity, I set off with a couple of colleagues to meet Sorrell at his West End office.
How we got lucky
The market saw WPP (and Sorrell, no doubt) as tarnished. WPP was just the holding company though, and its stretched balance sheet looked like it was being sorted out. What was always clear to me was the high quality of the operating businesses. That was never in doubt. And, like now, the economy was already recovering, especially in the US, so revenues were coming back strongly. Costs were also being cut much more effectively than the market realised. Headcount was down and surplus property was being disposed of. This clearly meant that profit forecasts were going to be upgraded. In fact, they were entering into a long trend of upgrades.
We were able to buy at 50p, which wasn’t quite the lowest point, but it was low enough. WPP was embarking on one of my favourite stock-market journeys: from a cheap, low-rated and slightly tainted stock to high-priced titan. Gradually investors were won round as the improving results came through and the stock lost its controversial image.
Five years later, still holding the shares (the better pros really do invest for the long term!), we got lucky. Media shares were swept up in the TMT (technology, media and telecoms) bubble and WPP ended up peaking at £13. Sorrell became Sir Martin, expert on global business and a regular at Davos.
We made 26 times our money in six years. What were the main lessons?
To be prepared to back your judgment against the market, especially when a stock is considered risky or controversial.
And to look through the temporary negatives and see the permanent qualities of a company – to not be frightened to be optimistic and look for what might go right.
I’ve a string of companies that I am very optimistic about now – and I’m looking forward to recommending them to Red Hot readers. But I’ll also tell you about the two or three big investment stories that I think could lead you to massive gains in the next few years. Maybe not as big as 26 times your money. There was a lot of luck involved there! But I really do think that the accelerating pace of change in technology – from ‘big data’ to biotech – gives us every opportunity to make good money in this market.
• This article is taken from David Thornton's free twice-weekly small-cap investment email, The Penny Sleuth. Sign up to The Penny Sleuth here.
Information in The Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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