Advertising Agencies. Watch this Ad Space. Equity Research. April 25, 2013

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1 April 25, 2013 Alex Wisch Equity Analyst Westcott Rochette Equity Analyst Watch this Ad Space We are positive on the global advertising agencies over the next 12 months, as we expect global advertising expenditure the main driver of the sector to start accelerating over the next few months. Ad forecasts by key independent market research groups have been cut repeatedly for over a year. We argue the trough has been reached, with upgrades likely in the near term, led by a stronger-thanexpected recovery in North America, as already evidenced in the Q1 13 reporting season. The largest global ad agencies are also likely to benefit from their growing exposure to emerging markets. We estimate the major emerging markets will add USD200 billion to global advertising spend over the next 15 years as the economies shift towards more consumer discretionary spending. Brazil, Russia and China will account for about 29% of global ad growth over the next three years, according to forecaster ZenithOptimedia. Ad agency conglomerates also offer growing exposure to digital advertising, which will continue to be the most dynamic area of advertising over the next three years, in our view. Digital solutions allow agencies to tap client budgets beyond traditional sources in advertising and promotion. Publicis generates 37% of revenues from digital sources. Internet advertising, including search, display and classifieds, is growing significantly faster than TV, radio, and print, and is likely to go from 16% to 23% of total global ad spend in the five years to 2015, according to industry forecasters. The top four global ad agencies in our coverage score well against these cyclical and structural trends. We have Buy recommendations on the US-listed groups, Omnicom and Interpublic, and also on Paris-listed Publicis, while we have a Hold recommendation on London-listed WPP. This reflects our slightly more positive view on ad markets in North America and emerging markets, and caution regarding Europe. We also favour higher relative exposure to digital advertising. Recommendations Name Bloomberg Ticker Price Cur Rec Target Price P/E 2013E Dividend Yield (%) - FE 2013 EPS 4-YR CAGR W Europe (% 2012 Revenues) Analyst Name Interpublic IPG US 13.5 USD Buy % 16.4% 20.1% Westcott Rochette (US) Omnicom OMC US 58.0 USD Buy % 3.7% 25.1% Westcott Rochette (US) Publicis PUB FP 50.8 EUR Buy % 10.0% 28.5% Alex Wisch (UK) WPP WPP LN 10.5 GBP Hold % 9.1% 36.8% Alex Wisch (UK) Source: equity research estimates, as of April 22, 2013 This report is for information purposes and should not be considered a solicitation to buy or sell any security. Neither Standard & Poor s nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without written permission. Copyright All required disclosures appear on the last two pages of this report. Additional information is available upon request.

2 Contents 2 Contents 2 Advertising outlook Downward revisions in ad forecasts coming to an end 3 Regional exposure 5 Structural changes 8 Agency growth outlook driven by emerging markets 8 Digital advertising 17 Company portraits 22 Summary of recommendations 22 Our forecasts vs consensus 22 Publicis 23 WPP 24 IPG 25 OMC 26 Disclosures / Disclaimers 30

3 Advertising outlook Downward revisions in ad forecasts coming to an end Industry forecasts for global advertising growth have been on a downward trajectory For the better part of the last two years, global advertising revenue forecasts have proven optimistic and disappointed on the downside. Key forecasters like Magna Global, GroupM, and ZenithOptimedia have revised their global forecasts for 2012 and 2013 almost every quarter since mid-2011, when the pace of the economic recovery started to slow. In mid-2011, Magna was forecasting 2012 global advertising growth of 6.5%, a forecast that was cut to 5.0% by end-2011, and later to 4.8% in 2012 and finally to 3.8% by end GroupM and ZenithOptimedia also saw a steady downward trajectory in sales estimates (see the chart below). Evolution of Global Ad spend Growth Forecasts for 2012 and Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec % growth y-o-y 2013 % growth y-o-y Source: ZenithOptimedia, based on statements from March 2012 through to December 2012; April 22, 2013 Evolution of Global Ad Spend Growth (%) Forecasts for 2012 and 2013 (Breakdown by Region) Global W Europe N America Global W Europe N America Mar Jun Sep Dec Source: ZenithOptimedia, based on statements from March 2012 through to December 2012; April 22, 2013

4 We pinpoint two of the biggest culprits for the downward pressure on projections: 4 1) A challenging Europe whose economic deterioration has proven both more severe and protracted than expected. 2) A more modest pace of advertising recovery in developed markets than prior cycles. Disappointing Europe and a slower economic recovery account for downward revisions to global forecasts The European economies continue to disappoint and account for the bulk of the revisions, driven by a prolonged recession, austerity programmes, and elevated unemployment. The macro pressures have proven too difficult for companies to overcome, and advertising budgets have come under pressure accordingly looks to be a continuation of this trend as Publicis indicated a more severe 6.5% organic revenue contraction in Europe in Q1 13. While Europe has been an easy target, we believe forecasters and the agencies were also caught off guard by how long companies maintained their own austerity programmes in regard to advertising. The pace of the advertising spend recovery began to level off much sooner than in prior recoveries. In 2012, total ad dollars in the US remained 8% below the 2007 peak. Companies have focused more diligently on bottom line results and emphasised promotions more heavily in lieu of advertising relative to other cycles. There has also been a greater emphasis on return on investment (ROI) of advertising spend, shifting budgets to more effective digital campaigns and stretching the ad dollars further. While the difference has not been as severe as in Europe, it has required an adjustment for the ad agencies. Nearing an inflection point However, we believe we may be nearing an inflection point in the global forecasts. In our opinion, the agencies and forecasters alike have factored in a more conservative outlook for 2013 that allows room for upside revisions. We believe the combination of what we consider subdued advertising expectations and improving economic sentiment in the US marks a potential inflection point in ad spend In 2013 to date, the biggest disappointment remains Europe. While we believe there is scope for further disappointment in this region, the figures for North America remain far more resilient and even appear to be gaining some momentum. A big factor is a healthier and we believe sustainable economic recovery, with consumer sentiment on the rise amidst a very accommodative fiscal policy by the Fed, in our view. We are also entering a period in the economic recovery where companies emphasis begins to shift more toward revenue growth and less on margin expansion. This shift lends itself to expansion in advertising budgets as companies accelerate new product introductions and are more aggressive seeking customers. In addition, the structural changes taking place in the advertising industry, with a larger share of ad dollars being spent on digital channels, favour North America where the practice is more established. Moreover, for the first time over the last year, the agencies collectively put forth a much more confident tone. To cite a grossly overused financial term, they seem cautiously optimistic.

5 Regional exposure 5 Greater exposure to a difficult European market limits our outlook for WPP relative to Publicis, Omnicom and IPG Advertising agencies, and in particular global conglomerates offer exposure to advertising across all regions. However, WPP, and to a lesser extent Publicis, have a relatively higher share of revenues from Europe, as can be seen in the chart below. We believe that European exposure is a key risk in the short-term, which is reflected in our relatively more cautious view on the shares of WPP vs Publicis, Omnicom and Interpublic. Revenues Exposure by Geography (2012) Source: Company reports, equity research; April 22, 2013 regional outlook A healthy US market combined with faster growing emerging markets drive our global growth forecasts Typically, the advertising agencies aim to grow at a rate slightly above global GDP. However, regions can experience wide divergence in growth rates that can influence both the agencies near-term growth rates as well as the aggregate global advertising levels. Today, the widening spread of the growth rates of the United States and Europe is a good example. This year, we expect the US economy to return to a steady growth mode with its core advertising growth rate (excluding the special effect of the Olympics and Presidential Elections in 2012) at about 3% to 4%. By contrast, we expect the outlook for European advertising to continue to worsen from already depressed levels. We see no prospect of a recovery before As it stands today, we are anticipating 2013 growth rates in the major regions as follows. North America (+3 to 4% core growth) Western Europe and the UK (Flat to down 2%, with risks on the downside) Rest of World (+8 to 10%, driven largely by the four BRIC countries Brazil, Russia, India, and China).

6 Regional exposure influences our opinions on the global agencies 6 While we appreciate the favourable long-term prospects of the global agencies, we believe the near-term risks to the European economies warrant more caution on those conglomerates relatively more exposed to Europe. On this basis, we have a Hold recommendation on WPP, but Buy recommendations on Publicis, Interpublic, and Omnicom. We believe IPG s and OMC s geographic profile, with heavier concentration in the improving US market, positions these companies to better absorb further European pressures, while Publicis also benefits from its inroads into higher-growth digital advertising. WPP (29% of 2012 revenues outside of US and Europe): Currently, WPP has the greatest relative and absolute exposure to the emerging markets, with almost a third of its revenues outside of the non-traditional regions. WPP s management also likes to emphasise its much higher absolute level of exposure to the higher growth markets relative to its peers, which we have illustrated in the chart below. WPP has been active in building its presence in these markets and is wellpositioned to benefit from growth in these regions. However, WPP also has the largest relative exposure to weak western Europe. PUB (24% of 2012 revenues outside of US and Europe): Publicis has been just as active in building its exposure to the developing markets, with roughly 24% of its revenues originating from outside of the United States and Western Europe. The company aims to raise the amount of revenues from faster growing markets to 35% of the group total by 2018, as stated on the April 2013 Capital Markets Day in London. Growth in these markets, alongside the group s expansion in digital businesses has allowed PUB to generate growth slightly above peers over the past 18 months. In the latest set of results for Q1 13, group organic growth was only 1.3%, but countries, Greater China and India, delivered y-o-y growth rates above 10%, while Russian growth was in the 5-10% category organically. This compares to most of Western Europe on negative ground. OMC (23% of 2012 revenues outside of US and Europe): OMC is employing a slightly different approach to building its emerging market exposure. It favours organic growth vs large bolt-on acquisitions. The group does engage only in small purchases, which allow it to enhance only specific capabilities. Management argues that this approach allows the group to integrate smaller acquisitions into its platform more seamlessly and cost effectively, supporting a more cohesive offering, even if that means sacrificing some growth relative to its European peers. IPG (25% of 2012 revenues outside of US and Europe): IPG s exposure to the non-western markets is also relatively high, which is a product of its early focus on Asia and strong presence in Brazil. Although the company s revenues are lower on an absolute basis, we believe it has more than adequate coverage to each of the major markets to successfully serve multi-national companies.

7 7 Revenues in Faster Growing Markets - Top 4 Global Ad Agencies ( ) Source: Company data, S&P estimates. April 22, 2013 WPP reports in USD; peer USD revenues as shown in annual results presentations, but translated at average exchange rate for the year (IPG, Publicis and Omnicom); OMC assumes non-euro currency Europe, i.e. Switzerland, Turkey, Norway, Denmark, Sweden and Eastern Europe are 3% of revenue and Canada 1.5%

8 Structural changes 8 Agency growth outlook driven by emerging markets One of the greatest long-term investment strengths of global advertising agencies is the growing exposure to developing markets where growth rates are poised to remain higher than the developed world. While the developed markets remain extremely important in terms of size and developing technology and creativity, they do not provide the same growth potential as the developing markets where the consumption per capita is still expanding and discretionary outlays increasingly drive a greater proportion of the GDP mix. The global advertising agencies provide exposure to the growth theme in the consumer sector in emerging markets. We anticipate growth from these markets will support above average revenue growth for the large global advertising agencies over the foreseeable future. Market growth much higher in developing markets Advertising expenditure in China, Brazil and Russia is projected to grow more than three times as fast as in developed countries over the next three years A look at the top 10 advertising markets by country illustrates the growing importance of the emerging markets. While the United States is clearly the market leader, China and Brazil are already among the top 6 advertisers, with Russia projected to join them in the top 10 by 2015 (ZenithOptimedia). Even more pronounced is the projected growth rate of these three major emerging markets compared to the more traditional developed markets on the list. Over the next three years, the three BRIC countries are forecast to grow at an average of 10.7% per annum compared to just a 2.8% rate for the seven developed markets. Top 10 Advertising Markets and Projected Three Year Growth Rates (USD mln) Source: ZenithOptimedia, equity research, December 2012; April 22, 2013

9 Agencies follow client growth into emerging markets 9 Multinational expansion into emerging markets has historically led global agencies to increase exposure in these countries The global agencies recognised the phenomenon of growing wealth among consumers in emerging markets long ago and began shifting their focus towards these geographies, accordingly. We believe the desire to build out emerging market capabilities is a by-product of following their clients. Armed with the advantage of strong relationships with multinational clients, the agencies saw first-hand that greater resources were going towards growing sales in the developing markets where the growth profile was much healthier than domestically. Increasingly, the agencies saw an opportunity to build their own presence in these markets to better serve multi-national clients. As the local market expertise became more established, opportunities to serve local marketers also developed. Publicis stated that as of Q1 13, two thirds of its clients in Greater China are multinational companies, with one third being local groups. However, the group said it is local advertisers that are currently seeing the most dynamism, highlighting future trends, in our view. The favoured expansion method into emerging markets has been through acquisitions, but the agencies have also built local expertise organically in some cases. Typically, the entry came through a joint venture or acquisition of a local market operator, which then allowed the parent to layer on some its own technology and best practices. The four major global agencies increased their revenue exposure to non-western markets by six to nine percentage points since 2006, led by WPP WPP has been the most aggressive in terms of its ramp up of capabilities beyond traditional developed markets, with its exposure up to roughly 30%. However, the other major global agencies have not lagged too far behind and established significant presence in faster growing markets as well. IPG is second with roughly 25% of its sales outside of the US and Europe, while Publicis has 24% and OMC 24%. In effect, we think all four major holding companies have more than sufficient international coverage to serve a global client across all of the major geographies, and they are also starting to cater to a growing number of local clients in these markets. Percentage of Revenue Outside of North America and Europe Source: Company reports ( ); April 22, 2013

10 Agencies provide attractive exposure to consumers in higher growth markets 10 In our opinion, the global agencies are in a prime position to benefit from the positive macro factors that will drive consumer wealth in the emerging markets. The large global agencies have already developed a solid foundation in the key higher growth markets like Brazil, Russia, India and China, so the heavy lifting on the investment ramp is largely behind them, in our view. We believe they are in a good position to leverage that base to drive above-average growth and returns going forward. The ability to serve multinational clients in a coordinated effort has been significantly upgraded and enhanced, which should foster improved collaboration and partnerships as the multinationals continue to expand further in the markets. Accounts concentration positive for global ad groups We see this factor also influencing further consolidation of accounts in favour of global holding ad agencies, over locals and independents. The benefit of coordinating a consistent message across multiple markets while catering to specific customers in a region is gaining resonance with greater frequency. While we recognise that every account is different and some will prefer local market independent agencies, we see this trend of global account consolidation continuing. Sizing the market opportunity outside of the developed countries While it is obvious that developing markets have the potential for greater growth as they catch up with developed markets in terms of wealth, in this section we size the magnitude of the opportunity. We see potential for the major emerging markets to add USD200 billion to total global advertising spend over the next 15 years We see potential for the top nine major emerging market countries to add at least USD200 billion to global advertising spend over the next years. Collectively, these nine markets generated roughly USD91 billion in advertising revenue in Our baseline assumption that these markets will approach onethird the level of advertising dollars spent per person in the more developed Western markets, implies a tripling of the market over the next 15 years. China, Brazil, Russia, India, Indonesia, Turkey, Poland, Mexico, and South Africa.

11 (We appreciate that other countries outside of these nine present attractive opportunities and are likely to garner increased attention as these markets begin to mature, but we are limiting the scope for purposes of this exercise.) 11 As a base of reference, ZenithOptimedia sizes the 2012 total global advertising market at approximately USD498 billion. What we would classify as developed markets - the US, Western Europe, UK, Japan, Australia, Canada, and Korea - comprise roughly 71% of that total or USD352 billion. Potential Size of Major Emerging Markets Compared to Current Developed Markets Assuming Annual Advertising Spend per Person of USD126 one third that in Developed Markets (In Billions of USD) Source: Ad Age (June 2012), ZenithOptimedia (December 2012), CIA World Factbook (April 2013), equity research estimates; April 22, 2013 Using advertising dollars spent per person as a proxy China would surpass the US as the largest advertising market if annual advertising spend per person reached just one third the level in the developed world There are several ways to measure the spending gap between countries, with advertising dollars to GDP being one such common approach. We are choosing to focus on advertising dollars per person, which we believe is an equivalent way to interpret the market situation. Namely that developed countries spend a much greater proportion of their money on measurable forms of advertising, but that gap is narrowing as the emerging market consumer accumulates more disposable income. Intuitively, this makes sense. Historically, wealth in the emerging markets is often more concentrated with a less developed middle class less devoted to discretionary purchases. Spending money to advertise commoditized staples produces little marginal return and advertising is more limited as a result. However, as wealth accumulates and the economies start to develop a more robust middle to upper class, purchasing power begins to shift towards more discretionary goods. Brand building and product differentiation begin to make more sense in this environment, driving advertising spend to help influence those purchase decisions. This phenomenon has been occurring in the BRIC countries already. (BRIC is an acronym referring to Brazil, Russia, India, and China, representing the leading countries in the developing market expansion.) A market like Brazil or China can

12 hardly be classified as emerging in the traditional sense of the word at this stage. Both countries already operate with a sophisticated advertising and consumer markets. Nevertheless, the rate of participation in the consumer economy remains well below the levels seen in the traditional developed countries. We see material growth ahead, even in these later stage emerging markets, as the economies continue to shift toward consumer driven growth. 12 Developed countries versus emerging markets in terms of ad spend per person Average annual advertising spend per person in the developed countries stands at between four times (Brazil) and eight times (China) the level in the major emerging markets The average ad spend per person p.a. in the major Western and developed markets was c.usd400 in By comparison, Brazil spends an average of c.usd92 per person p.a., with Russia at USD68 and China at USD27. These three countries are generally considered the major focus markets for the global agencies and represent a significant source of growth in both the near and long term. In the five other markets we deem of particular significance, the annual ad spend per person ranges from USD26 (Indonesia) to USD85 (South Africa), with Mexico, Poland and Turkey coming somewhere in between. India is a unique market, which due to its cultural and socio-economic make-up, is unlikely to mirror the development of the other BRICs and should be considered in isolation, in our view. India s annual ad spend is only USD5 and remains well below the other markets. However, given its sheer size and well-educated, burgeoning middle class, we think it represents an interesting long-term opportunity. Comparison of Ad spend per Person in Major Developed and Emerging Countries Source: Ad Age (June 2012), ZenithOptimedia (December 2012), CIA World Factbook (April 2013), equity research estimates; April 22, 2013

13 Propensity for advertising shows a wide variance 13 While the average annual spend is USD400 per person in the Western and developed markets, the amount does vary widely across countries. The highest is Switzerland with USD737. The US is relatively high at USD512. Japan is at the developed average of USD400. The UK, Germany, and Canada are around USD300. Lower on the developed scale are France and South Korea at USD200 each. Baseline premise: the emerging markets will achieve onethird the Western spend Emerging markets advertising per person should expand as wealth accumulates and purchases shift to more discretionary items from commoditised staples We start with the premise that over time, as a more robust middle class develops in the emerging countries and the discretionary market grows, advertising spend per person will climb towards levels seen in mature markets. As a baseline, we set a target that the emerging markets will reach one-third the average of developed countries of USD400 annual spend per person over the next years. This works out to a baseline target of roughly USD126 per person per year. For some countries, this level seems almost a certainty (Brazil, Russia, South Africa) and they are likely to surpass the target much earlier than 10 years. For others, limiting factors like population dispersion or societal makeup might make this target seem a high hurdle to achieve within this time frame. Recognising these realities, we apply the baseline assumption across our eight focus markets (excluding India, which we handle separately) and test the results against industry forecasts. Brazil, Russia, and China the current focus markets Among the major emerging markets, Brazil and Russia are already moving rapidly towards the low end of the spending share in mature markets. They are currently growing at double digit rates and have the ability to catch up relatively quickly, in our view. Brazil is among the top markets at USD92 but still growing double digits. Russia is USD68, with room to expand. China is relatively low at USD27. While we anticipate continued fast growth state regulations, control of media, income inequality are all limiting factors.

14 Collectively, these three countries have total advertising expenditures of roughly USD65 billion. ZenithOptimedia projects these three countries to account for 29% of the entire worlds advertising growth over the next three years. This is where the lion share of the focus lies for the major global agencies, as a result. 14 By many accounts, the maturity of the advertising market in Brazil is already near that of the developed markets, but we believe there is still room for further growth Based on current rates of growth, it would take Brazil just four years to reach our baseline target of USD126 per person of annual advertising spend. With Brazil set to host both the World Cup for football (soccer) in 2014 and the Summer Olympic Games in 2016, the country is poised to assume prominence on the World Stage and be a focal point for many marketers accordingly. Brazil also serves as a launch pad into other Latin American countries as well. Conceivably, Brazil is likely to extend its advertising propensity rate well beyond our target levels. Russia would achieve the USD126 ad spend target in just seven years at current rates. Its strong ties to Europe combined with rich resource-based exports have accelerated its exposure to western style marketing, with advertising picking up steam. Russia is poised to enter the list of top ten advertising markets by Ironically, those same factors that have driven accelerated rates of growth in recent years are threatening the near-term economic prospects, with European macro weakness and falling commodity prices threatening to stall Russia s economic growth. While this may depress near-term advertising levels, the longterm factors supporting elevated advertising growth remain intact. China presents the biggest overall opportunity given its size, wealth, and directed shift towards a consumer driven economy China is starting from a very low base, but growing rapidly. The sheer size of the country as well as its wealth accumulation in recent years makes it a prime target for advertising, particularly in luxury goods. China has already ascended to the number three advertising country, with expectations that it will soon surpass Japan to move in to the second spot. Despite the large total, the advertising dollars per person spend remains relatively modest at just USD27, well below western developed markets as well as Brazil and Russia. The country would have to sustain its current 10-12% growth rate for the next 16 years to get to our baseline target. A shift towards a consumer driven economy by a new political regime supports the prospects of sustained double digit growth, we believe. To date, much of the global agency participation in the market has come from multinational clients attempting to market their products to the Chinese consumers. Although China faces greater political risks and operating restrictions, in our opinion While China remains a compelling market opportunity, we also acknowledge that operating in the country presents some additional challenges for the global agencies. Government oversight on media, ownership restrictions, and navigating local business practices that might not adhere to western standards are three such challenges. While advertising agencies have not faced incidences on this front, recent enforcement of the Foreign Corruption Practices Act has ensnared some U.S. publicly traded companies in recent years, drawing focus on the issue. In spite of these challenges, the market is too important to ignore and the global agencies generally appear to be navigating these obstacles to establish themselves in the market.

15 The next frontier regions other critical advertising markets 15 The agencies have established positions in the next frontier markets beyond the much talked about big three of China, Brazil, and Russia Although the lion s share of the advertising focus in emerging markets tends to go to the BRIC countries, marketers are increasingly pushing into other markets for growth. We highlight several next level markets that we believe represent decent growth opportunities and present an emerging focus of marketers and agencies alike: Indonesia, Turkey, South Africa, Mexico, and Poland. We note that there are several similarly situated countries in the regions that likely present compelling growth opportunities as well. Other important growth markets likely include Argentina and Columbia in Latin America and Vietnam in Southeast Asia. We estimate that these five countries will add roughly USD50 billion in total advertising spend over the next years. Indonesia the fourth largest total contributor to global growth spend, projected to add USD4.5 bln to Indonesia s ad spend rate is comparable to China at USD26 per person. Turkey the bridge between Europe and the Middle East. Small now, but growing rapidly. Also small spend per person at USD34, but Western ties can be leveraged and it could provide a springboard into MENA. South Africa the most developed in Africa with spend at USD86 per person currently. Also critical to have established presence in the region as a gateway into broader Africa. Mexico and most of Latin America, including Colombia and Argentina. Mexico is a proxy for these markets, but with close ties to the US, a more immediate opportunity. Mexico is still relatively far below peers on ad spend at USD46 per person. Some catch-up is likely. Its drug related violence may be impeding some marketers from embracing the market. Poland is another interesting country that has growth potential, but currently appears in limbo due to its inclusion in the Eurozone and uncertainty around the broader EU. It currently stands at just USD60 per person ad spend, significantly below Eurozone peers, and has the potential to catch up in terms of ad spend once the problems of the EU are addressed. India the tiger opportunity India presents a unique market full of promise, although the trajectory is not as clear as some of the other major emerging countries India almost has to be considered in isolation given the untapped opportunity coupled with many significant hurdles that have to date impeded the growth of advertising. The second most populous country has a large, highly educated population and a rapidly growing middle class. These factors alone should suggest a burgeoning advertising sector. However, the advertising rate, on both an absolute and per person level remains well below its peers. There are several factors that likely account for this low level: restrictions on national and foreign owned retail (usually a high advertising sector), socio-economic issues and high levels of poverty, poor overall infrastructure that limits the capital investment required to establish a strong manufacturing base, and a traditionally socialist government. Despite these issues, India holds significant promise and the major agencies are establishing their positioning in the market as a result. Given its large well-

16 education population and a government that is increasingly showing willingness to open up the economy, we believe it is only a matter of time before advertising begins to flourish. Discussions about opening up retail to foreign operators, for example, would invite more multinationals into the market and drive greater advertising levels. 16 Even if the advertising market advances towards its peers, given the high degree of poverty, we believe a much lower target for advertising spend per person is appropriate. In this context, we have applied a 75% reduction to the average ad spend of USD126 which results in USD33. This target rate for India is just above where Indonesia and China are currently operating, and in line with Turkey. At this level, we assume that India can get to an almost USD40 billion market in the next 15 years, from just USD6 billion today. We note, to achieve this target India will have to grow at roughly 13% per year for the next 15 years. Putting the growth projections into perspective As a reality check on our assumptions, we compare the projected advertising growth contribution for the major markets, using ZenithOptimedia s projections. Five of the countries among the top ten dollar contributors to growth are in our target emerging market group that we deem of significant importance, with a sixth emerging market (Argentina) also expected to make it to the top ten. Four of the top five contributors to global growth over the next three years are projected to be emerging markets Not surprisingly, four of the top five contributors to total growth are based on ZenithOptimedia s projections and are also on our focus list, with Indonesia joining China, Brazil, and Russia. The China 15-year target market size, based on ZenithOptimedia s three year total contribution projection, would require acceleration in total ad spending. If the country continues an aggressive shift towards a consumer led economy, such as acceleration may be a possibility. More likely, the curve would flatten and provide a longer tail-wind of growth. Conversely, Brazil, Russia, and South Africa are on track to achieve the target levels much sooner and our baseline appears to have undershot for those markets. Top 10 Dollar Growth Contributors to Global Advertising Spend Against 15-Year Target Source: ZenithOptimedia, December 2012, equity research; April 22, 2013

17 US and Europe remain critical markets 17 Despite US being a more mature market, its total contribution to global growth over the next three years is projected to equal China, Brazil and Russia combined Although the rate of growth in the developed markets is likely to be more muted than the higher growth emerging markets, they remain critical advertising markets and still contribute to the overall growth. The US is poised to contribute as much to the total global advertising growth as China, Brazil, and Russia combined over the next three years. In this case, the difference is largely due to the relative size of the United States on top of a decent 4 to 5% growth projection. Likewise, three other relatively mature markets are expected to be in the top ten contributors to global growth. Japan, South Korea, and Germany are all expected to add at least USD1.9 billion to the USD2.5 billion over the next five years. (Western Europe as a whole is projected to add USD4.7 billion). In addition to the potential sales growth contribution from the developed markets, companies moving into emerging markets rely on the top four global agencies to support them. The developed markets also breed innovation that can be applied globally. The expansion and application of digital advertising techniques tend to be developed in the US and refined for international dissemination, for example. So while it is tempting to focus just on emerging markets, the more mature developed markets remain significant to both top and bottom line results. Digital advertising The other big structural growth driver of the advertising industry is exposure to digital advertising, which is a broad area encompassing anything from digital marketing, data and insight services, to internet advertising. In terms of the absolute ad dollars spent, internet advertising is by far the largest area of digital advertising, including Display, Classified and Paid Search. Global ad agencies benefit from digital advertising in three ways: Being exposed to the fastest growing area of advertising; Being exposed to client budgets beyond advertising & promotion, in particular, technology or even retail channels; EBITA margin enhancement due to exposure to complex consulting-driven, fee-based higher value services.

18 Internet: The Fastest Growing Area in Advertising 18 Internet advertising continues to take share vs traditional advertising media According to ZenithOptimedia s December 2012 figures, Internet advertising contributed 18.0% of total World advertising expenditure in 2012, still lagging behind Newspapers at 18.9%, despite the extended decline the print sector has seen over the past ten years. There are marked differences between countries, but the trend is clear: newspaper and magazine advertising were 30% of total global advertising in 2011, but are likely to be just 23% by 2015E according to ZenithOptimedia. In the same period, Internet advertising is likely to go from 16% to 23%. Global Ad Spend by Medium 100% 90% 16.1% 18.0% 19.8% 21.6% 23.4% 80% 70% 60% 6.7% 7.1% 39.9% 0.5% 6.6% 0.6% 6.5% 0.5% 6.4% 7.0% 0.6% 6.3% 0.6% 6.9% 6.7% 40.2% 6.6% 40.1% 40.1% 40.0% 50% 40% 30% 20% 9.4% 8.8% 8.3% 7.8% 7.3% 10% 20.3% 18.9% 17.8% 16.8% 15.9% 0% Newspapers Magazines Television Radio Cinema Outdoor Internet Source: ZenithOptimedia, December 2012; April 22, 2013 Agencies have been quick to react to these changes by offering an increasing amount of digital advertising services, and reducing exposure to print media. While in the world of print media, margins depended heavily on the ability of an agency to secure good pricing in broadsheets, in the world of digital advertising agencies must offer insight, data, and value added services in order to show the effectiveness of a campaign. Publicis has been very acquisitive in Digital Media and it now generates 36.9% of its revenues (end-q1 13) from digital sources, which, delivered organic growth of 8.5%. The group s growth has been mainly via acquisitions. In 2007, Publicis bought digital agency Digitas, followed by Razorfish from Microsoft in Last year, Publicis again made a sizeable acquisition in the digital space, acquiring one of the last remaining digital agencies with global scale in the industry, LBi.

19 Search and beyond 19 The bulk of internet advertising expenditure (almost half) is spend on paid search, where the key market players are Google, Yahoo, and MSN s Bing, to name the largest. However, it is within Display advertising that internet advertising will see the biggest increase in expenditure over the next few years, according to ZenithOptimedia. Growth in Display Advertising tops Paid Search 25% 20% 15% 10% Display Classified Paid search 5% 0% Source: ZenithOptimedia, December 2012; April 22, 2013 Display advertising on the internet is likely to see higher growth than search over the next few years According to ZenithOptimedia, expenditure on internet display advertising will have doubled by 2015 vs 2011 to a level of USD57 bln, trailing just behind paid search at around USD61 bln. There is an ongoing debate in the industry, questioning the role of the agency in a world where search is the main form of advertising, with some talking about disintermediation, or eliminating the role of the agency. Those fears have proven unfounded over the last two years, with big players like Google still very much in favour of the role of the agency in helping the client make key strategic decisions. Agencies are also quick to point out that clients don t go to a particular car company to ask which car to buy, but rather use independent reviews, and independent dealerships. It is also the nature of product marketing that requires a holistic approach to advertising campaigns where search can, and usually is, one aspect of a campaign, but not the whole campaign. In particular, TV viewership has stabilised among most developed economies and it continues to play an important role in the advertising mix. Sticking with our car example, in order for a potential car buyer to search for a particular car model, he/she needs to be aware that a new model actually exists, and for that to happen, TV and any form of display advertising, on and offline, continue to play key roles in the advertising mix.

20 If anything, we argue that the sheer complexity of media viewership means that the role of the agency is required more than ever before. An advertising campaign may begin on TV, and may be followed on direct marketing, display, dedicated websites, street advertising, and search. In the meantime, data is being harvested, analysed and used to change the mix through the product cycle. In this environment the role of the agency remains extremely important. 20 Agency role still vital What this also means, however, is that demands on the agency in terms of data and analysis are increasing along with the sophistication of advertisers that demand an ever increasing number of measureable results. It also means that it is becoming more expensive for agencies to deliver real value for clients, which now demand proprietary data and insight that can help them reach out to a specific audience at a lower price. Beyond A&P Another important element of the expansion in digital advertising is the expansion of the addressable market for the big global advertising agencies. Traditionally almost all revenues are derived from clients Advertising & Promotion (A&P) budgets, broadly under key chief marketing officers (CMOs). In turn, these budgets are related to sales budgets and are heavily cyclical in nature. During cyclical economic upturns, companies usually launch new products, and CMOs are encouraged to increase the level of advertising to make consumers aware of product innovations. During economic downturns, product launches are typically withheld and advertising activity is reduced in favour of promotional activity to keep sales from falling. During the downturn of 2008 and 2009 advertising budgets were severely cut, leading to negative advertising figures across most of the developed world. Digital advertising, however, is allowing ad agencies to tap another source of income beyond A&P budgets: technology. When ad agencies offer clients to monitor, analyse, harvest and leverage client data, the purchasing decision does not necessarily come from CMOs, but rather CIOs, or CTOs. The same is true when agencies offer to construct special dedicated websites, or data warehouses to monitor customer behaviour, which, in turn, can be used to alter product design decisions, or product placement decision, again activities that go beyond A&P. So far, advertising agencies do not break down the amount of revenues coming from these sources, and it is still marginal, in our view. However, we see potential for growth outside the traditional advertising markets. The only caveat here is that competition in this space is also fierce, with data companies or consulting companies also vying for a share of CTO s and CIO s budgets.

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