Over the last decade, Engine has acquired numerous businesses from across the spectrum of marketing communications. Most of the acquisitions were paid for in large part through Engine equity, with the promise of future share value growth and realisation replacing that of the typical ‘earn-out’ structure. This can be attractive to business owners who want to de-risk and be part of something bigger. They clear some cash on day one and the risk of their retained investment is spread across the group, rather than being based entirely on their own business’ future performance, as with an earn-out model.
Structuring deals without earn-outs can mean that acquired businesses are more likely to work together, because they are all working towards a common goal: to increase the value of the group’s shares. For Engine, this means it can present a more integrated offer where appropriate; co-locate its businesses in one building; and merge agencies where it made sense to do so in terms of service offer, cost efficiencies, etc. However, for this to work it’s really important that vendors continue to believe the equity story. With no earn-out potential, they need to see the value of their shares grow and a tangible opportunity to sell them at a future point.
This has been an increasing problem for Engine over the last few years, where tough trading conditions, underperforming business units and accumulating interest payments have meant that shareholders saw the value of their shares going in the wrong direction. This must have been especially frustrating for those in the group’s more successful agencies, such as Partners Andrews Aldridge and MHP. Many have subsequently left the business, retaining their shares, but no longer able to contribute to their value.
Ex-employees are likely to be bought out entirely for cash by Lake Capital, who won’t want a large number of minority shareholders who no longer contribute to the business. But once debts and payments to current PE backers, HIG, have been deducted, the £95m price tag means that those shareholders will be selling at a fraction of the price that they bought in at when they sold their businesses to Engine. Not a great outcome, but at least they will be getting cheques.
The shareholders still in the business will have been sold a new vision: the rollover of their equity interest into a US company, renewed growth and prosperity, likely culminating in a listing on NASDAQ or similar. So no cash for them yet. Instead, roll the dice again and hope that Terry Graunke can steer the new group to an equity realisation event in the not-too-distant future. However they may take some comfort from Lake Capital’s impressive track record, which includes the $500m sale of Lighthouse to Cordiant in 2000.
At a strategic level, the deal is very interesting. Global brands are increasingly looking for alternatives to the big holding companies. This deal creates a group that can provide a genuine challenge to the establishment.