M&C Saatchi’s London home in Soho’s Golden Square is covered in scaffolding at the moment, but that repair job is nothing compared with the work that the four founding partners – David Kershaw, Jeremy Sinclair, Bill Muirhead and Maurice Saatchi – need to do to rebuild the agency group’s reputation.
Insiders admit that the four veterans – some of the most celebrated names in British advertising in the past 50 years – feel "battered but determined" after the past week.
They have been struggling with an escalating accounting scandal in the UK arm that has resulted in an £11.6m ($15.2 million) "adjustment" over two years and a slump in trading, including the loss of the valuable NatWest advertising account.
M&C Saatchi’s share price, which was within touching distance of £4 in March, has collapsed by three-quarters this year, falling as low as 79p last week when the company admitted that the accounting "misstatements" that first emerged in August were worse than expected.
Sources close to M&C Saatchi maintain there has been no evidence of fraud, but some shareholders are known to be "cross".
Tim Bush, a spokesman for Pirc, a leading corporate governance and shareholder advisory group, says: "These problems did not occur overnight. Aggressive accounting will always run out of road space as the numbers will need to grow."
M&C Saatchi’s stock market value fell below £100m last week, meaning it is more vulnerable to a takeover or the founders could try to take it private.
Tristan Rice, partner at M&A advisory business SI Partners, says some potential buyers may be wary because M&C Saatchi looked like it was outperforming competitors in recent years during a tough period for the agency sector but that record is now in doubt.
"To a certain extent, they were confounding expectations by saying they were growing strongly year on year, because most conglomerates like Engine were not growing that much," Rice explains. "It’s not as rosy as it looked."
There are also mounting questions about whether M&C Saatchi can keep agency leaders in local markets happy when the value of their stock has slumped and if the founders, who still own nearly 20%, need to hand control to a new generation.
The four founders set up the agency in 1995, along with Maurice's brother, Charles, who soon stepped back.
Kershaw, the chief executive, is now 65 and Sinclair, the chairman, is 73. Saatchi and Muirhead are also 73. All four sit as executive directors on the eight-strong board.
There are only three independent, non-executive directors, but they are big names: Sir Michael Peat, Prince Charles' former private secretary and a former KPMG accountant; Michael Dobbs, a Conservative peer and author of House of Cards; and Lorna Tilbian, a media banker.
Allies say the founders are willing to make "fundamental" changes to rebuild trust. They point out how the company has already tightened up financial controls but concede the board needs "fresh blood" and succession is now "higher up the agenda".
Appointing an independent chairman to replace Sinclair, one of the top creative directors of his generation, is likely to be a priority if M&C Saatchi is to placate shareholders.
Here, Campaign looks at what went wrong at M&C Saatchi and what might happen next.
Building M&C Saatchi was an act of redemption
M&C Saatchi is a relatively small group in global terms, with £255m in annual turnover and about 2,600 staff, including 800 in the UK, and operations across the Americas, Europe and Australasia.
The downturn in its fortunes matters because of what the agency brand and its four founders represent.
This is a business that was set up in 1995 as an act of redemption by its founders.
Charles and Maurice Saatchi, the most famous brothers in advertising, had launched Saatchi & Saatchi 25 years earlier in 1970 – with the help of Sinclair, Muirhead and Kershaw, along with other big beasts such as Tim Bell and Martin Sorrell, who came and went.
Saatchi & Saatchi became the world’s biggest agency group with its motto "Nothing is impossible", but the brothers overreached themselves and made a failed tilt to buy Midland Bank (now HSBC), before losing control and leaving at the start of 1995.
Their immediate response was to launch M&C Saatchi, a business that was deliberately more modest in its global ambition, even if it had a fearsome slogan: "Brutal simplicity of thought."
A focus on steady, organic growth, rather than using debt to make lots of acquisitions, has worked well for the founders, who have long had a private eyrie on the seventh floor of their Golden Square home.
Next year’s 25th anniversary of M&C Saatchi ought to have been a moment of celebration that capped a remarkable run with pleasing symmetry, but the accounting and trading problems now cast a heavy shadow.
The founders must be mindful of what happened to their old colleagues, Bell at Chime and Sorrell at WPP, who failed to adapt to changing market conditions and lost control of their businesses.
Accounting problems in the UK
Visitors to the white-washed lobby of M&C Saatchi’s offices are greeted with a slogan, written in giant, black letters on the wall, that declares: "It’s easier to complicate than simplify."
There is a painful irony to that message, given the accounting problems that have hit the group’s UK business, which represented about 42% of group turnover last year.
M&C Saatchi has given limited details about the accounting woes except to say that they have been restricted to four unnamed UK subsidiaries and do not extend outside the UK.
Campaign understands that most of the problems involve accounts that were overseen by an unidentified person in the UK finance team, who reported to Jamie Hewitt, the long-serving group finance director.
Hewitt stepped down in spring 2019 and his successor, Mickey Kalifa, an external recruit, went back over some of the accounts. KPMG had audited the financial results and flagged some concerns.
It was only then that one of Kalifa’s lieutenants in the UK finance team discovered something was amiss.
Problems included the "timing of revenue recognition" and "incorrect accounting of some assets and liabilities". For example, the company treated some items such as software and furnishings as assets on the balance sheet when they should have been written down.
Kalifa alerted Kershaw and there was an emergency board meeting in early August, resulting in a stock market announcement warning of £7.8m in charges on 12 August and the shares tumbled from 339p to 256p.
"We believe we have discovered the full extent of the issues, but to be doubly sure, the board is appointing independent advisors" from PwC "to undertake a review", the company told investors at the time.
However, the mood music from Golden Square failed to improve and the company confirmed on 4 December that PwC had identified "other areas" that were problematic and the charges rose to £11.6m.
Most of the problems related to 2018, which will require a £9.55m adjustment to previously published accounts, while 2019 involves £2.05m.
Even now, the final amounts are still "subject to completion of the 2019 audit", which won’t happen until March 2020.
PwC identified additional problems in the way half-year profits were reported in 2018 and this "may have occurred in half-year reports since 2014".
M&C Saatchi has acknowledged that it needs better audit controls. It is "reorganising" its finance functions and introducing an Oracle cloud-based accounting and forecasting system that will work "consistently" across the group, "replacing the many different accounting systems currently operating across the world".
Separately, M&C Saatchi told shareholders that trading was weak in the fourth quarter of 2019 and annual profits were likely to be significantly lower than expected – down between 22% and 27%.
That double whammy of accounting problems and poor trading sent shares crashing from 148p to 79p.
Analysts at stockbroker Peel Hunt said "the magnitude" of the profits downgrade, rather than the accounting adjustments, was most likely "top of investors’ concerns".
Still, there are unanswered questions about the finances. Those close to M&C Saatchi insist any massaging of numbers was done out of an eagerness to please and it wasn’t fraud.
"People had tried to make a picture that was prettier than it was – it wasn’t for financial gain," one insider claims.
Yet it is not clear if staff may have benefited in other ways – for example, if they hit bonus targets and cashed in shares. It is thought that the company is looking into that issue in the wake of PwC's review.
Losing clients
Even without its accounting problems, there have been signs of financial weakness in several parts of M&C Saatchi’s UK business, including at the customer relationship management shop Lida and the flagship creative agency, according to Campaign’s analysis of accounts for the subsidiaries at Companies House.
Lida suffered a string of big account losses, including Boots and Ikea in 2017, and changed much of its senior leadership midway through 2018.
The CRM agency filed UK accounts in November that show turnover slumped by more than a third and it made a £578,000 loss last year.
M&C Saatchi offered no comment when Campaign asked if Lida is one of the four UK subsidiaries that has suffered accounting problems.
The creative agency has also had "a tough couple of years", according to 2018 accounts for M&C Saatchi (UK), which were filed in October.
The agency reported 6% revenue growth but made a £2.9m loss. "No major clients were won", it took a £1.6m write-down on the acquisition of Lean Mean Fighting Machine and there was growing exposure to the top five clients, which represented 69% of revenues.
NatWest’s decision to split with the UK agency last month was a further blow because the account is understood to be worth more than 10% of revenues.
Campaign revealed last week that the agency has offered voluntary redundancy to all staff and the parent company has set aside £2.5m to cover the cost of the UK restructuring.
It is important to note, however, that subsidiary accounts sometimes offer an incomplete picture.
Some other parts of M&C Saatchi, including the performance marketing, sports marketing and talent management divisions, appear to have been doing well in the UK.
"There are the best part of 140 entities in the group around the world and only a very small number have had an issue," an executive at an M&C Saatchi subsidiary said. "We have some tremendous businesses here and that hasn't changed in the last week."
Lax corporate governance?
Kershaw, Sinclair, Muirhead and Saatchi have a close-knit friendship and deep loyalty to each other.
Their connection to the glory days of advertising in the 1970s and 1980s, and acclaimed work such as "Labour isn’t working" and the "Pregnant man", mean they still have a swashbuckling reputation, even as the ad industry has moved to embrace new capabilities such as data and technology.
The founders have delegated a lot of responsibilities to agency leaders, including Moray MacLennan, one of their longest-serving lieutenants, but they have resisted ceding control.
"They have a touch of grandness about them," a former leader of a rival agency observes. "M&C Saatchi is an account man-led agency. They are very good, but with big egos – Maurice, Bill, David, Moray and so on. They are account men who think they can do it all, but they aren’t so strong on creativity or planning."
M&C Saatchi’s 2018 annual report did contain various claims about corporate governance that now seem far less reassuring in light of the accounting failures.
"The board believes that the diversity of skills and experience which the executive directors bring to the board is more valuable at this stage of the business’ development than having non-executive directors comprising at least half the board," the annual report said.
However, M&C Saatchi is hardly an early-stage business and City guidelines recommend half the board should be NEDs.
M&C Saatchi’s governance report added proudly: "Other than walking around and talking to people, we have no formal mechanism for engagement with [our] workforce."
Such claims made the directors sound like Mad Men from the past when companies are under pressure to raise standards for corporate governance and they fit a wider pattern at M&C Saatchi, which only appointed Tilbian as its first female non-executive director in 2018.
A source close to M&C Saatchi points out the board's audit committee is independent of management. Only the three NEDs sit on the committee and they pushed for greater scrutiny of the accounts.
What happens next?
"There is a very wide spread of outcomes," one City analyst believes.
Loyalists say M&C Saatchi’s underlying UK businesses are strong, the problems are being fixed and the old team will "prevail".
But the founders face two big challenges: how to protect the company from predators and how to keep talent on side.
The status quo is still among the most likely options for M&C Saatchi.
Since floating on the stock market in 2004, the company has survived several dramas, including the loss of the British Airways account in 2005 and the financial downturn of 2008-2009, when the share price sank close to 30p.
PR man Matthew Freud built a 3% stake in 2009 and made a big profit when the stock recovered.
The M&A rumour mill has been buzzing again since November, when The Sunday Telegraph reported that M&C Saatchi was talking to its long-standing banking advisors, Clarity, which helped the agency group sell its stake in Blue 449, formerly known as Walker Media, earlier this year.
"If I were them," the former rival agency leader says of the M&C Saatchi founders, "I would look at a management buyout with private-equity backing. The stock market would be livid, but they look very vulnerable to me and it would be better than a merger."
Kershaw, Sinclair and Muirhead bought £1m of shares between them last week on the day the price crashed to 79p in a show of support.
The four founders own just under 20% – a significant minority stake in the event of a takeover approach.
Yet Rice believes it is far from certain that another agency group would want to buy M&C Saatchi, because there isn’t much demand for what he calls conglomerates with "these traditional, multidisciplinary functions" including creative and PR.
"There’s quite a big, legacy business that is being chipped away at, year after year," he says.
Other groups of a similar size, such as Chime and Creston (now known as Unlimited Group), have struggled on the stock market and sold to private equity in recent years, while Engine has failed to find a buyer.
Rice adds: "The most likely option is that M&C Saatchi will struggle on. They will restructure, make a few disposals and try to make it a bit more contemporary."
Problems with a shared ownership model
The status quo comes with plenty of challenges. M&C Saatchi has pioneered a "shared ownership" model that means local agency entrepreneurs own stakes in their businesses alongside the parent company.
However, M&C Saatchi’s plunging share price has raised doubts about whether some of the local leaders, particularly those outside the UK, will want to buy themselves out or quit.
"The business needs to try and hold on to people around the world who are all motivated by a share price that was £4," one former agency executive who knows M&C Saatchi says. "The partners encouraged people to hold their shares. Sinclair, in particular, was keen for the founders to hold on to their stock."
Allies believe the founders can hold the line at this difficult time. Most of the local agency leaders hold only minority stakes, so it is hard for them to seize control, one person with knowledge of such deals suggests.
However, it could still be difficult to keep agency talent on side when acquisitions have been funded through shares.
Many of these agency entrepreneurs have "put options" that allow them to sell shares in a pre-agreed manner and M&C Saatchi owes as much as £22m in potential "liabilities", according to the group's accounts.
The M&C Saatchi camp maintains it won’t force talent into settling those put options at the current unfavourable share price.
One agency executive, who knows M&C Saatchi well, warns: "There will inevitably be some [local agency leaders] who choose to defer [payment because of the low share price], so there could be worse to come [when their earn-outs complete and they expect to be paid in full]."
Or as Rice puts it: "With a shared ownership model, every business reaches a crossroads where there’s a successful outcome or you’ve got to reassess the value of those shares."
At least the £25m sale of Blue 449 to Publicis Groupe in January was well-timed.
Campaign understands that M&C Saatchi used a chunk of those cash proceeds to settle some put options at various subsidiaries during the first half of the year.
It means some of these agency leaders have banked money, rather than holding shares that have slumped in value.
M&C Saatchi has conserved cash since the accounting woes emerged and has told shareholders that it expects to have £5m in net cash at year end.
Founders 'not going to abandon ship'
M&C Saatchi’s founders are now on a mission to redeem the agency’s reputation as it prepares to mark its 25th anniversary.
"They are not going to abandon ship before they set it right," one person who is close to the founders vows.
A City analyst is optimistic, saying M&C Saatchi is still "one of the best names in advertising", it has a lot of "capable" agency leaders and it has coped with numerous "bumps" previously.
In theory, at least, the businesses outside the UK aren’t affected beyond the share price decline, another ally says.
But the brutally simple truth is that M&C Saatchi's pride has been badly dented and it won't be easy to rebuild earnings or the share price.
Kershaw admitted as much to Campaign in September when he called it the "most painful" moment in the history of the M&C Saatchi corporate brand.
One observer who knows the founders says: "The way people see M&C Saatchi – the way they are regarded – is as important as the money to them and that will affect any decision they make."
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