MDC Partners Inc (MDCA): Like Valeant Pharmaceuticals, But with Understated Debts by Gotham City Research

Gotham City Research’s Opinions

  • MDC Partners shares are worth less than $1.00 per share, implying 96%+ downside.
  • MDCA will restate several years’ historical results as a result of the issues covered in this report and elsewhere.
  • The on-going SEC investigation will lead to new revelations of wrong-doing.

Summary Of Findings

  • 2015 organic revenue growth is ~1.5%, not 7.2% as reported. Organic growth well below industry averages.
  • MDCA’s true Debt is understated by ~$300 million, or 23% of stated Debt as of 2015.
  • At least 42%-53% of reported profits are suspect.
  • 7+ executive departures within recent quarters. At most 3 of Crispin Porter Bogursky’s original 13 partners remain.
  • Doner lost a key 16 year-old client account in Q4 2015.
  • 72andSunny was recently sued twice for copyright infringement. Crispin Porter Bogursky was similarly sued several years ago before CP+B’s fell from grace.
  • BDO and David Wiener & Co are quasi-captive entities MDCA used to structure its dubious accounting strategies.
  • Tax deductible intangibles and goodwill have declined from 100% tax deductible in 2013 to only 16% in 2015.
  • MDC Partners’s former auditor KPMG expressed “an adverse opinion on the effective operation of, internal control over financial reporting”. MDCA soon after hired BDO.
  • The BDO audit partner assigned to MDC Partners, after MDCA’s switch from KPMG to BDO, was sued in Nussdorf v BDO Seidman for promoting fraudulent & illegal tax shelters.
  • Deferred acquisition considerations paid out to acquired companies’ partners may be taxed at ordinary income.
  • Dubious related party transactions continue, despite Miles Nadal’s departure, e.g. Lori Senecal’s husband hired last year & compensated $1 million for 5 months’ work.

MDC Partners Inc (MDCA): Like Valeant Pharmaceuticals, But with Understated Debts – Introduction

GOTHAM CITY RESEARCH first heard about MDC Partners early last year when MDC Partners was referred to as the “Valeant Pharmaceuticals of advertising agencies”. At the time, Valeant’s stock price had reached new all-time highs, leading many observers to believe that Valeant was a great company. Like Valeant, MDCA entered the public markets via reverse merger. Many low quality companies & outright frauds have historically entered the public markets via reverse merger. MDC Partner’s story and its accounting did not make much sense at the time, but we did not examine it more carefully until recently. On the one hand, MDC Partners boasts claims to generate industry-leading organic growth & solid EBITDA margins1:

MDC Partners Valeant Pharmaceuticals

[drizzle]On the other hand, MDC Partners appears to be an exceptionally poor company, bleeding cash & issuing debt2:

MDC Partners Valeant Pharmaceuticals

Gotham City Research has not seen such conflicting qualities in a company since Valeant and Quindell. We have come to believe that MDC Partners is, indeed, an exceptional company – for all the wrong reasons. The following specifically lead us to believe the shares are worth less than $1 per share:

  • MDC Partners’s true debt is understated by at least 23%.
  • 2015 organic growth is ~1.5%, not the 7.1% figure the company reports.
  • Key executives are leaving, and growing evidence 72andSunny has peaked.
  • Pattern of deception and fraud among MDCA’s business partners and/or quasi-captive entities.

Gotham City Research believes the days of MDC Partner’s misrepresentations are coming to an end. We anticipate that further evidence of malfeasance will be brought to light in the near future.

MDCA’s Unstable Business Model: Why it Can Fail Overnight

One year ago, MDC Partners disclosed that it had received a subpoena from the Securities and Exchange Commission (“SEC”). Soon after, Miles Nadal – MDCA’s founder & CEO (at the time) left the company.1 MDC Partners and its enablers would have you believe that MDCA’s problems were limited to Miles adal’s improper spending of the Company’s resources. In fact, MDC Partners now claims it is cfiinmitted to conducting business in accordance with the “highest standards of business ethics, and to full and accurate disclosure”? If that were true:

  • Why does MDC Partners remain under on-going SEC investigation?
  • Why do we find evidence MDCA continues to mask its deteriorating financial condition?
  • Why does MDCA continue to rely heavily on aggressive accounting (e.g. Non-GAAP and/or pro-forma accounting), even after Miles Nadal’s departure (see below)?

Answer: MDC Partners’s Accounting Conceals an Unstable Business Model that can Fail Overnight

Some companies provide Non-GAAP and/or pro forma figures so that their readers can better gauge the health of their underlying businesses. We do not believe that is the case with MDCA. In fact, we believe MDCA uses dubious accounting and business practices to confuse, rather than inform its audience. MDCA is a highly levered roll-up of (mostly) ad agencies, with understated debts, overstated profits, and overstated organic growth. MDCA can fail overnight, and its management tries to conceal its fragile business model.

Gotham City Research believes MDC Partners is similar to other human capital-intensive businesses – e.g., law firms, investment banks, hedge funds –that have failed overnight, especially when laden with debt & aggressive accounting:

MDC Partners Valeant Pharmaceuticals

How is MDC Partners different from the Above Businesses?

Imagine a highly levered bank (or hedge fund) that overstates its returns, understates its current operating expenses, capitalizes its bonus payments owed to employees, and then understates the value of those debts. We believe that is MDC Partners, and that it can fail overnight (if not within weeks or months), just as many banks and funds have failed overnight.

How MDC Partners Overstates Earnings & Understates Debt: Quasi-captive Entities + Accounting

We believe accounting staff within MDC Partners – Michael Sabatino and his crew – worked along with quasi-captive intermediary(ies), (e.g., BDO and David Wiener Associates) so that MDC Partners could:

  • Overstate organic growth
  • Understate Deferred Acquisition Consideration-related debt
  • Overstate reported profits
  • Minimize taxes for all stakeholders, e.g. MDC Partners’ and its acquirees’ taxes

MDC Partners Valeant Pharmaceuticals

Gotham City Research believes that the above scheme could theoretically continue indefinitely until or unless:

  • MDCA’s Growth disappears, or the company can’t paper over its deteriorating results.
  • MDC Partners incurs too much debt
  • Whistleblower(s) and/or regulator expose MDCA’s schemes.

As it turns outs, Gotham City Research believes all three conditions above have been met within the last 12 months. We start by first exposing MDCA’s reported organic growth rate as a farce

Organic Revenue Growth is ~1.4% not 7.1% as Claimed

For highly acquisitive companies such as MDC Partners, organic growth is a very important measure to gauge the underlying health of their core businesses. The shares of other acquisitive companies, such as Quindell and Valeant, have run into trouble when they sought to conceal the deterioration of their true organic growth rates. We find that MDCA meaningfully overstates its organic growth rate relative to its peers. On one hand, MDC Partners claims it is a growth company1:

MDC Partners Valeant Pharmaceuticals

In reality, we believe MDCA is a low growth company. An independent calculation of organic growth leads to a 1.4% growth rate for 2015. Key executive departures, MDCA’s loss of clientele, and accounting irregularities –all are consistent with a low growth rate.

Organic growth Closer to 1.5% NOT 7.1% – Well Below Its Peers’ 2.8% Average

MDC Partners claims that 2015 organic growth was 7.1%, yet we find the number was 1.4%:2

MDC
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