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:
On the other hand, MDC Partners appears to be an exceptionally poor company, bleeding cash & issuing debt2:
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:
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
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:
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
Perhaps the Company’s claim that its organic growth is 4x more than peers is a Freudian slip; in reality, MDC Partners’s reported organic growth of 7.1% is overstated by more than 4x. How we believe MDCA overstates organic growth:
How we believe MDCA overstates organic growth:
- MDCA Treats Some Acquired Revenue as Organic Revenue – MDCA’s claimed 7.1% organic growth rate is calculated by using an apple vs orange comparison. They take credit for a full years’ 2014 acquired revenue figure compared against a half years’ acquired revenue figure. This is an incorrect comparison. We include adjustment* factors so that the numbers are comparable (leading to comparable revenue**).
- Discontinued operations – MDCA has historically dropped acquired companies whose revenues are declining, and then restate its overall financials as if they never owned these companies. Removing the discontinued operations’ revenue via restatement distorts the organic growth calculations, as it artificially inflates the organic growth calculation.
Other Signs of Business Deterioration – Executive Departures, Loss of Clients, & More
Recent executive departures, further support our belief that MDC Partners’s core operations are deteriorating. The departures would explain why MDCA overstates its organic growth: in reality, key talent is leaving and business is deteriorating, just as the whistleblower alleges. We discuss the executive departures in further detail later in the report, but here are some highlights3:
- “72andSunny Veteran Grant Holland Joins Omelet L.A. as CCO” – September 17, 2015
- Jeff Sweat founds ‘Mister Sweat’ leaving 72andSunny sometime September 2015
- “McCann New York Re-hires Dan Donovan as Executive Creative Director” – August 31, 2015
- “Andrew Keller Is Out at Crispin Porter + Bogusky After 5 Years as CEO” – August 19, 2015
- “Evan Fry executive director of creative development.” – August 19, 2015
- “ ‘Epic Split’ Creative [Martin] Ringqvist Leaves 72andSunny” – August 11, 2015
- “President Steve Erich Leaves Crispin, Porter + Bogusky” – June 15, 2015
- “Hey, Bob Winter Has Landed a New Gig as Well” – March 25, 2014
Recall that Crispin Porter Bogursky used to be MDC Partners’s crown jewel. It has fallen sharply (and steadily) from its peak. Of its original 13 partners, we believe no more than 3 remain4. As we discuss later, Gotham City Research is seeing recent evidence that 72andSunny will decline as Crispin Porter did.
Loss of Key Clientele
In December of last year, MDC Partners’ subsidiary, Doner, lost a long-time client5:
“Cox Automotive has appointed Zambezi as the lead brand strategy and creative agency for its Autotrader and Kelley Blue Book brands following a competitive review. MDC’s Doner has worked on the business for the last 16 years.”
As executives and/or talented personnel leave, we anticipate deterioration in the quality of work provided to clients, and therefore, further loss of business. This happened to Crispin Porter Bogusky, formerly MDC Partners’s crown jewel. We see signs that this is taking place with 72andSunny as we discuss later in this report.
Organic Growth Accounting Irregularities
The true organic growth rate may even be worse than the 1.4% we calculated. The reported figures necessary to calculate organic growth may not be accurate nor reliable, as demonstrated by the following accounting irregularities6:
The figures identified above in red – the $13.7 million and $46.3 million – are both from the 2015 10K. Both are supposed to represent acquisition-related revenues for 2015, yet variance between the two figures is unexplained.
We find similar problems with the 2014 equivalent numbers7:
Revenue-related Disclosures Have Worsened with “New” Management
“It takes two to lie – one to lie, and one to listen.” – Homer Simpson
Under the “new” management (we say “new” because CEO Scott Kauffman, is a long-time MDC Partners Board member and CFO David Doft is long-time CFO. all the Miles Nadal-related wrong-doing happened under both Kauffman and Doft’s watch) revenue disclosures have worsened:
“Next, you will notice that beginning with this period, our financial statements now reflect one operating segment, which in turn equals one reportable segment.
We will no longer be reporting results for Strategic Marketing Services and Performance Marketing Services.
So, by no means, are we looking to reduce transparency. We actually think this will help enhance transparency, especially with a more cleaner breakout of corporate as an isolated item versus before.
CFO David Doft MDC Partners’s Q4 2015 earnings call8
We believe that most people would refer CFO David Doft’s above statements, particularly the “we actually think this will help enhance transparency”, as untruthful. The MDC Partners 2014 and 2015 10Ks clearly falsify his claims, as shown on the next page.
In the 2014 10K, MDCA provided a revenue breakdown by 3 segments (including Corporate):9
In the 2015 10K provides a revenue breakdown by 2 segments (including Corporate):
Although MDC Partners appears to be (mostly) a roll-up of ad agencies, it does have stakes in other businesses such as Y Media Labs, Kingsdale Shareholder Services, etc. Investors would benefit if the company separately disclosed the financial results of these other businesses.
No Evidence of Investing in Technology Capabilities
CEO Scott Kaufman claimed:
MDC’s heritage of investing in digital and technology capabilities organically, alongside creativity at the core of its agencies, continues to be one of its greatest differentiators and will remain a priority going forward. ”10
Gotham City Research investigated Scott Kauffman’s above claims and found them untrue. Specifically:
- MDC Partners has spent $0 on research and development.11
- The words ’research’ and ’development’ are barely mentioned in MDCA’s filings, in the context of investing in digital and technology capabilities organically.”
See full report below.