Wachovia analyst says market overreacted to Omnicom headline

By Ronda Fears

Nashville, Tenn., June 13 - The reaction to the Wall Street Journal article about Omnicom was out of proportion, said Wachovia Securities convertible analyst Sri Nadesan, as most of the allegations do not appear to have substance and, moreover, the company appears to have adequate liquidity to meet 2003 debt obligations.

"We believe the market's reaction is out of proportion to the points raised in the WSJ article," Nadesan said in a report Thursday.

"We believe most of the issues raised, even if they are true, [and] we do not necessarily think all the criticisms are valid, will not have a significant impact on the company's financial results."

An article in the Wednesday edition of the Wall Street Journal on Omnicom's accounting practices caused another round of anxiety in the financial markets regarding the company's stock and convertible debt.

Omnicom's stock fell to as low as $51.50 during the day before closing at $62.28, down about 20% from the previous day's close.

The company's convertible bonds, the 0% of 2031 and the 0% of 2032, also fell as the implied credit spreads widened sharply. The 0% of 2032 fell 4.725 points to close at the asking level of 93.3 as the implied credit spread on this bond, putable in July 2003, ballooned to 499 basis points. The other bond, the 0% of 2031, putable in February 2003, fell 3.6 points to the asking level of 95.8 as the implied credit spread widened to 525 basis points.

During the remainder of 2002, Nadesan said, the company does not have any significant amount of debt maturing, but in 2003 the company faces the puts on the two convertible bonds - $850 million in February 2003 and $900 million in July 2003 - plus the repayment of its five-year term loan, which at the end of the first-quarter had a balance of $300 million.

Therefore, in 2003 the company faces the prospect of repaying $2.05 billion of debt.

"We believe the company has adequate liquidity to meet all of these debt maturities in cash based on its current cash balances and credit availability," Nadesan said in a report Thursday.

"Investors should keep in mind that, if necessary, the company has the option to pay the puts on the two convertibles with stock. The company also has the flexibility to cut back on discretionary acquisition spending to preserve cash in 2002 and 2003, should it become necessary."

While most of the issues raised in the news article, even if true, would not seriously impact Omnicom's financial results, Nadesand said there are two issues with the potential to do the most damage that are worth examining in detail - how Omnicom computes organic growth and the effect of earnouts on compensation costs.

Omnicom reported in its SEC filings that its organic growth was 8.4% for 2001 and 3.7% for the first quarter of 2002. The WSJ article alleges the company "includes any newly generated revenue of just-acquired companies immediately" that could cause organic growth rates to be higher.

"After listening to Omnicom's response to the article in a June 12 conference call, it is not clear to us whether the company's methodology is incorrect,' Nadesan said.

"Even if Omnicom's reported organic growth rate benefited from the company's methodology, we believe excluding the incremental revenue of the newly acquired companies may not severely affect the reported organic growth rates."

On the issue of earnout payments made to executives of companies acquired in the prior years, the analyst said it seems Omnicom's approach in keeping these payments out of the income statement is reasonable.

In 2001, out of $845 million of payments made for acquisitions, $157 million were for these contingent earnout payments.

"On the June 12 conference call, Omnicom's management said its best estimate of earnout payments through 2005 is $250 million to $300 million," he noted.

"The company also said the contingent earnout payments could go up or down. If the earnout payments can go down, and if they have gone down in the past, that could reduce the company's originally agreed on purchase price."

Omnicom's current debt balances, at the end of first quarter, consisted of long-term debt, including current portions, of $2.69 billion and short-term bank debt of $205 million, or total debt of $2.9 billion.

The company had about $550 million of cash and short-term investments, as of March 31.

Omnicom also has a $1.58 billion credit facility that can be extended to April 2004 and a five-year term loan facility that matures in June 2003.

As of March 31, the company had issued $404 million of commercial paper supported by its credit facility, leaving $1.18 billion available, and had borrowed $300 million under the five-year term loan facility. This leaves a total availability of $1.38 billion under the two facilities.

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