The question for Dentsu—to keep or to divest its global operations?

The global agency business is a very Western-dominated sector in terms of each of the major groups’ origins and stock market listing (and arguably the next level down as well). That reflects the historical nature of the industry (the modern-day advertising industry having originated in the 19th century West) and the size of the market itself. It is a feature that is unlikely to change any time soon.

There is, of course, one major exception to this. That is Japan, a market dominated by local groups and where European groups have to resort to partnerships with local players to thrive. Traditionally, the major Japanese agencies focused typically on their home markets. Dentsu has been the exception to this rule. It did have a partnership and shareholding (that ended a decade ago), with Publicis. However, its acquisition of Aegis Plc in 2013 transformed it into a global player.

After Dentsu bought Aegis, it set about refocusing the business. The market research business, which was heavily focused on lower margin custom research, was sold and the core media assets were supplemented by an expansion into technology and data. The acquisition of a majority stake in Merkle in 2016 (with a full acquisition in 2020) has been widely seen as an intelligent move and roughly 35% of revenues in the group were in the fast-growing customer transformation and technology (CT&T) businesses. The non-Japanese assets comprised 61% of 2022 revenues, helped by a weak yen. The  board is now 40% non-Japanese, including the CFO Nick Priday, and 60% of the senior management is as well.

It is fair to say that Dentsu has strengthened its commitment to the international side of the business over the years. In November 2022, Hiroshi Igarashi, Dentsu's president and CEO made a public commitment to that aim with the re-organisation of the global management structure to bring about an integrated global organisation. More importantly—and proof of the adage, actions speak louder than words—that has been backed up by hard cash. 

Dentsu announced in February 2022 that it would spend ¥250 to 300 billion (about $2 billion+) on acquisitions over the (then) next three years, and it is already halfway through this spend. All six acquisitions have come ex-Japan, including Tag on the digital publishing side, the third biggest deal in the group's history.

It has also improved the percentage of international investors in the group (from 20% in 2019 to 30% in 2023). However, analyst coverage has been slower to adjust. That is not a reflection of the efforts; instead, both European and US analysts and investors are stretched with their core responsibilities and their internal politics of covering a Japanese company.

The question now is where does Dentsu go next. The Dentsu International businesses would undoubtedly be considered part of the ‘big five’ global agencies. However, size-wise, there is a gap between them and the other four major global agency groups. International’s revenues were approximately $5.2 billion in 2022 vs $10.9 billion for IPG, the next biggest agency group. The acquisitions will help narrow the current gap. Still, other groups are, of course, also acquiring assets all the time. (Another obvious argument is that I am missing out is on the 40% of the business that is Japan which is a topic for debate).

Scale by itself is not an issue necessarily but media and data are businesses where scale is a factor and the chances are scale will become more, not less, important over time. So one question might be whether there is a rationale for more, potentially bigger acquisitions in the future (although the weakness of the yen may be an issue, given it makes international acquisitions more expensive). The obvious candidates would be the significant groups such as Havas and/or Stagwell that would create scale but not flag any major competition issues. 

My view—and I would point out that my comments are my views and not based on any conversations—is that this is not a discussion for now but is probably a decision that management needs to contemplate in the future.

Another question would be the potential for internal tensions between the Japanese and non-Japanese parts of the business. The departure of Wendy Clark raised questions but, barring this, Dentsu has the same issues as other agencies that see management churn. 

I think it is fair to say, at this stage, that the management team has taken concrete steps to make sure this is not an issue, as noted above. I would also use a parallel with the banking sector, where Japanese banks have substantial operations in North America and Europe and where, while there are some cultural differences, it does not seem to have significantly impacted those institutions' performances. Of course, the same point could be made against companies headquartered in one country and with global operations—UK vs. non-UK, American vs. non-American.

Finally, and not overlooking this, what about the performance of the international business? Put simply, it is okay. As I mentioned above, 35% of group revenues come from the fast-growing CT&T business, which will be a powerful boost to organic revenue growth. As I alluded to above, there are questions about scale, particularly in media and there is no doubt that the exit of Wendy Clark did raise some questions. However, the assets' organic revenue growth performance remains solid and generally in line with peers. There is nothing that particularly flashes any major warning signs.

I came into this piece thinking there may be a reasonable chance Dentsu may decide at some point to exit the international side. That may happen at some point in the future (if it did, I think there would be a spin-off with Dentsu keeping a sizable stake), but given their actions and seeming commitment, that certainly does not look like the intention today. Dentsu seems committed to the battle.

As usual, this is not investment advice.