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Hold the Champagne! Wall Street Can't Believe Interpublic's Amazing Q2 Earnings

Interpublic (IPG's)'s Q2 2010 earnings results were so good that four Wall Street analysts expressed polite doubts that the ad agency holding company's performance is sustainable. They're probably right: IPG is looking too good to be true.

It was only in April that analysts were predicting IPG would fail to grow its revenues organically this year. Yesterday, CEO Michael Roth reported 8.5 percent organic revenue growth in just the last quarter. (Total revenues were up 9.7 percent to $1.62 billion, and net income increased 165 percent to $83 million.) Even IPG's latest PowerPoint from Hell -- long a harbinger of doom -- is starting to grow a smiley face:


But hold the champagne! Wall Street seems to believe that IPG will have difficulty keeping up the pace. One analyst suggested that IPG's incremental profits were an almost impossible feat. The analysts asked essentially the same question -- "Please tell us where all this extra money came from?" -- at least four different ways.

It began with Alexia Quadrani of J.P. Morgan, who wanted to know if the amazing June performance would carry through into July. Probably not, Roth told her, because "obviously July is not as strong a month historically as June." Then Matt Chesler of Deutsche Bank laid it on the line:

It was obviously a really strong sequential improvement in revenue from the first quarter to the second quarter: it's over 11% improvement. How sustainable is that? As I look back historically, that's a bigger sequential move than I've seen in the past. Can you give us some examples -- real-world examples -- that helps to explain how the business can improve of that magnitude from one quarter to the next?
In the call and in his press release, Roth said that increased revenue and profit came from several new business wins (Universal McCann won L'Oreal and Burberry, for instance), a general benefit from macroeconomic improvements, favorable comparisons from the lousiest of quarters in 2009, and a close attention to costs.

Peter Stabler of Credit Suisse then asked whether IPG is "benefiting here from not having to hire." All Roth had to do to reassure Stabler was agree with him and note that IPG laid off 5,500 people in the recession and it becomes more profitable if it can service new advertisers without hiring those folks back. But instead Roth said this:

I don't agree with the premise that you said. We added significantly in terms of our headcount in the quarter. In fact, I think we were up over 500 people.
If IPG's amazing margins aren't coming from stingy hiring, where are they coming from? James Dix of Wedbush Securities laid out his back-of-the-envelope math:
I figure my follow-up, I would maybe ask one about margins, since no one had actually asked one yet. [Laughter.] I guess one way I was looking at it is, I mean, if you look at where you came in for the quarter versus what the Street was expecting, you beat by around $100 million in revenue and around $50 million in operating profit. So on that basis, your incremental margin was roughly 50%. And my understanding is for an agency group or even an agency, 50% incremental margins is very high. So, is that the right way to look at how you did in the second quarter? And if so, how sustainable is that level of incremental margin?
(To put that in perspective, agency margins tend to be in 10 percent range.) Roth replied:
... if we could take 50% conversion, we'll take it all day long, okay? So I think that's an attractive number to deliver. If we deliver conversions of 30% to 40%, I think that's a good number. So if you want to build in whatever organic growth you have, then we should be trying to deliver those type of conversions. And I think if you run the math, it's consistent with the numbers we're saying.
I've previously argued that Q2 results will bode well for the advertising economy as a whole, and that as long as government officials don't talk us back into recession the good times are probably here to stay. But IPG's results were so golden there's room for caution. The company can't possibly repeat that type of success consistently, quarter-on-quarter, year-on-year, can it?

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Image by Flickr user ori2uru, CC.