Advertising: A public divorce

Cossette’s founders disagreed on how to build the iconic ad agency. Now comes the custody battle.

Cossette Inc.’s growth from humble Quebec City ad agency to the country’s largest advertising and communications company was no accident. For more than 30 years, the successful formula never wavered: disciplined management led by founding partners Claude Lessard and Francois Duffar, deep personal relationships with blue-chip corporate clients, and aggressive expansion. While other Canadian ad shops have risen — and often fallen — on the shoulders a few outsized creative personalities, Messrs. Lessard and Duffar have taken a businesslike approach to the industry and generally shunned the spotlight, even after taking the company public a decade ago. Their success was such that the two founding partners were inducted, side-by-side into the Marketing Hall of Legends in 2006.

But in July, Duffar emerged from two years of semi-retirement to launch a hostile $82.7-million takeover bid for the firm he spent a career building. Cossette’s stock has been a poor performer in recent years, but Duffar has offered few details about how he and his backers plan to reverse the trend, promising only that “a reorganization of its resources and capital will lead to a more efficient and dynamic Cossette.” So far, investors are applauding (the stock shot up 45% from its prior 30-day average price when news of the $4.95 per share cash offer emerged), but the bigger questions revolve around how the new Cossette will deal with lower client spending due to the economic downturn, not to mention the public impression that Cossette’s founding partnership, which worked so well for so long, has crumbled.

Cossette operates in a business where the major assets are intangible and people-based, namely long-standing client relationships and the loyalty of talented, mobile employees. And while this might be an ideal time to scoop up the firm for a bargain price, many wonder about the lasting damage to the firm’s image. “To try and flip the company on its back [in the midst of an economic downturn] is not good,” says Ian Saville, the former head of Cossette’s Toronto office, who sold out his sizable stake in the firm five years ago. “A hostile takeover when you are a steel company is one thing…but in our business the assets are the management team and the clients.”

While Cossette’s 1999 public offering has not proven a winner for shareholders (the stock debuted at $12.25), it did bankroll the firm’s acquisitions in the U.S. and in Europe. It also made some in senior management very wealthy. For example, when Saville and another staffer sold their shares back to the company, they received a combined $19.8 million.

Duffar, however, was always less enthusiastic about taking Cossette public than his longtime partner, and his latest move is part of a long-simmering plan to make the agency network private once again. “[Duffar] saw the company going down and down, and decided to propose to go private,” says a source close to Cosmos Capital Inc., Duffar’s takeover entity. “He found people to back him up.” Those backers include Georges Morin, the firm’s recently resigned senior vice-president and a large holder of multi-voting shares, former BCE chief executive Jean Monty who, as a client, played a pivotal role in Cossette’s past growth, and Burgundy Asset Management Ltd., which owns 11.1% of Cossette’s subordinate shares.

Observers suspect Duffar (who declined to comment) has likely been assembling allies for his takeover bid since May, when he announced his resignation as an officer of the company and started a weakening of the multi-share voting trust that locked control of the firm in the hands of insiders. The trust has since received a fatal blow with Morin’s resignation.

Saville, who has spoken to Lessard as well as Morin in recent weeks, worries about the reaction of Cossette’s clients, a blue-chip roster that includes the likes of McDonald’s, General Motors and Procter & Gamble. “It is bad timing and seems very much driven not by business but more by personality.” Another former Cossette executive, Bos Toronto vice-president Claude Carrier, says, “Their client base will be very scared for the next little while. Those things usually spook clients.”

The source close to Duffar said Cossette’s former president and vice-chairman has been busily reassuring clients and keystaff. “He’s had all his background checked before to be sure that clients won’t leave, upper and middle management will stay with the company. He is quite confident the business will go on and be better after because they will be more [focused] on the needs of clients and less on the needs of shareholders.”

Cossette’s current management argues that it needs the financial muscle that the public markets provide, and it has a competitive advantage when it can offer clients a full menu of communications services and expertise rather than specializing in a few areas. That full-service agency approach has certainly been successful in Canada, where Cossette has grown by gobbling up business that belonged to smaller, more specialized competitors. Cossette ranks no higher than 23rd internationally though, meaning it is still a bit player in the U.S. and a self-described “mid-size, convergent group” in the U.K.

And while Cossette’s combination of organic and acquisition-driven growth has shown up in rapidly growing revenues, bigger profits have been more elusive. Over the past five years, revenue has risen 40% to $253.3 million in fiscal 2008, but the profit of $8.9 million spun out last year was barely one-half of what a much smaller Cossette earned in fiscal 2004. And lately, the global recession has taken a toll — net earnings in the first half of fiscal 2009 were $1 million (or 6¢ a share) down from $4.2 million (25¢) for the same period in fiscal 2008, while revenue slipped to $113 million, from $119.3 million reported in the first half of the prior year.

Cossette has formed a committee to consider the unsolicited offer and explore “various strategic options,” a process that could include directors seeking out offers from a friendly bidder. But National Bank Financial analyst Adam Shine, who has covered the company since it went public, doesn’t anticipate any bids much higher than Duffar’s $4.95 offer.

Even if Lessard and his board were to fend off Duffar’s group successfully, management’s ironclad voting control (maintained through its multiple-voting share structure) will soon be shattered. With Morin’s resignation from Cossette, a three-month countdown has begun after which his shares will convert to regular single-vote shares. Based on a 1999 voting trust agreement, that will trigger the multi-vote shares of Lessard and fellow management loyalist Pierre Delagrave to convert to single-vote shares in mid-October. “Even if the board of Cossette dismisses the Cosmos bid as simply not high enough and Cosmos disappears for a few months, the optics of the situation at Cossette change inevitably post-Oct. 16 where we will continue to speculate [about] when some outside party will come in and take a run at Cossette,” says Shine.

All this will inevitably resurrect comparisons to the last great Canadian takeover fight in the ad business — the battle for control of Cockfield Brown. Defunct since 1983, the Montreal-based agency grew rich masterminding the sale of war bonds for the government during the Second World War. For a while, it was Canada’s largest ad agency but fell victim to the loss of a major client and a lengthy fight for control. In a 1999 editorial celebrating Cossette’s IPO, Marketing magazine stated that it was “entirely unfair” to draw comparisons with Cockfield Brown. The similarities now seem obvious. The hope is, maybe this time there will be a happier ending.