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When WPP agreed to pay more than $1.3 billion to acquire Ed Meyer's Grey Global Group in the autumn of 2004, it summarised the potential benefits as: more clients (like Procter & Gamble), more cross-selling opportunities, more media buying clout and more revenues from developing markets such as Latin America and the Far East. In other words, its chief executive, Sir Martin Sorrell, wanted to make WPP bigger, quicker.

Two years on, it is reasonable to ask if the deal is paying off.

From Grey's perspective, the rationale was highly compelling. It substantially reduced the group's vulnerability to the loss of one or more of its dominant blue-chip clients; it resolved 77-year-old Meyer's succession problems; and it put a bundle of dollars into his bank account - approximately $53 million in outstanding deferred bonuses and pension contributions, $35 million for tearing up his old contract and more than $250 million for his Grey shares.

And by mounting an auction, albeit with only three potential buyers (of which only one could promise to produce the cash), Grey managed to extract a bigger price from WPP than might otherwise have been possible. The deal price of $1,005 per Grey share showed a 33 per cent rise over the price quoted on the day when rumours first started to circulate in June 2004. Even in the three days preceding the deal announcement, WPP lifted the value of its offer by 5 per cent.

WPP Confident

Presumably, WPP was confident the price was worth paying. Yet Grey had made a profit of only $28 million the year before. So, if nothing changed, all WPP would get from its $1.3 billion investment would be a return of 2 per cent - far less than could be earned by leaving the $1.3 billion in the bank.

WPP reckoned it could do quite a lot to improve efficiencies in the existing business. By 2006, it expected to boost Grey's profit margins from an abysmal 6.6 per cent to a tolerable 11.5 per cent. It would achieve "synergistic" gains of $20 million per annum, reduce the effective tax charge on Grey's profits from 50 per cent to a more typical level and get additional benefits from better cash management.

However, even after taking all these measures, WPP would probably only have improved the post-tax return on its investment to a little more than 7 per cent. That may have more than covered the cost of capital, but is hardly something to write home about. For the pay-off to be worth the outlay, it would need to make a bigger return on the capital invested, and to do so, Grey would have to grow, not only by improving margins as WPP promised, but also by stealing market share from its peers.

So what has happened? Well, as an outsider, it is impossible to tell with certainty how Grey has performed financially, but there are clues. In the ten months following the takeover, Grey increased its operating profit at an annualised rate of 57 per cent. And its reported operating profit margin on revenue was lifted to nearer 10 per cent.

Improvement

Whether or not that improvement has been maintained since is hard to guess, although those close to the company say the overall performance is getting even better. Indeed, one analyst reckons WPP has exceeded its own initial predictions. Grey Healthcare and MediaCom are said to be doing particularly well so far. Nevertheless, it is arguable that profits have not yet reached a level that fully justifies the purchase price.

Even insiders acknowledge that some elements of the Grey empire have proved troublesome - particularly the GCI public relations network and, to a lesser extent, the Joshua operation. To some degree, these troubles have been reflected in the performance of the UK companies involved. Four of Grey's six most important UK operating subsidiaries traded at a loss in the year after the WPP purchase.

But there has been good news from MediaCom. In the UK, its revenues and operating profit contribution shot up by 30 per cent and 70 per cent, respectively, in the first year of WPP's ownership, although its hold on the Metropolitan Police and Masterfoods Italian business is under threat. Globally, it has won big accounts from Ikea, Time Warner and Nokia, as well as picking up the Gillette business from fellow WPP agency MindShare.

Although Grey's below-the-line network, Joshua, was on the "sick list" when WPP acquired it, the UK business traded at a small profit immediately following the takeover. In July this year, it won the M&G account after rebranding itself Joshua G2 to embrace Grey's direct marketing and digital capabilities. Before that, it won the Tussauds and Sensodyne accounts. But it has also parted company with NatWest and the Norwich and Peterborough Building Society.

Grey London

It's no secret that Grey's London advertising agency has been beset by all sorts of problems, with senior executives coming and going, while revenues declined and profits turned to losses. But on the global stage, City analysts' fears that the push for better profit margins might drive away clients seem to have been overstated. Those analysts now believe Grey's worldwide advertising network has performed tolerably well - increasing revenues from existing clients and losing less business than expected to its competitors.

Nevertheless, Grey London's current hold over the internet service provider AOL appears to be at risk, with the direct business moving from Joshua to Chemistry, and the above-the-line business also being reviewed. And everyone agrees Grey has been less than impressive in new business. Its failure to take the £75 million BSkyB account, widely believed to to be a WPP fait accompli, underlined its shortcomings in this arena.

Grey's London agency has had some modest business wins. It picked up the Christmas TV advertising for Toys R Us. And earlier, it was appointed to launch a new Hugo Boss men's fragrance.

In May 2005, WPP appointed Tamara Ingram as the group chief executive of all the Grey UK operations, presumably with the intention of bringing more order, stability and profitability to the scene. At that time, the condition of Grey's PR outfit, GCI London, was particularly worrying. Revenues fell by nearly 20 per cent in the year after acquisition, contributing to a £7.7 million operating loss for the period. Much of that loss arose from writing down the value of earlier investments in GCI Healthcare, GCI Jane Howard and GCI Financial (Holdings), but even the core PR business drifted into a loss.

So, in the UK at least, the signs of a successful revitalisation of Grey are not too evident yet. There has been plenty of cost-cutting and management shuffling, all of which is relatively commonplace immediately after an acquisition. Indeed, it is nearly always best to get the nasty business out of the way quickly, but building something better usually takes longer.

City investors will always look for quick gains, but in reality, sensible recovery plans rarely produce lasting results within a couple of years. So, if WPP has not yet delivered sufficient profit from Grey to fully justify the purchase price, that doesn't mean it can't. But it will almost certainly take a little more time and effort.

- Bob Willott is the editor of Marketing Services Financial Intelligence (www.fintellect.com) and a special professor at the University of Nottingham Business School.