51job: Washed Out Valuation, Doubts Remain Unaddressed

Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on 51job, Inc. (JOBS):

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Investment Conclusion. Based on weak hiring activity in a slowing economy – mitigated by subsidies and a lower tax-rate – we are revising our estimates as follows: 2008 GAAP EPADS to $0.43 on net revenue of $119 million (12% YoY growth) from $0.40 on net revenue of $121 million; 2009 GAAP EPADS to $0.35 on net revenue of $120 million (1% YoY growth) from $0.55 on net revenue of $140 million; and 2010 GAAP EPADS to $0.45 on net revenue of $141 million (17% YoY growth) from $0.70 on net revenue of $168 million. Using our forward estimates, the current $37 million enterprise value translates into a statistically compelling 0.3x net revenue, 2.2x EBITDA, 1.1x tangible book value – and just 12% of the $316 million valuation accorded ChinaHR by MWW. Still, we would only become constructive on the shares upon 1) purposeful implementation of the $25 million buyback, which would enhance future EPS power; 2) more effective monetization of existing market share on the bottom-line; and 3) adherence to acceptable governance standards, i.e., never placing management interests ahead of shareholders. Pending resumption of YoY revenue growth or a cost realignment, we compute fair value at $8 or 1) net cash of $5.50 per ADS; plus 2) a valuation for the underlying business of $2.50 per ADS, or 4-5x forward GAAP EBITDA.

3Q08 Results. GAAP EPADS of $0.15 vs. $0.13 a year ago on net revenue of $29.1 million (5% YoY growth) beat our $0.09 estimate on net revenue of $29.4 million. However, non-operating items boosted results by 5.4 cents. Specifically, a disturbing shortfall in print advertising revenue – cushioned by strong HR outsourcing activity – was offset by government subsidies and lower taxation. Revenue from online recruitment services rose 17% YoY to 37% of the total. Operating income fell 31% YoY to $3.3 million (11.2% margin) and missed our $3.4 million estimate (11.6% margin). Metrics show a contraction in print advertising page-count (-5% YoY) with lower average revenue per page (-15% YoY in dollar terms due to city-mix); and decelerating growth in the number of employers using online services (only +5% YoY) but with higher revenue per employer (+12% YoY)…

Investment Background. According to recent surveys, a shortage of qualified staff and high turnover ranks as the biggest business concern in China. 51job is enviably placed to capitalize on the rapidly evolving market for HR services in China – by applying a proven business model across its vast labor force (5x U.S.). Compared with traditional job search channels such as referrals and fairs, pioneers like 51job offer significant reach and speed advantages. Favorable demographic drivers include GDP growth (~10% in recent years), Internet usage (ranked #1 worldwide), an aging workforce and increasing private, urban and service sector employment. iResearch forecasts that the total recruitment market in China will increase from $568 million to $1.39 billion in 2005-10, implying 20% compound annual growth. During this period, the online recruitment segment is expected to advance from $99 million (17% of the total) to $631 million (45%), or 45% compound annual growth. Superior positioning includes a premium brand/pricing; comprehensive online/offline offering; wide geographic presence (25+ cities); large direct sales force (over 1,900 representatives); and unmatched job seeker database (access to more than 20 million resumes for professional, clerical, industrial and hourly jobs). EPS growth stands to benefit from ramp-up of online subscriptions (from single-digit penetration of client budgets at present) and a scalable model offering 30%-plus operating margin (excluding share-based compensation).

JOBS is suitable for aggressive investors. In our opinion, principal risks include the following:

• Deterioration of economic conditions in China, slowing of hiring activity or a “hard landing” scenario.
• Competition from ChinaHR and Internet portals could pressure future profitability by way of higher marketing expenses and/or lower pricing.
• Rapid online migration could result in cannibalization of offline revenue.
• 51job has an inconsistent execution record.
• Uncertainties in the PRC regulatory and legal system, particularly laws governing foreign ownership and licensing/operation of HR and Internet business entities. Note that 51job is incorporated as a holding company in the Cayman Islands.
• Disruptions such as spread of the H5N1 virus or a recurrence of SARS, political unrest, breakdown in relationship with a major publishing/distribution contractor, etc.
• Influence of Recruit Co. and current management over all matters requiring a shareholder vote.
• Correction in the U.S. markets.

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ANALYST CERTIFICATION

I, Ashish Thadhani, certify that all the views expressed in this research report accurately reflect my personal views of the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of this report.