51job: Online Revenue Trails Rival ChinaHR

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 curtailed demand for recruitment services in a worsening economic downturn – compounded by grossly irresponsible acceleration of S&M spending – we are sharply lowering our estimates: 2009 GAAP EPADS to $0.00 on net revenue of $110 million (-8% YoY) from $0.35 on $120 million; and 2010 GAAP EPADS to $0.05 on $127 million (+16% YoY) from $0.45 on $141 million. The current enterprise value translates into a rich 11.4x 2009E EBITDA. Pending resumption of YoY growth and aggressive cost reductions, we compute fair value at $5.50 or 1) net cash of $5.50 per ADS; plus 2) naught for a shrinking, unprofitable and inflexible business. We would only become constructive on JOBS upon effective monetization of existing market share on the bottom-line. Even MWW has admitted that its ChinaHR buy-out agreement encouraged this unit to pursue unprofitable and unsustainable growth; post-acquisition (page 2), it intends to improve profitability with a 20% workforce reduction that should resize this business with current activity. However, 1Q09 guidance from 51job implies an operating deficit (the first since 1Q03) and absence of any meaningful action to shore up profitability.

4Q08 Results. GAAP EPADS of $0.03 on net revenue of $27.2 million (-2% YoY) missed our $0.07 estimate on $27.2 million. Weakness in the print advertising and online recruitment segments was offset by continued momentum in (non-recruitment) HR outsourcing activity. Revenue from online recruitment services rose 1% YoY and comprised 37% of the total. Operating income fell 79% YoY to $0.9 million (3.2% margin) and failed to meet our $2.3 million estimate (8.5% margin). The entire shortfall is attributed to unprecedented S&M spending (up 17% QoQ to 31% of revenue) despite an earlier management assertion to the contrary and 7% QoQ drop in net revenue. Metrics show a deeper contraction in print advertising pagecount (-13% YoY) with lower average revenue per page (-28% YoY in RMB due to city-mix); and fewer number of employers using online services (-1% YoY) with lower revenue per employer (-5% YoY).

Noteworthy developments are summarized below.

• September 2008. 51job directors approved a $25 million ADS buyback. In 4Q08, the company repurchased 137K ADSs at an average price of $6.65 – for a total of just $0.9 million despite talking up this program as a priority.
• August 2007. 51job and Recruit (see April 2006 alliance below) agreed to form a separate company that will provide coupon advertising services in China. 51job will fund $4.3 million for a 40% equity stake in the new company.
• November 2006. The class action lawsuit against 51job and its officers, which followed a 4Q04 EPADS shortfall, was dismissed.
• August 2006. 51job announced an exclusive partnering agreement with CareerBuilder.com (owned by Gannett (GCI), Tribune and McClatchy (MNI)), under which the two sites will have links that provide job posting and resume access.
• June 2006. Mr. Charles E. Phillips, Jr. – President of Oracle (ORCL) – resigned from the board citing personal reasons. Mr. Phillips had served as a director for two years.
• April 2006. In a private transaction, existing shareholders comprising management and Doll Capital Management (DCM) sold to Recruit Co. the equivalent of 4.2 million ADSs (or 15% of the total) at $26 each (47% market premium). Recruit was granted a three-year option to purchase an additional 25% stake from these shareholders at the higher of two prices: 1) floor of $26 per ADS – as long as JOBS does not drop below $10 at the time; or 2) 15% market premium with a $51 cap. If exercised, management ownership would decline (from 50% before April 2005) to 35% and that of DCM (from 25%) to nil. Recruit has since raised its interest from 15% to 39%.
  Separately, 51job entered into a business alliance with Recruit that will explore new information service opportunities in China. Founded in 1963, privately held Recruit is a leading provider of HR services in Japan. It also provides information services across diverse businesses such as learning, real estate, automobiles, travel and coupons. In fiscal (Mar.) 2007, operating income exceeded $1 billion on sales of $4 billion.
• October 2005. 51job signed a letter of intent to purchase a $14 million service and headquarters complex in Shanghai, which it began occupying in late-2006.
• July 2005. The Chinese government changed its currency policy. Over time, anticipated Renminbi appreciation should translate into higher dollar-denominated operating income, offset by near-term currency translation losses.
• May 2005. Shareholders approved a $25 million stock repurchase program over a 12-month period. In 2H05, 51job repurchased 686K ADSs at an average price of $13.65.
• February 2005. Monster Worldwide acquired a 40% stake in rival ChinaHR for $50 million. In 1Q06, Monster increased its ownership to 44.4% by acquiring shares from existing holders for $20 million. In October 2008, Monster paid $174 million in cash for the remaining 55.6% interest in ChinaHR. For the year ended December 2008, ChinaHR recorded a net loss of $22.5 million. We believe that 51job has been drawn into a needless battle over incremental market share that has severely undermined its profitability and credibility.
• January 2005. 51job pre-announced a 41% shortfall vs. 4Q04 EPADS guidance due to unprecedented revenue softness in late-December. The sudden (post-IPO) slowdown was attributed to a shift in budget allocations to earlier quarters of the year – borne out in 4Q05 – and moderation of overall demand from ~70% YoY growth.
• September 2004. 51job raised net proceeds of $76.8 million from its IPO at $14 per ADS.

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 and pricing; comprehensive online/offline offering; wide geographic presence (20+ 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.

Disclosure: The author of this report has a long position in the ADSs of 51job, Inc.