51job's Aggressive Marketing Posture Delays Upside

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

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Solid 4Q: 33% YoY Growth, 15% Op. Margin, Cash ~$5 / ADS; Aggressive S&M (Sales & Marketing) Posture Delays Upside, EPS Estimates Cut

Investment Conclusion. Based on stepped-up operating expenses (marketing, sales force expansion and online product development) – offset partially by continued currency-aided revenue growth – we are reducing our estimates: 2008 GAAP EPADS to $0.55 on net revenue of $131 million (23% YoY growth) from $0.68 on net revenue of $128 million; and 2009 GAAP EPADS to $0.75 on net revenue of $163 million (25% YoY growth) from $0.90 on net revenue of $159 million.

We are lowering our target from $23 to $20.50. In 12-months, this would correspond to a $434 million enterprise value and 25-30x forward GAAP EPADS – a premium to 20% compound EPS growth in 2007-09E. Although 51job stated that "business fundamentals are stronger than ever," we are disappointed by ballooning near-term S&M expenses (27% of 2008E net revenue vs. 22% in 2007) – ostensibly to match rival ChinaHR.com. On a positive note, the $360-405 million valuation placed on ChinaHR.com by Monster (MNST-Hold) has positive implications for 51job ($386 million), which remains much larger and more profitable than its nearest competitor.

4Q07 Results. GAAP EPADS of $0.10 vs. $0.09 a year ago on net revenue of $27.7 million (33% YoY growth) beat our $0.09 estimate on net revenue of $26.0 million. 51job posted positive variances in net revenue ($1.7 million led by training/outsourcing – this segment could benefit under the new labor law) and tax/other items ($0.2 million) – offset partially by operating costs ($1.1 million) and a forex translation loss ($0.5 million).

Revenue from online recruitment services advanced 40% YoY to 36% of the total. Operating income rose 57% YoY to $4.1 million (14.9% margin) and exceeded our $3.5 million estimate (13.3% margin) by 17%. Metrics showed somewhat slower growth in print advertising page-count (+21% YoY) with lower average revenue per page (-3% YoY in dollar terms attributed to city-mix); and steady growth in the number of employers using online services (+30% YoY) with higher revenue per employer (+8% YoY). Net cash climbed to $138.0 million (or $4.85 per ADS) from $131.7 million on September 30...

Investment Thesis. 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 #2 behind the U.S.), 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 1,600 representatives); and unmatched job seeker database (access to more than 16 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.com 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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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.