Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on 51job, Inc. (NASDAQ:JOBS):
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Downgrading to Sell; EPS Estimates. Pushed Out By One Year
Investment Conclusion. We are downgrading our rating to Sell from Buy. Based on widespread weakness in hiring activity – attributed to a slowing economy, new labor law and disruptions from the Sichuan earthquake and Beijing Olympics – we are sharply reducing our estimates as follows: 2008 GAAP EPADS to $0.40 on net revenue of $121 million (14% YoY growth) from $0.55 on net revenue of $134 million; and 2009 GAAP EPADS to $0.55 on net revenue of $140 million (16% YoY growth) from $0.75 on net revenue of $167 million. At this time, we are also introducing a 2010 GAAP EPADS estimate of $0.70 on net revenue of $168 million (20% YoY growth). Near-term, JOBS could find support at the $12 level on the basis of 1) net cash of $5.30 per ADS; plus 2) a valuation for the underlying business of $6.90 per ADS, or 15x forward GAAP EPADS. Despite claims of undisputed market leadership and a backdrop of double-digit GDP growth, 51job has neither monetized its heavy S&M investments, nor demonstrated the critical margin discipline necessary for sustaining EPS growth and shareholder returns. Even more troubling is the agreement with Recruit Co. that allows management to not only sell stock for $26 per ADS but also profit from a falling price.
2Q08 Results. GAAP EPADS of $0.10 vs. $0.14 a year ago on net revenue of $30.4 million (16% YoY growth) missed our $0.14 estimate on net revenue of $32.6 million. 51job posted negative variances in net revenue ($2.2 million primarily in the print advertising segment) and a non-deductible currency translation expense ($0.5 million) – that were only partially offset by lower operating costs ($1.5 million). Revenue from online recruitment services rose 30% YoY to 38% of the total. However, operating income fell 22% YoY to $4.4 million (14.5% margin) and also missed our $5.2 million estimate (15.8% margin). Metrics show a significant deceleration in print advertising page-count (+1% YoY) with lower average revenue per page (-4% YoY in dollar terms due to city-mix); and slower growth in the number of employers using online services (+12% YoY) along with higher revenue per employer (+16% 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 1,600 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.
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.