51job, Inc: Marketing Expenses and High Taxation Dent EPS Estimates

51job, Inc: Marketing Expenses and High Taxation Dent EPS Estimates

Ashish R. Thadhani (Gilford Securities) recently sent a note to clients on Chinese human resource recruitment company 51job, Inc. (JOBS). Excerpts follow:

• Investment Conclusion. Based on stepped-up S&M spending and the expiration of key tax benefits – tempered by print advertising and training/outsourcing revenue — we are reducing our estimates: 2007 GAAP EPADS to $0.50 on net revenue of $103 million (23% YoY growth) from $0.60 on net revenue of $100 million; and 2008 GAAP EPADS to $0.68 on net revenue of $125 million (22% YoY growth) from $0.80 on net revenue of $121 million. We are introducing a 2009 GAAP EPADS estimate of $0.90 on net revenue of $152 million (21% YoY growth). We are also lowering our target from $28 to $21.50. In 12-months, this would correspond to a $465 million enterprise value and 25-30x forward GAAP EPADS – in line with 26% compound EPS growth in 2006-09E and a discount to the current valuation (32x). We are disheartened by the aggressive emphasis on marketing initiatives at the expense of long overdue margin/EPS discipline. This represents the third investor setback in as many years, undermines claims of market domination and also raises questions about management alignment (see April 2006 agreement on page 2). Still, we believe that 25% upside potential justifies a Buy.

• 2Q07 Results. GAAP EPADS of $0.14 vs. $0.12 a year ago on net revenue of $26.2 million (28% YoY growth) fell short of our $0.16 estimate on net revenue of $25.1 million. EPADS was held back by $0.02 due to a high tax-rate. 51job posted a positive variance in revenue ($1.1 million primarily in print advertising and training/outsourcing) – offset by operating costs ($0.6 million), forex ($0.2 million) and taxes ($0.7 million). Revenue from online recruitment services advanced 36% YoY to 34% of the total. Operating income rose 54% YoY to $5.7 million (21.6% margin) and surpassed our $5.2 million estimate (20.8% margin). Results benefited from a longer post- Chinese New Year peak recruiting period in 2Q07 vs. a year ago. Metrics showed improving growth in print advertising page-count (+37% YoY) but lower average revenue per page (-15% YoY in dollar terms attributed to city-mix); and normal growth in the number of employers using online services (+32% YoY) with steady revenue per employer (+3% YoY). Net cash climbed to $126.0 million (or $4.45 per ADS) from $119.0 million on March 31.

• Investment Thesis. 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 $1.33 billion in 2005-10, implying 19% compound annual growth. During this period, the online recruitment segment is expected to advance from $99 million (17% of the total) to $604 million (45%), or 44% compound annual growth. Superior positioning includes: premium brand/pricing; a comprehensive online/offline offering; wide geographic presence (25 cities); large direct sales force (over 1,500 representatives); and unmatched job seeker database (access to more than 12 million resumes for professional, clerical, industrial and hourly jobs). EPS visibility stands to benefit from top-line and profitability drivers. Specifically, 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 lower pricing and/or higher marketing expenses.
– 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.