Recruiting in China

Ashish R. Thadhani (Gilford Securities) recently sent a note to clients raising his price target for 51job, Inc. (JOBS) based on the Company's strong Q406 results. Key excerpts follow:

* Investment Conclusion. After incorporating stepped-up S&M – funded by lower G&A and near-term taxation -- we are maintaining our estimates: 2007 GAAP EPADS at $0.60 on net revenue of $100 million (20% YoY growth and up from our prior $99 million projection); and 2008 GAAP EPADS at $0.80 on unchanged net revenue of $122 million (22% YoY growth). Due to the late Chinese New Year, our 1Q07 assumptions reflect a shorter peak recruiting period of five weeks vs. eight a year ago. We are raising our target from $26 to $28. In 12-months, this would correspond to 35x forward GAAP EPS of $0.80. Our recommendation is backed by an EV of $344 million or 20x forward earnings plus continued purchases by CEO Yan. We also point out 1) recent newspaper alliances in the U.S. should validate the 51job online/offline model to maximize local reach; and 2) 2007 is expected to be the last year in investment mode for rival ChinaHR.com, which remains much smaller and less profitable than 51job.
* 4Q06 Results. GAAP EPADS of $0.09 vs. $0.08 a year ago on net revenue of $20.8 million (23% YoY growth) matched our $0.09 estimate on net revenue of $20.1 million. Non-GAAP EPADS of $0.14 vs. $0.10 also met our $0.14 expectation. 51job posted positive variances in print advertising revenue and G&A expenses – offset by gross margin and S&M spend. Non-operating interest, subsidies, forex and tax variances offset each other. Revenue was driven by online recruitment services, which advanced 37% YoY to 34% of the total. Operating income of $2.6 million (12.6% margin) was right in line with our estimate of $2.5 million (12.5%). Other highlights included diminished seasonality (-4% QoQ) and clear market leadership based on online postings, traffic quality and pricing -- despite competitor claims to the contrary. Metrics showed growth in print advertising page-count (+33% YoY from a depressed level) and lower revenue per page (-14% in dollar terms due to seasonal promotions and city-mix); and moderating growth in the number of employers using online services (+30%) with steady revenue per employer (+5%). Net cash climbed to $111.3 million (~$3.90 per ADS) from $104.5 million on September 30.

Noteworthy developments

December 2006. In an SEC filing, Recruit Co. disclosed an increase in its holdings to 5.1 million ADS equivalents (18% ownership stake).

November 2006. CEO Rick Yan reported additional market purchases totaling 317K ADSs at an average price of $16.04 between November 13-22. This activity took his ownership to 8.6 million ADS equivalents or 30% of the total. Separately, the class action lawsuit against 51job and its officers, which followed a 4Q04 EPADS shortfall, was dismissed.

September 2006. CEO Rick Yan reported market/private purchases totaling 818K ADS equivalents at an average price of $14.57 during the 30 days ended September 13. This activity took his ownership to 8.2 million ADS equivalents -- well above what is covered under the agreement with Recruit.

August 2006. 51job announced an exclusive partnering agreement with CareerBuilder.com (owned by Gannett, Tribune and McClatchy), 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 holds 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. 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 the leading provider of HR services in Japan. It also provides information services across diverse businesses such as learning, real estate, automobiles and coupons. In fiscal (Mar.) 2005, Recruit operating income exceeded $1 billion on sales of $3.5 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.com for $50 million – or 9x 2005E revenue of $14 million (up 100% YoY and 70% online). At the time, ChinaHR.com had 3.2 million registered users and 480 employees in 10 major cities. In 1Q06, Monster increased its ownership to 44.4%. It acquired shares from existing holders for $20 million, implicitly valuing ChinaHR.com at $450 million. Monster expects to assume full control of this subsidiary in early-2008. Financial backing by Monster has not altered the competitive landscape materially. However, 51job does anticipate heated competition until such time that ChinaHR.com – which is likely to remain unprofitable through 2007 – becomes directly answerable to public shareholders.

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 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 $570 million to $1.26 billion in 2005-10, implying 17% compound annual growth. During this period, the online recruitment segment is expected to advance from $100 million (18% of the total) to $570 million (45%), or 42% compound annual growth. Superior positioning includes: premium brand/pricing; a comprehensive online/offline offering; wide geographic presence (25 cities); large direct sales force (over 1,200 representatives); and unmatched job seeker database (access to more than 11 million resumes for professional, clerical, industrial and hourly jobs). EPS visibility stands to benefit from top-line, profitability and taxation drivers. Specifically, ramp-up of online subscriptions (from single-digit penetration of client budgets at present); a scalable model offering 30%-plus operating margin (excluding share-based compensation); and initiatives to avail of tax incentives.

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.
* Despite recent improvement, 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.