Description

Overview: Dice Holdings (DHX), is a small cap “Magic Formula” stock, with a high ROIC/FCF business model, whose shares have not participated in the market rally and significantly underperformed the market in the last 12-18 months, as the Company’s financials have been pressured by the combination of the weak job market, some investments to its improve its technology and digesting some tangential acquisitions. During this transition period, most growth oriented investors and sell-side analysts have given up on the stock, resulting in a ~24% decline in the share price over roughly the last year, compared with a 24% gain for the S&P 500. While this call may be early as it is unclear if near-term margins have bottomed, there are some indications that employment industry fundamentals are becoming more favorable. Thus, I believe the shares are worth watching by value investors with longer term time horizons who are attracted to companies with high return/FCF business models. Noteworthy, DXH’s business model has among the highest returns (EBITDA/revenue and RIOC) and most attractive valuations (EV/EBITDA multiple and FCF/EV yield) among the broad group of job recruiting comparables. On an absolute basis, the shares are selling at an EV/EBITDA multiple of 7.2x and a FCF/EV yield of 9.1% relative to depressed FY 2013 ttm results.

Profile: Dice Holdings (DHX) operates a number of specialized job recruitment web sites that focus on select vertical markets. The Company targets industry sectors that have traditionally had high turnover rates and employs advanced professionals. The Company’s value proposition for professionals in targeted industries is access to a large number of job postings as well as career development services (webinars, career fairs, industry news/data, career guides, detailed salary information, networking forums, etc.). For DHX’s base of recruiters and employee customers looking to fill key roles in their organization, the Company offers access to a industry specific pool of qualified professionals, access to proprietary resume databases and through the use of proprietary  search engines and tools, an efficient way to target their searches. The combination of DHX’s well recognized web brands (which average 11 to 28 years in operation), and the size and quality of its database of industry specific candidates is a valuable asset that provides the Company a competitive advantage. The majority of DHX’s revenues are generated from employers and recruiters who purchase recruitment packages through monthly or longer-term contractual agreements. A small portion of revenues in one of the Company’s business (Slashdot Media) are derived through website advertising.

DHX’s history dates back to 1990, when the Company began an on-line job posting service under the name Data Processing Independent Consultants Exchange in the San Francisco bay area targeting the technology industry. In the 1999-2005 period, the Company went through a series of changes, including being acquired, changing its name and being sold to the private equity firms of General Atlantic LLC and Quadrangle LLC, who currently own 16.0% and 10.2% of the shares respectively. During the mid-2000 period, the Company began diversifying from a primary focus on the technology industry with the acquisition of other vertical focused recruitment companies in other industry sectors. In 2005, DHX had its IPO.

Currently, DHX’s focuses on eight different vertical industry sectors through its specific websites. The Company’s financials are broken down into five specific industry groups, which include:

-- Tech & Clearance (61.8% of revenues in FY 2013): This sector comprise three of DHX’s industry specific websites. Dice.com is a career site focused on technical and engineering professionals. This is the Company’s largest contributor to revenues and DHX’s original website, dating back to the founding of the organization in 1990. The IT Job Board was purchased by DHX in July 2013 and builds upon and expands geographic expansion to the Dice.com brand, with a focus technology recruitment in the UK, Germany, Belgium and the Netherlands. ClearanceJobs.com is the leading web-based recruitment site for security-cleared professionals targeting positions with U.S. government contractors, federal agencies, national laboratories and universities.

-- Finance (16.4% of revenues in FY 2013): eFinancialCareers.com is the worlds leading financial services industry recruitment website. Acquired in November 2006, EFinancialCareers.com was originally launched in the UK and now operates in 19 markets in three languages across Europe, Asia, Australia and North America. Additionally, through various distribution and partnership agreements, this division operates the career site for over fifty business organizations through the world.

-- Energy (11.0% of revenues in FY 2013): Rigzone.com is a leading website targeting the oil & gas industry. In addition to offering energy industry users career opportunities, the site also provides various industry content and data. Rigzone.com was acquired by DHX in August 2010 and with the acquisitions of WorldwideWorker.com in May 2010 and OilCareers in April 2014, the Company has increased its penetration of this sector.

-- Healthcare (2.6% of revenues in FY 2013): DHX entered the healthcare industry in June 2009 with a small acquisition and gained critical mass with the November 2013 acquisition of HEALTHeCAREERS. The Company plans to combine its prior offerings in this industry under the HEALTHeCAREERS brand in 2014. This division also included Biospace, a website that targets the biotechnology industry.

-- Hospitality (0.7% of revenues in FY 2013): With the November 2013 acquisition of onTargetjobs, the Company gained the leading website for hospitality jobs for the hotel, restaurant, food service, casino and retirement industries. Given the high employment turnover rate in these industries, this sector fits DHX’s profile.

-- Corporate & Other (2.6% of revenues in FY 2013): The major contributor to revenues in this division is Slashdot Media, which operates a website (SourceForge.com) focused on connecting together technology professionals and enthusiast to distribute open source software and discuss current issues within the technology community. Unlike DHX’s other websites, Slashdot Media has an advertising driven business model. In addition, the Company operates Targeted Job Fairs, which produces and hosts career fairs for technology, energy and security clearance professionals.

The following table highlights some key statistics for DHX’s leading websites:

Asset Light, High Return Business Model: DHX operates an advantaged asset light, high returns business model that throws off a healthy amount of free cash flow. The high quality of the job specific pool of talent and resumes that the Company provides recruiters and corporate HR departments, coupled with its proprietary search tools, allows it to have traditional software margins in the 90% range. While down from historic levels due to some strategic investments being made in the business, the Company still enjoys EBITDA/revenue margins of ~30%. These margins are well above other generalist on-line operators, such as Monster Worldwide (MWW), whose similar margin is in the ~14% range. This highlights the Company’s unique value add proposition that DHX delivers to recruiters and HR organizations who are looking for high level professional talent with specific attributes and are willing to pay a premium for these candidates. These margins are also well above other public executive recruiters, such as Korn Ferry (KFY) and Heidrick & Struggles (HSII), as well as temporary staffing companies, such as Robert Half Int’l (RHI), Kforce (KFRC) and Manpower (MAN), whose margins range from 3%-12%. Given the low capital intensity of the business that does not require a lot of working capital or fixed assets, DHX enjoys a ROIC well in excess of 100% (excluding goodwill & intangibles). This translates into the ability of the company to generate a healthy amount of FCF. Historically, DHX has use this cash flow to diversify and grow its business by acquiring tangential websites targeting advanced professionals in industries with high employment turnover. Additionally, as in the current period, this cash has been used to repurchase stock.

Some Industry Headwinds May Be Moderating: In the last couple of years, DHX has been facing a fair amount of industry headwinds relative to the weak ongoing US economic recovery, high domestic unemployment and below average turnover among professionals in most of the company’s vertical markets. The picture is similar in Europe, where a number of economies are also continuing to wrestle with weak economic conditions post the debt crisis a few years ago, which has restricted employment growth and turnover. Additionally, some of DHX’s verticals have faced their own challenges which has impacted the Company’s business. As the leading recruitment site in the financial services community and given its particularly large exposure to the financial markets in Europe, has positioned eFinancialCareers in an industry that has seen massive headcount reductions over the last few years in the U.S., Europe & Asia. In the security clearance industry the impact of sequestration and defense budget cuts has impacted job growth. DHX’s more diversified revenue model relative to its past, has helped offset some of the softness it has seen in these sectors. Reflecting the boom in the oil & gas industry over the last couple of years, Rigzone has been the bright star of the Company’s operations, while Dice.com has seen more moderate growth.

On a positive note, management has indicated on the last few quarterly conference calls that they are beginning to see the first signs of stabilization in the Company’s finance business (16.4% of revenues in FY 2013 versus 25.1% in FY 2011). Through FY 2013 the y/y declines in eFinancialCareers’ revenues have been moderating and in Q4, billings were up y/y for the first time in while. A possible turn in DHX’s second largest vertical market would not only have a positive impact on the Company’s financials, but would help improve investment sentiment.

Some Favorable Industry Trends and Some Issues: Some of the favorable industry trends that have benefited the Company include the shift from print to on-line classified advertising and ad spending as well as the ubiquitous nature of internet and web as a research service to facilitate business productivity. In addition, the advent of social media as an information resource for job seekers, benefits DHX’s web based approach of building industry specific community networks. The successful establishment of industry specific databases of highly qualified professionals that can be mined by recruiters and HR departments are by their nature made possible by the advent of the web. These proprietary databases represent a very valuable tool for recruiters and a similarly valuable asset for web owners like DHX. Anecdotal evidence from my research suggests that the sectors of the recruitment market that are gaining share include the vertical recruiters (like DHX), aggregators and social media (i.e. Linkedln) at the expense of executive recruiters, generalists and print media.

The impact of Linkedln is probably the greatest concern/uncertainty overhanging the shares. No doubt, Linkedln has taken share within pockets of the professional sector of the recruitment market. However, it is unclear who the share has come from and how deep the impact will be in the future. Relative to DHX, the anecdotal evidence of my research suggests that on the margin the Company may be feeling some impact at the low end of the market from potential new customers who may be doing more one-off searches. This may push the Company to make some adjustments to its pricing policy to address this class of potential user. However, for the great majority of the markets that DHX serves, the use of Linkedln tends to be more of a complementary tool to assist in analyzing a potential employee as opposed to finding that candidate. Noteworthy, typical Linkedln job postings tend to result in many hundreds of applicants for a given position. As an example, the following is a link to a job posting for a event drive, value oriented hedge fund analyst at a New York City firm: http://www.linkedin.com/jobs2/view/10861584?trk=job_view_browse_map  At this time, after listing the position for only 30 days, 995 applicants have applied. I would guess that most do not have the necessary qualifications. Thus, someone in the organization (I would speculate a non-HR employee at a high level in the organization) would have take a fair amount of time away from their traditional job responsibilities to read through all these resumes to figure out which, if any, posses the required qualifications, do some background checks and then begin the interview process. This may not be a good use of time and there is no assurance a qualified candidate will emerge after all this work is done. The employer posting the job may have come to the same conclusion given the posting at the top of the ad stating “this job is no longer accepting applications”. The point here is that while Linkedln provides a wealth of information on potential candidates, this method of solicitation in finding potential candidates may not be right for every organization.

Investments To Improve The Technology Platform Should Help The Company’s Competitive Advantage: One of the factors that have pressured DHX’s margins during the last ~24 months has been spending on technology related initiatives to help solidify the Company’s competitive position relative to two of the major technology discontinuity shifts in the market. Today most companies with a technology based business model that hope to maintain their competitive advantage, have to have a business strategy that embraces both social media and mobile computing. In regard to these challenges, DHX appears to have done a reasonably good job regarding embracing social media, while mobile continues to be a work in process, but a major area of focus.

DHX’s new President & CEO, Michael Durney, who began his role in October 2013, has made improvements to the Company’s technology platform one of his major priorities. One of the Company’s key initiatives is to be at the forefront of new technology trends and to use data analytics to provide more value to its customers. Given the proliferation of social media, the Company hopes to take advantage of this relative to achieving this objective. DHX has developed a IT profiling product, labeled Open Web, that embraces and takes advantage of the proliferation of social media as an information resource to provide recruiters and HR departments with a broader pool and a deeper profile of perspective job candidates, whether or not they have profiles on the DHX network. Based on specific job requirements, Open Web searches the accessible parts of some 50 social and professional networks, indexing a candidate’s contributions and postings to build the profile of that individual. Open Web pulls together various pieces of information about specific candidates, summarizing an individual’s experience, skills, and interests in a profile. That information is indexed from the sources where it is obtained and with a mouse click, is available for review. A beta version of Open Web was introduced in January 2013 on Dice.com as a temporary free service for review by the Company’s customers, and launched as a paid additional service in October 2013. Management indicates that the feedback to the product has been favorable, acceptance is building and that renewal rates for customers using Open Web are higher than the corporate average. Currently DHX is making strategic investments to bring the capabilities of Open Web to its other industry specific platforms (Rigzone and eFinancialCareers will likely be next). The success of Open Web should enable DHX to help maintain its competitive advantage in the market place and favorably impact the Company’s renewal rates, ASP’s and revenue growth.

Relative to mobile, DHX has been investing in bringing to market mobile enabled versions for each of its major vertical market offerings. In 2013 the Company launched its first mobile app for Dice.com. However, the feedback from users was described by management as disappointing. With a commitment by management to get it right, a new version in the works. Learning from its past mistakes, the mobile app for Rigzone has been well received, receiving 4.5 stars in the Apple Store and the Android version receiving 5 stars. In addition to a new version of the app for Dice.com, I expect to see additional apps for the Company’s other brands this year. Given that no other competitor has established a time to market advantage with mobile apps, this gives DHX the opportunity to maintain its competitive advantage during this technology transition.

Financial Trends Highlighted By Moderating Growth And Margin Pressures: The following table provides the revenue breakout for each of these sectors over the last few years followed by the historic income statement and cash flow.

Note: * FY 2103 includes acquisition related costs of $2.2 million

From a revenue growth perspective, in the last few years all of DHX’s growth has come from the Tech & Clearance and Energy sectors as well as from a number of acquisitions. Conversely, the finance sector (eFinancialCareers) has been the drag on revenue growth, while some of the industry sectors that have lacked scale (i.e. healthcare) as well as the Company’s ad-funded Slashdot Media division have been a drag on profitability. For the most part gross profits have held up well reflecting a stable pricing and competitive environment. However, the big issue (which has weighed on the stock) has been the increase in operating expenses, which has pressured EBITDA.

The big issue that has dragged down profitability over the last 24 months, has been the buildup in operating expenses, especially G&A and R&D. The increase in G&A appears to be the result of a number of acquisitions, that have added to the Company’s infrastructure costs. During this period G&A expenses as a percent of revenues increased from 13.3% to 16.9%. The increase in R&D is tied to a number of strategic investments being made to the Company’s technology platform (Open Web and mobile apps) to take advantage of the changing dynamics of the market and maintain DHX’s competitive advantage. Noteworthy, during the 2011-13 period, R&D spending more than doubled in dollar terms and increase as a percent of revenues from 5.8% to 10.5%. Given the overall challenging industry conditions which is restricting organic revenue growth coupled with the timing on recent acquisitions and continued investments, the Company’s margins are likely to remain under pressure this year.

Another issue that has been a drag on DHX’s profitability has been problems in the Slashdot Media operations. The market for traditional display advertising among the major technology vendors has declined and the Company has not been well positioned. Additionally, there were execution issues within the sales force in this division. There has been a change in leadership with this division and these issues are currently being addressed by management, but will likely continue to pressure financial results in the near-term.

As illustrated above, DHX has a rich FCF model. However, FCF has declined commensurate with the pressure on operating margins. Historically, the Company has used its cash flow primary for acquisition opportunities to expand its market opportunities and to repurchase stock. The Company used $50 million in November 2013 to acquire onTargetjobs, which significantly expands the Company’s presence into the healthcare market. In December, DHX announced a $50 million stock repurchase program, which is in addition to a similar sized repurchase plan put in place in January 2013, and is the latest in a program that began in 2011. These factors have necessitated the Company to take on some additional debt. However, despite this increase in debt, the Company’s EBITDA/interest expense ratio is very healthy.

A Possible Return To Historic Margins Would Translate Into Meaningful Upside: Historically, the company’s financial model had generated EBITDA margins in the 40% range. However, beginning in FY 2012 and continuing through FY 2013, margins have been in a steady decline, with management targeting 30% adjusted EBITDA margins in FY2014. Admittedly, it is unclear if this will mark the bottom of margins. Despite these investments and somewhat inflated costs, DHX’s EBITDA margins are significantly higher that other recruiting and staffing companies (see table in valuation discussion below). Management believes that on a longer term basis, the Company’s margins can return back to roughly the 40% range.

If management is correct in that these issues are mostly temporary in nature and margins can return to historic levels, there should be a significant amount of leverage in DHX’s financial model, as these costs are reduced. Based on my calculations and using the Company’s current revenue rate, if DHX’s margins return to historic levels, I estimate DHX could generate EBITDA of ~$100 million, FCF of ~$65 million and EPS of ~$0.75 per share. While I do not expect to see margins rebound to these levels in the near term (and will likely require revenue growth), these figures provide some insight relative to potential future margin leverage.

At this point, I believe most sell-side analysts and investors have given up on the prospect of margins returning back to historic levels. Moreover, consensus forecasts in the next 12-24 months do not expect much, if any, rebound in margins. Thus, the low future margin expectations create an opportunity for a potential advance in the share price if margins can show any meaningful rebound. The transition in senior management with Michael Durney taking over as the new President & CEO in Q3 could set the stage for some positive changes at the Company. While I do not expect major changes to the DHX’s major strategic initiatives under Mr. Durney has leadership, he has spoken about such things as instilling a sense of urgency at the Company and getting better at product development.

Attractive Valuation On Both An Absolute & Relative Basis: The shares of DHX have not only not participated in the overall market rally during 2013/14, but have significantly declined in absolute terms over this period. Since the beginning of 2013, the shares of DHX have declined approximately 24% (and are off ~30% from their high), while the S&P 500 has gained about 24%. The drop in the share price of DHX reflects the declining profitability of the Company (impacted by the weak revenue growth and the strategic investments being made) and competitive concerns from social media companies, especially Facebook and LinkedIn. During this transition period in the Company’s financial model, DHX has lost just about all of its support from the sell-side. My understanding is that only one of eight sell-side analysts following the stock has a soft buy rating (“Accumulate”) on the shares. Tied to this transition, it appears that more growth oriented and traditional internet technology investors have fled the stock. With expectations so low and some signs of stabilization in industry headwinds, I believe that the decline in the share price has created an opportunity for value oriented investors with longer term time horizons to purchase the shares at attractive levels.

Given the Company’s deferred revenue financial model, I believe it is most appropriate to value the shares on EBITDA and FCF. Based on ttm depressed results in FY 2013, reflecting the strategic investments the Company is making, the shares are currently trading at a EV/EBITDA multiple of 7.2x and a FCF/EV yield of ~9.1% when adjusting for one time items, interest and temporary changes in working capital. Based on Cap-IQ consensus forecasts for 2014, the shares are selling at a 6.3 multiple of EBITDA. I believe this is an attractive valuation for the shares of DHX on an absolute basis when you consider the Company’s high ROIC financial model. On a relative basis it is noteworthy to point out that DXH’s business model has among the highest returns (EBITDA/revenue margins and RIOC) and most attractive valuations ( EV/EBITDA multiple and FCF/EV yield) among the broad group of job recruiting comparables. The analysis below illustrates this returns/valuation disparity, which is why the shares have recently been a consistent name on the “Magic Formula” list.

Risks:

• A further decline in margins
• Market share losses to social media, or horizontal focused companies
• Weakness in the economy, which pressures employment growth and turnover
• Pricing pressures from competitors
• Declines in renewal or retention rates
• Difficulties in integrating recent acquisitions
• Recent insider stock sales

Catalyst

• Signs of inproved job growth
• An increase in organic growth rates
• Increased ASP's or improved renewal rates
• Signs of acceptance of OpenWeb
• Releasing new mobile apps
• Any indication that margins beginning to stabilize/improve
• Improved results from Slashdot Media
• An upgrade from any of the sell-side analysts