Description

Heidrick & Struggles International (NasdaqGS:HSII, “H&S” or the “Company”) is a long. H&S is a leading global provider of executive search and consulting services to businesses. The Company was founded in 1953 and is headquartered in Chicago. LTM financials (as of 6/30/20) were $679mm revenue, $193mm gross profit (28% margin), $70mm EBITDA (10% margin), $61mm EBIT (9% margin), $6mm of capex, and $70mm of levered FCF (17% LFCF yield). While HSII is not a great business, the stock is down 35% YTD and we believe it’s priced attractively on an absolute basis and relative to its historical trading multiples and the comp set. We believe the stock’s fair value is $30, representing 40% upside.

The Executive Search (“ES”) segment represents 91% of total sales (Americas is 59%, Europe is 19% and Asia Pacific is 14%), with the remaining 9% of sales coming from the consulting segment. The Americas ES business is by far the most profitable business, generating a 24% EBIT margin and $101mm of 2019 EBIT. The Asia Pacific ES business is the second most profitable, generating a 14% EBIT margin and $14mm of 2019 EBIT. The Europe ES business is not very profitable, generating a 5% EBIT margin and only $3mm of 2019 EBIT. Lastly, the consulting business is not profitable, generating a -29% EBIT margin and -$19mm of 2019 EBIT. The consulting business has consistently lost money over the past several years. In contrast, the Americas ES business could be called the Company’s crown jewel given it has consistently generated a low to mid 20s EBIT margin for the past 5+ years and generates the majority of H&S’s profits.

The Company’s exposure by industry (based on percentage of billings) in 2019 was 26% financial services, 21% industrial, 21% global technology & services, 17% consumer markets, 12% healthcare and life sciences, and 3% education, non-profit and social enterprise.

H&S’s Q2’20 revenue was down 15% compared to Q1’20 and 16% relative to prior year. Q1 revenue was in line with prior year. Q2’20 Adj. EBITDA of $12mm (8.5% margin) was down 48% compared to prior year and 1H’20 Adj. EBITDA of $36mm (11.4% margin) was down 19% compared to prior year.

One concern bears have is how will executive level hiring occur in a virtual world? We think companies are coming around to the idea of not only extending work from home policies but also interviewing virtually via video calls. While companies would prefer to have in-person interviews, what we are hearing is in many instances, companies are okay interviewing virtually, so long as the final round is held in person. Given offices around the country are starting to open back up, we think executive level hiring will increase as companies get more comfortable with the predominantly virtual interview process and their own hiring needs ramp up.

Analyst consensus estimates for 2020E are $589mm revenue, $63mm EBITDA, $44mm EBIT, and $1.41 EPS. Analyst consensus estimates for 2021E and 2022E generally assume similar earnings to 2020 which could prove conservative.

Current trading multiples off 2019 are 3.3x EBITDA, 5.6x EBIT and 9.0x P/E. Trading multiples off 2020 are 5.4x EBITDA, 7.7x EBIT and 15.3x P/E. We focus on EBITDA and EBIT multiples rather than P/E given HSII has a $79mm net cash position ($209mm debt vs. $288mm cash) which may not be picked up in the P/E multiples (which could therefore appear inflated). The Company’s 10-year average LTM EBITDA multiple is 6.2x, suggesting HSII is trading at a 47% discount to its historical average multiple (or a 13% discount using 2020E EBITDA).

In comparison, the public comps (Korn Ferry, Manpower, Kelly Services, Robert Half, and TrueBlue), while generally being larger scale and more diversified, actually have margins in-line or worse than HSII. Nonetheless, these comps trade at median multiples of 9.2x LTM EBITDA (vs. 3.3x for HSII), 11.5x LTM EBIT (vs. 5.6x for HSII) and 11.7x NTM EBITDA (vs. 5.8x for HSII). Therefore, we believe HSII is trading at attractive multiples on an absolute basis and on a relative basis (both relative to its historical long-term average multiples and relative to the comp set).

HSII is capex light and generates significant levered FCF. Management has stated they would like to increase their presence in the consulting space primarily through acquisitions. FCF could be used for accretive acquisitions at this point in the cycle. That said there is risk with the execution of an acquisition strategy, and our preference would be to see the majority of FCF returned directly to shareholders through dividends and buy backs. HSII currently offers a 2.8% dividend yield which we believe could be boosted, and the Company has historically bought back an immaterial amount of shares (<1% of the share count each year).

Catalyst

• Macro continues to improve, resulting in increased hiring
• Cost saving initiatives are successful
• Management does something shareholder friendly with the net cash position, such as a large dividend or buyback