Description

Hudson Global is a worldwide provider of staffing and recruiting services with sponsorship from two major hedge funds and a stock that is significantly undervalued with respect to its peers. Despite being a mircrocap with only 33 million shares outstanding, Lone Star Value Management has accumulated 8.4% of the company’s common stock while Cannell Capital has accumulated 6.1%.  Both have been involved with the company for several years. The story begins in 2014 when a proxy fight led to the removal of then CEO and chairman, Manuel Marquez, in favor of a new board run and controlled by Lone Star’s Jeff Eberwein. Since that time, the company has sold off several assets worldwide, returned special dividends totaling $3.4 million to shareholders in Q1 and Q2 of 2016, and instituted a $10 million stock repurchase program, consistent with what you might expect from a board controlled by a large and savvy shareholder. Nevertheless, HSON stock has continued to decline from a high of $4 in 2014 to a low of $1 earlier this year, recently rallying to $1.37 where it sits today. Progress has been made in the turnaround of the company’s businesses, in the reduction of costs, and the selling of non-core assets, however they still have yet to turn cash flow positive, partly as a result of a significant slowdown in their China business and the effect on financial services firms of the United Kingdom’s Brexit vote.  As of today, the company has $423 million in 2016 revenues, $21 million in cash, revolver debt of $7.8 million, and at $1.37 per share, a market capitalization of roughly $45 million. The revolver debt is tied to growth in the company’s accounts receivable and will decrease as these receivables are paid, so I do not include it in the company’s enterprise value calculation. Similarly, a portion of the company’s $21 million in cash is earmarked for restructuring expenses and is also removed from the calculation. Therefore, I estimate the EV of the company at about $30 million, calculated by taking the market cap of $45 million and subtracting from this number $15 million of the $21 million in cash on the balance sheet, which represents an estimate of what will remain once the company turns cash flow positive. Comparable companies in the sector, both domestically and globally, are trading at EV to Revenue multiples averaging 0.6, which when compared to HSON’s multiple of 0.07, is 8.5x times higher, implying that HSON stock could see a very significant return – possible several hundred percent - should the turnaround in their business prove successful.

History

To understand why HSON stock has been declining since 2011, and why the company has had so many difficulties, it is important to understand the company’s history. Hudson was a spinoff from TMP Worldwide in 2003, which was better known to most of us as Monster.com. TMP made nearly 400 acquisitions in the HR and recruiting space in the late 1990s and early 2000’s of which 67 were eventually spun off as Hudson in 2003. Following 9/11 and the DotCom bubble burst of the early 2000’s, it became increasingly clear that the strategy of attempting to take-over the HR world through a massive acquisition strategy wasn’t going to work and the company began to look for ways of simplifying their portfolio. A new CEO was hired in 2011 with experience at Spencer Stuart who attempted to unify all the business segments into one single strategy, and in 2014 a proxy fight occurred resulting in a change in control at the board. The 5-person board now consists of Jeff Eberwein of Lone Star Value Management; Stephen Nolan, Hudson’s former CFO (now CEO); Ian Nash, an ex-Michael Page and Robert Walters operator; and Rick Coleman and Alan Bazaar, both of whom joined with Jeff Eberwein. The new board attempted to narrow the portfolio further and continued to divest businesses that were not core to their new strategic focus. The US Legal eDiscovery business was sold in November 2014 for $23 million; the US IT business was sold in June 2015 for $17 million; and the Netherlands business was sold in May 2015 for $9 million. Also in 2015, the company exited through liquidation its operations in Luxembourg, Czech Republic, Ukraine, Slovakia and Ireland.

In addition to their long history of lackluster financial performance which was a direct result of the company’s haphazard piecemeal formation, there was yet another event that contributed to the stock’s six-year decline. Sagard Capital, one of the company’s top three shareholders, decided to sell their entire position between the end of 2015 and December 2016.  Despite the company’s attempt to stem the selling by purchasing 25% of Sagard’s position in September 2016 and requiring them to agree to a 60-day lock-up on any remaining shares as a condition of the purchase, Sagard sold the remainder of their position in December immediately after the lockup expired. The stock’s final trip down from $1.40 to $1.00 appears to be a selling climax, unrelated to news events, and hopefully marks the low of the move.

Today

The company is now divided into three main geographic areas: Asia-Pacific, The Americas, and Europe.  Below is a list of countries in which HSON continues to operate in each of these geographic areas:

The company’s financial results in 2016 were not as dire as one might be led to believe from the performance of the stock. In fact, after a single glass of wine, one might be tempted to call them encouraging. Hidden at the bottom of the year-end press release are two tables (reproduced below) which compare results for 2015 and 2016 assuming constant currency and adjusting the 2015 results for discontinued operations – something that isn’t done in the GAAP presentations and which causes the financial results to look much worse than they actually are. From these tables we can see that, on a constant currency basis, adjusting for discontinued operations, the company grew revenues by 4.6% in the Americas, 9.1% in Asia-Pacific, and had total global revenue growth of 1.5%. Only their operations in the European segment dragged them down on a revenue basis, with revenue contracting by 7.7%, due almost entirely to their over-concentration in the UK financial sector and the downturn it experienced as a result of the Brexit vote. However, the company is actively diversifying away from its concentration in the UK financial sector and the effects of this one-time event should pass over time.

Another point of note is that the collapse of Hudson’s business in China, which had been growing at a 30% clip for several years in a row, did not cause an overall decline in total revenues year-over-year in its Asia-Pacific segment (although it did affect gross margins) because strong growth in other areas of the Asia-Pacific region, such as HK and New Zealand, offset the downturn in China. In fact, as mentioned in the latest conference call, the company showed strong growth in 9 of its 12 markets worldwide.

Had it not been for these two adverse events, Brexit and the downturn in China, it is likely that Hudson would have shown high single-digit or even low double-digit EBITDA for the year, which is a very different picture than what the stock might suggest.

One concern when looking at the 2016 financial results is the company’s consumption of cash. Excluding $5.1 million in cash used for stock buybacks, one-time dividend payments of $3.4 million, a settlement with the former CEO for $3.8 million (including legal fees), and restructuring expense of $4 million, the company still had negative free cash flow of approximately $4.4 million after accounting for capital expenditures of $2.8 million. While not enough to sink the ship, it is a long-term concern given the company’s small cash position of only $21 million, particularly if a world-wide recession ensues before the company has turned significantly cash flow positive.

China is another significant risk because the condition of Hudson’s business there is difficult to know with certainty. In addition to a contraction in hiring which affected all HR companies operating in the region, Hudson was badly damaged by the loss of their senior management who abandoned the company to form a competing firm, taking talent and clients with them. Hudson replaced this management team temporarily with a senior management team from Australia, however it remains to be seen if this business can be permanently stabilized.

However, even after taking these risks into account, a valuation in the $30 million range is far too low for a company with $423 million in revenues operating near break-even. This is not a company with collapsing revenues or which is facing imminent bankruptcy. In fact, on a constant currency basis, after accounting for discontinued operations, it’s revenues have been growing. Furthermore, if it had not been for two unfortunate events, largely outside the company’s control, the company would already be enjoying positive FCF. To be sure, there is no certainty the company will succeed in their turnaround effort, but as long as there is no world-wide recession on the horizon and cash burn remains low, there is time remaining for them to execute and not much needs to happen to earn a positive return on the investment.

Valuation and Upside

Hudson Global does not have positive EBITDA at the moment nor is its gross margin fully maximized. Therefore, the most meaningful and enlightening valuation metric, and certainly the easiest to calculate, is its EV to sales ratio relative to its competitors. Should Hudson be able to reach its potential, its gross margin and EBITDA margin should be reflective of its peer group, and as a result, it should trade in approximately the same range. Below is a list of the publicly-traded domestic and international staffing and recruiting firms in alphabetical order. The EV to sales ratios range from 0.2x at the low end to 1.8x at the high end.  Hudson has an EV to sales ratio of approximately 0.07x.

Those companies with businesses most similar to HSON are the UK and European-based recruiters, Robert Walters, Hays and Michael Page, which have an equally strong focus on permanent recruitment and whose operations span a similar range of geographic regions. Michael Page trades with an EV to sales ratio of 1.2x while Robert Walters trades at 0.3x. For the domestic group, the average EV to sales ratio is 0.62x whereas the average for the international group is 0.61x.  Should Hudson Global be successful in achieving EBITDA margins equivalent to its peers, and if the stock were to trade in line with the average of the group, this would imply a price of $8.25 per share for HSON common, which is an increase of 500% over its current price of $1.34.

 A Quick Note on NOLs

Hudson Global has approximately $400 million in NOLs. $100 million of these are domestic NOLs while $300 million are international NOLs.  Of the international NOLs, France, Australia, New Zealand and the UK make up about 50%.

Risks

Worldwide recession

China and UK business deteriorate further

Inability to turn cash flow positive

Catalyst

Stabilization of China business

Stabilization of UK business

A few quarters of positive FCF