Description

Korn Ferry (NYSE:KFY, the “Company”) is misunderstood by the market and a long. Korn Ferry is a leading provider of executive search and consulting services to businesses. The Company was founded in 1969 and is based in California. LTM financials (as of 10/31/23) are $2.8bn revenue, $611mm gross profit (22% margin), $325mm EBITDA (12% margin), $280mm EBIT (10% margin), $65mm of capex, and $236mm of levered FCF (8% LFCF yield).

While KFY is up 17% YTD and has had a recent run up, the stock remains 30% below its 5-year high from late 2021 and we believe is 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 $89, representing 50% upside.

In terms of business overview, Korn Ferry has five segments:  Consulting, Digital, Executive Search, Professional Search & Interim, and Recruitment Process Outsourcing (RPO). Below is a description of each business:

• Consulting provides consulting services primarily around organizational and talent needs (24% of revenue, 16% EBITDA margin)
  • This segment competes with consulting firms like McKinsey, Willis Towers Watson and Deloitte
• Digital provides technology-enabled performance management tools (13% of revenue, 28% EBITDA margin)
  • Competitors include AON, Mercer, and Willis Towers Watson
• Executive Search helps companies recruit board-level and C-suite executive and general management talent (31% of revenue, 24% EBITDA margin)
  • This segment competes with other executive search firms like Egon Zehnder, Heidrick & Struggles, Russell Reynolds and Spencer Stuart
  • During Covid, investors were concerned about how executive hiring would occur in a virtual world. Now three years post Covid, we’ve seen that hiring can be successfully done virtually even at the more senior levels (supplemented by in person interviews when needed), so in our view this is no longer an impediment on the stock / broader recruitment industry (not to mention the fact that many firms are back in office)
  • While this segment is one of the Company’s highest margin segments, it’s more cyclical than the steadier businesses like consulting and digital
• Professional Search & Interim helps clients source middle and upper management employees (18% of revenue, 22% EBITDA margin)
  • This segment primarily competes with firms such as Robert Half, Michael Page, Harvey Nash, Robert Walters and BTG
• RPO provides recruitment outsourcing solutions (15% of revenue, 12% EBITDA margin)
  • Competitors include Cielo, Alexander Mann, IBM, Allegis and Kelly Services

10 years ago Executive Search comprised ~70% of Korn Ferry’s sales. I’ve worked with Korn Ferry’s Executive Search practice before and had a very positive experience. KFY has a great reputation in the industry. That said, while this is a solid EBITDA margin business (20%+), it’s cyclical and during the GFC saw its revenues decline ~30%. Coupled with negative operating leverage, EBITDA for this segment declined more than 50% during the GFC, which is mitigated in part by the Company’s net cash position. The executive search business is often viewed as a commodity offering in the industry, yet we believe a competitive moat exists for long-established players like Korn Ferry.

Over the past 10 years, the Company has done a nice job diversifying its revenue streams into less cyclical segments like consulting and digital, which together comprise ~40% of sales currently. In comparison, Executive Search has declined from ~70% of sales 10 years ago to ~30% of sales. This is a massive shift in the Company’s business model that we believe is underappreciated by the street, in part due to KFY not being a well-known stock (for example, this is the first time KFY is being posted on VIC).

Despite this shift, the Company’s current trading multiple of ~7x LTM EBITDA is actually a discount to KFY’s 10 year average trading multiple of ~8x. In comparison, we believe KFY should be trading at a 9x multiple based on our SOTP analysis and given its significantly greater scale and diversified revenue mix versus 10 years ago.

Public peers (e.g., Robert Half, Cognizant, Accenture, Booz Hamilton) trade anywhere from ~10-15x, recognizing some of these are larger peers and should trade at a premium to KFY. KFY also has low capital intensity and a strong FCF profile, much of which is used on dividends and share buybacks. For instance, the Company recently increased its dividend by 83%.

We forecast FY2025E (year ending 4/30) revenue of $2.9bn and EBITDA of $464mm. At a 9x EBITDA valuation, this implies a target share price of $89, which represents 50% upside to the current share price.

Risks include (i) economic recession, which would impact revenue and in particular margins / earnings given negative operating leverage (mitigated by net cash position) and (ii) ability to successfully integrate acquisitions.

Catalyst

• Broader economic recovery from lower inflation and rate cuts results in greater hiring and consulting activity
• Recent headcount reductions result in cost savings and margin improvement