Description

A short in MNST provides the opportunity to profit from a highly cyclical company parading as a GARP investment. Trading at 25x peak earnings and 10.6x peak EBITDA (GAAP), with multiple near-term catalysts that should begin to play out as early as next quarter, MNST has plenty of room to go, even if the path down is a bit rocky. Despite buyout rumors, an excellent story, obvious long-term favorable trends, and an across the board consensus by analysts that MNST will continue to grow EBITDA in the teens for the foreseeable future (despite what mr. market is hinting), people tend to forget that, in actuality, MNST is a highly cyclical business with the same economic sensitivity that all perm placement staffing companies experience. MNST is likely to experience write-downs and margin compression as the job market continues to worsen, and as its incredible operating leverage begins to work in reverse (small declines in revenue disproportionately hurting the bottom line), causing an eventual overreaction to the downside that could, in a couple years time, make this a very attractive long. This dynamic played out in the last recession (when MNST had better growth prospects than today), and will be even worse this time. For those of you who read my HSII write-up, I view MNST as a higher risk, higher reward play, despite already being down substantially in the past few months.

Like that short, this one relies on the broader macro thesis that the US is likely to experience, at the very least, a brief recession, and that job growth will likely remain sluggish for at least a couple years, even if the recession itself is relatively short.

Countering the bull story:
Online job postings are increasingly replacing classified ads as the most popular way to recruit employees. The story was new and hot five years ago, but things are no longer as they used to be, though you wouldn’t know by listening to the bulls. Niche sites have already begun to chip away at MNST’s US share as the US market has matured. Career builder, with the backing of MSFT and a consortium of newspapers, has now surpassed MNST as the #1 job site in terms of revenue, and its backers have been pouring money into development. Longer term, social networking sites like Facebook and Linked-In, as well as vertical search sites like getthejob.com, pose real long term threats to Monster’s business. These businesses offer significant advantages to the MNST/Career building model; the threat of a game changer is a real one.

As the world continues to become better connected, and our networks expand, job boards like MNST that match strangers with one another become less and less valuable. Anyone who has looked for a few jobs will tell you that applying through a form is mostly worthless, and if you talk to employers who try to recruit off MNST, you’ll likely hear the same thing (lots of quantity, not much quality). In fact, much of MNST’s business is derived from headhunters, and if you need any indication about what’s in store for them, take a look at my HSII write-up.

I believe there is a real chance that MNST, at least in its current iteration, goes the way of Infoseek, Altavista, or your favorite obsolete internet site at some point in the next several years, but none of that is central to my thesis here. I mention it to counter some of the prevailing bull arguments. The other two main bull arguments (buyout and international growth) I will counter later in the write-up.

Explaining the cyclicality:
MNST is a mostly fixed cost business whose revenues are directly tied to the number of job postings sold and the average price received per posting. These two factors themselves are largely driven by the health of the overall job market. When the job market tightens, recruiters and companies have more jobs to fill and more difficulty finding talent; often, they are relatively price insensitive and are likely to post a higher portion of their jobs to the public, and a higher proportion of those on multiple sites. If you are a recruiter who stands to make $25k from a placement, for example, posting on multiple jobs sites is a no-brainer. Margins and revenues at MNST rise, and incremental revenue falls almost entirely to the bottom-line. As the job market turns, companies have an easier time finding talent (they are more likely to know someone they trust who needs a job) and when they do post a job online, they are less likely to post on multiple sites and will be more price sensitive, further driving down listings, and potentially prices, too. Revenue drops, margins compress, and the writedowns arrive.

Despite being relatively early in its adoption curve in 2001, this impact was felt hard in the last recession. Back then, MNST was bundled in with a variety of traditional staffing and advertising businesses. Breaking out MNST revenue, we see MNST experienced a shock to operating performance:

	2000	2001	2002	2003	2004
MNST Rev	$379	$534	$402	$413	$516
YoY Rev Growth		41%	-25%	3%	-25%
Rev drop from 2001			-25%	-23%	-3.3%
Restructuring			-$49	-$29
EBIT margin		28.6%	6.1%	12.8%	19.7%
EBIT		$153	$25	$53	$102
EBIT Growth			-84%	115.4%	92.7%
EBIT Drop from 2001			-84%	-65.3%	-33.2%

Note the severity of the margin decline on the relatively small revenue drop. EBIT did not recover in absolute terms until 2005, four full years after peak earnings were reached. Revenues took 3 years to ratchet back up. And keep in mind, by unemployment and duration standards, that was a relatively weak recession. When you combine that with a more mature US biz, things could look evenly uglier this time around, but they don’t need to for this short to work.

MNST’s becomes a growth company again
With revenue on the rise and all the internet analyst from 2000-2002 fired, a wave of amnesia struck wall street. As MNST shed its traditional businesses and the economy recovered, MNST once again became a growth darling. Margins expanded, revenues rose, management cashed out their cheap options. Even as North America revenue has stalled (even before the employment picture turned south), analysts turned their attention to the international growth story. Here are the financials from the recent cycle uptick, by segment:

	2004	2005	2006	2007E
Revenue	$594	$818	$1,117	$1,343
Monster NA	$406	$522	$658	$708
Monster Int	$111	$187	$306	$475
Int Ad Fees	$78	$110	$152	$160
EBIT	$70	$141	$230	$243
Monster NA	$104	$171	$227	$238
Monster Int	-$2	-$7	$17	$45
Int Ad Fees	$20	$34	$45	$20
Corporate	-$52	-$57	-$60	-$60
NA EBIT Margin	25.7%	32.8%	34.5%	33.6%
Int EBIT Margin	-1.9%	-3.9%	5.7%	9.5%

Despite all the hooplah, MNST ‘s North America business has grown its revenue an estimated 51% peak to peak, for a CAGR of 7%. EBIT growth peak to peak for the NA business is about 56% peak to peak, or a 7% CAGR. Also, NA margins have stalled. This is increasingly looking like a low growth to declining business once you strip out the cyclicality.

The real growth story here has been the international business, though its still more a revenue story than a profit one. MNST still relies on NA for nearly all its income (note, mix is pre-corporate expenses):


EBIT Breakdown:

	2004	2005	2006	2007
Monster NA	85%	87%	78%	78%
Monster INT	-2%	-4%	6%	15%
Int Ad	16%	17%	16%	7%

Although the revenue growth has been nice in international, EBIT is still driven almost entirely by NA operations. Without the income from NA, MNST would barely cover their corporate costs on an EBIT basis.

There are also reasons to believe that margins internationally will have trouble rising, and may even drop as the US employment picture worsens. A good chunk of that international revenue comes from developed European markets that are facing a lot of the same issues we are in the US. At the same time, all the China plays are investing heavily to capture market share there, which should hamper margins in the near-term. Also, scale is a bigger problem abroad, as the majority of the most attractive markets do not allow MNST to leverage its fixed costs to the same degree they can in the US. The exec recruiters have faced the same issue here as well. MNST has also made it clear that they intend to grow the international business to maximize revenue and share rather than margin for the near-term. While this could be a positive long-term it won’t help when margins in the US begin shrinking. And even if MNST was able to grow international margins despite the headwinds, they’d have to improve far above current levels to make up for a shortfall in US income.

When will margins begin falling, and how low can they go?
MNST is a leaner company than is was in 2001, but it still suffers from a high portion of fixed vs. variable costs which make it prone to a sharp contraction in margins. More specifically, sales productivity is hit hard in downturns. You still need sales staff to sell new/existing customers, but all metrics (conversion, $/client, etc.) are lower than they are in good economic times Management recently announced a $80M restructuring in North America, should help some, but they also noted that $40M of that would be plowed into the international business, so it’s unclear home much benefit will be achieved net-net.

MNST typically sells its highest volume customers (e.g. recruiters, corporations, etc.) one year posting packages, so its revenues drop more gradually than they do at KFY and HSII who, by comparison, book the majority of revenue over 3 months. That’s one of the reasons MNST peaked a little bit later in the last cycle. This time around, however, MNST has actually seen revenue growth peaking ahead of the exec recruiters, perhaps suggesting that prior cyclicality was masked by the more favorable industry trends at that time.

Though NA EBIT margins may not decline to the levels we saw at the last trough (6.1%), it won’t take that much of a margin decline for earnings to collapse. I do expect that we’ll the top-line drop more this time around. I don’t have a specific target for revenue or margins, but a quick sensitivity table should give you a sense of what would happen to EBIT given some assumptions:

EBIT Sensitivity (% decline over 2007E EBIT of 243M)

		NA Rev Growth
		-5%	-10%	-15%	-20%	-25%
	30%	-0.3%	-4.7%	-9.0%	-13.4%	-17.8%
	25%	-14.1%	-17.8%	-21.4%	-25.1%	-28.7%
NA Margins	20%	-28.0%	-30.9%	-33.8%	-36.7%	-39.6%
	15%	-41.8%	-44.0%	-46.2%	-48.4%	-50.6%
	10%	-55.7%	-57.1%	-58.6%	-60.0%	-61.5%

I assume International EBIT margins rise to 12% in 2008 and revenue growth jumps 35%, which is generous considering economic conditions internationally, and relatively higher fixed cost base there. I also price in a little rebound for the ad biz. It is likely, in my opinion, that we would actually see international margins turn negative is economics abroad slowdown as well, but I chose 12% margins to be conservative. In the worst case scenario pictured here, which may very well end up being conservative, EBIT would drop upwards of 60% from FY07e.

MNST has some cash which, like KFY and HSII, they have been wasting on buying back their own expensive stock and expensive international businesses. These practices should continue to destroy value and erode the cash cushion, gradually eliminating the margin of safety

It’s clear from the above numbers that EBIT has a lot to fall if the thesis plays out. Since almost no one on the street is modeling the margin compression story, I expect that MNST could get awfully cheap, as it did in the last recession, which brings us to one of the big bull arguments…

Will MNST be bought out?
I have no special insight into the rationality of other market participants, but I think a buyout is relatively unlikely. Many of the likely candidates already own an internet job board (YHOO owns hotjobs, bunch of newspapers and Microsoft own Career Builder). GOOG wouldn’t buy them, either. There are a handful of others who might bid, but unless something happened soon I don’t think a buyout is likely once NA margins collapse. Management understands this is a cyclical business, and as with most cyclical businesses, management makes a killing from options that are issued at the bottom of the cycle. They will also find, with the depressed operating metrics and share price, that it makes no sense to sell as the cycle is on its way down. As the chart of any cyclical business indicates, it rarely is wise to sell the company on depressed earnings and in an unfavorable environment unless you have to.

Risks:
-History does not repeat itself
-NA margins defy gravity
-International saves the day
-Buyout in the next 3-6 months
-Employment bounces back more quickly than history would suggest

Catalyst

Declining North America margins and revenue, slowdown in International growth, stagnant or declining International margins, increased competition, downward analyst revisions, continued weakness in monthly MEI numbers.