Description

Saramin HR Co. Ltd.

Summary

This is a reactivation idea. Saramin is a South Korean recruitment platform growing at 11% 5-year revenue CAGR with 29% operating margin in 2019. Market cap of KRW294bn with KRW59bn of cash and virtually no debt. Strong cash generation with capex at 1-3% of sales and minimal working capital needs; EBIT to CFO conversion historically at ~100% or more. Following a sell-off after the pandemic hit earlier this year, the company now trades at ~7.8x 2019 EBITDA,~11.5x Price / 2019A EPS and a ~10.8% 2019A LFCF yield. Sell-side estimates expect company’s 2020E revenue to grow 4.7% while operating profit stays flat. Even in the worst case scenario where revenue and profits fall by 10% this year, it is likely to recover back to 2019 levels within the next one if not two years. South Korea’s economy has fared much better than other countries in this pandemic given its aggressive containment measures early on and tech industry resilience, with 2020 GDP growth projected to contract by just 2.3% and unemployment to rise from 3.8% at year end 2019 to 4.5%. Large fiscal stimulus by the government will also likely boost hiring for both public and private sector players this year.

Company Overview

SaraminHR is a South Korean recruitment platform that was launched in 2005 and has since grown to become the market leader. The company consists of an online job search and matching platform and an offline outsourcing and headhunting platform. The online platform makes money in a few ways:

1. Online job search and matching platform

1.  Advertising – charge a weekly fee to display an ad, text ads and resume database (90% of this segment)

2. Recruitment Solution – basically a HR service for large companies to establish personality testing systems and written exams to ensure fairness / no corruption

3. Talent Market – acquired a small talent market company in 2015 called O2Jobs and is the #2 player in C2C transactions

2. Offline outsourcing and headhunting platform

1. Talent dispatch / outsourcing – get paid 6-8% of employee salary

2. Headhunters – get paid 15-20% annual salary

The online matching platform made up 72% of revenue in 2019, of which advertising was ~90% of that, while offline made up 28%. The online matching platform has operating margins of ~25% while the offline platform’s margins are low at 1-2%, so online makes up >90% of profits. 

Historical Performance and Industry Development

The online platform has grown healthily in the last 10 years (22% revenue CAGR from 2009 to 2014) due to steady investment in its technology and platform and missteps at its competitors. Until the early 2000s, Incruit, Scout and JobKorea led the market, with JobKorea being #1 in 2005 when Saramin launched as the 6th/7th player. Yet over time, after JobKorea was acquired by Monster Worldwide in 2005, Monster underinvested in the company, instead paying out a large chunk of profits as dividends and focusing on capital return. In 2013, private equity firm H&Q bought a 49.9% stake in JobKorea and bought out the remaining stake in 2015 to become its sole owner. We think that these management distractions coupled with Saramin’s continued investment in its matching technology and user interface allowed it to overtake JobKorea to become #1, with JobKorea #2 and Incruit a distant #3. One proxy of market share is Saramin’s matching platform revenue as % of the domestic online matching market, and that has grown from 6% in 2009 to 24% in 2019.

Over the years, the market has consolidated as some of the smaller players like Findjob and Scout have exited the market. In 2015, Saramin started to raise its advertisement ASPs for its base product and launched a premium service product and has continued doing so over time since then. Together with volume growth, the online platform revenue has grown at a 16% CAGR from 2015-2019.

The cost structure of this business is relatively fixed, with R&D expense, marketing/advertising and labor expense being the main cost buckets. As a result of this operating leverage, operating margins have expanded over time from 9% in 2009 to 15% in 2015 to 29% in 2019. Since the appointment of a new CEO in March 2018, the company has scaled down plans to diversify into big data-related businesses and refocused on core operations, keeping expenses in check. While not much detail was given on those potential big data-related businesses, we take it as a positive that management stays focused on strengthening the core business and does not pursue growth into other areas blindly. Management has also rationalized marketing spend in recent years given its dominant position in the Korean market, with marketing costs falling by 30% from 2017 to 2018 and a further 27% in 2019 - one of the reasons for the operating leverage.

Cash Generation

The company has generated steady free cash flow in the last few years. Capex is low at ~1-3% of revenue annually. Working capital needs are also minimal. As a result, free cash flow has grown from KRW2bn at the beginning of the decade to KRW25bn in 2019. There was a KRW12bn cash outflow in 2018 related to a lawsuit between JobKorea and Saramin where Saramin was found to have crawled resume data from JobKorea and had to pay a fine. We think Saramin has learnt from this lesson and instituted greater control on their practices so this should be a one-off event. Other than that, CFO has consistently been ~100% of EBIT or higher (D&A was KRW2.8bn in 2019 so not that large), showing strong cash generation. See below charts for figures.

Valuation

I will begin by using showing what valuation multiples look like using 2019A numbers, before assessing what valuation looks like based on forward multiples in light of the pandemic impact.

Financial Projections and COVID-19 Impact

While the pandemic will definitely have an impact on Saramin’s performance this year, we think that Saramin will be able to get through it and resume growth on the other side. There are a few data points that can help us to range bound the potential scenarios. 

• Sell-side analysts are projecting revenue to grow by 4% in 2020, with operating profit flat and EPS declining by 6%. Moreover, pre-pandemic, sell-side analysts expected the company to grow revenues 15-20% per annum based on a market share consolidation and ASP growth.

• Saramin reported 1Q 2020 earnings in May and saw its revenue grow 4.4% yoy, with its matching platform revenue growing just 1.7%. 

• Keep in mind that the pandemic hit South Korea the hardest in the first quarter, with infections peaking on March 1st and down significantly by March 30th. Nevertheless, aggressive containment measures without lockdown measures coupled with its resilient tech sector has helped(2) South Korea fare better than other countries. Overall, macroeconomic forecasts peg South Korea’s GDP to contract by 2.3% (1) in 2020, while unemployment is set to rise 3.8% at the end of 2019 to 4.5% at the end of 2020(1) - these are significantly better statistics than projected for the US.  

• The Korean government has also announced significant stimulus, with plans to create 1.56mm jobs mainly in the public sector, including 550,000 regular positions in the public and private sectors. As such, Saramin’s HR consulting services for public agencies should see a recovery in Q3 2020. 

It’s hard to say how long the lingering effects of the pandemic will last and how South Korea’s economic recovery will look like. But we think there will likely be a gradual recovery from 2021 onwards and that companies will resume their hiring. Our model projects revenue to fall by 10% in 2020 (vs 4% growth for consensus), then recover from 2021 onwards. Under this scenario, it takes the company 2 years to recover back to 2019 levels. Beyond 2022, the company continues to grow at HSD levels moderating to MSD. 

We think this will likely prove very conservative. Pre-pandemic, sell-side analysts expected the company to grow revenues 15-20% per annum based on a market share consolidation and ASP growth. Unless you think the pandemic is permanently going to hurt the Korean economy (we think a very unlikely scenario), we think the company can likely grow revenue at 10% per annum, even if not back to the 15-20% trend.

In terms of margins, we assume the company cuts operating expense by 3% through cost-cutting measures and holds that flat until 2023, when the economy recovers and company returns to revenue growth. Margins thus fall to 22.5% in 2020 while recovering to 2019 levels of 29.2% by 2022. In the longer term, the company starts to enjoy some operating leverage again. In this situation, LFCF yield is depressed in 2020 at 5.5% but recovers to 8.0% in 2021 and continues to grow from there.

Returns Analysis

Given the company’s dominant market share and organic growth outlook, we think this company should trade at a more than 9x TEV / normalized EBIT multiple. 

One reference point is in 2015 when Monster sold its remaining 50.01% stake in JobKorea to H&Q Korea. As they disclose JobKorea specific revenues under their discontinued operations disclosure that year, we can get a sense for what valuation H&Q paid. Annualizing 9M2015 pre-tax earnings implies that H&Q paid US$170mm on $11.3mm of pre-tax earnings, or ~15x pre-tax earnings multiple(3). Based on this as well as the company’s historical valuation range, a TEV / EBIT multiple of 12x should be reasonable. Over a 5-year horizon, this should yield a 2.0x MOIC and ~15% IRR, with significant room for upside should things go better than expected. Given the large cash position and virtually no debt, there is also limited credit risk involved.

Reasons for Mispricing

1. Small cap Korean stock with limited research coverage

1. US$244mm market cap not suitable for large cap funds

2. Only 1 broker covers the company

2. Given the economic problems caused by the pandemic, recruitment / job platform companies have been shunned by investors and multiples have contracted significantly. 

1. While this is valid and appropriate for mature job platform companies, Saramin’s organic growth trajectory coupled with South Korea’s relative macroeconomic performance means that we should not lump it together with all the other recruitment comps (Robert Half, Randstad etc.)

Risks

1. South Korean economy is permanently impaired by the pandemic and takes more than 3 years to recover back to 2019 levels

1. We think the likelihood of this is very low as explained above given its current economic performance

2. Competitive landscape becomes more competitive again and forces company to spend more on marketing

1. Given that the market has become more rational and oligopolistic in recent years, we think there is unlikely to be a reversal in this direction.

2. Moreover, JobKorea is controlled by a PE firm who needs to exit the investment at some point and they will likely pursue the path of profitable growth instead of trying to start a price war which helps no one.

3. Capital allocation

1. While dividend payout is not fantastic, the company has had a 25% payout ratio for the last two years and has attempted to repurchase shares in the past. 

2. On the plus side, the company has not wasted any capital on expensive side projects or overpaid for acquisitions

Catalysts

1.       Recovery of South Korean economy and improvement in market sentiment

Sources

1. http://english.hani.co.kr/arti/english_edition/e_business/953785.html

2. http://www.koreaherald.com/view.php?ud=20200716000084

3. https://www.bamsec.com/filing/102041615000110?cik=1020416 (3Q 2015 10Q, Pg 10) 

Catalyst

Recovery of South Korean economy and improvement in market sentiment