Key lessons:

  • Even with a special situation or potential catalyst, make sure the fundamentals of the business are strong – protect your downside.
  • Don’t judge a business before making your homework.
  • Make sure you apply the right models to the right type of business.

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Behind every investment, there’s an interesting story. Here’s the story of Zhaopin.

Towards the end of my MBA in 2016, I was at Columbia Business School in New York and started exchanging a few emails with a young alumnae based in Hong Kong, named Jay Ju. Jay is a great investor and applies a very high level of intellectual rigor to his investment process. His strength lies particularly in value investing and special situations. He focuses mostly on Asian equities and as a Korean he knows that specific market inside out (including the soju that comes with it!). As we had a lot in common in terms of investment philosophy, upon my return to HK, I decided to intern with Jay for a few months. At the time, he was working out of a hip shared office space in Kennedy Town, which is about 15 minutes from Central district. It was quite a change from the usual cubicle and I found the environment rather stimulating.

Even before I started working with Jay in HK, he mentioned a Chinese company to me named Zhaopin (ya I know, it might not be the easiest one to pronounce), listed on the NYSE (stock code: ZPIN) with a current market cap of over US$1 billion. I didn’t think much of it at first, but decided to go with it and have a more in-depth look at the company. I conducted a full-blown analysis in the fall of 2016 and ended up investing in the stock. Let’s see how it’s turned out and what’s next…

In short, Zhaopin operates in the recruitment and career-related services industry in Mainland China. It offers services mainly via an online platform, complemented by a few offline services. The company is taking advantage of the increasing penetration of the online segment of the industry as compared to the offline part. The main service category offered is the online recruitment services which accounted for approximately 85% of gross revenues for the financial year 2016 (ended June 30th). The other services provided are campus recruitment services, assessment services, and other human resources related services. In terms of average daily unique visitors, Zhaopin is the most popular career-focused website in China and it is second in terms of revenues, after 51job, its main competitor. Zhaopin was incorporated in 1999 and listed in June 2014.

The next question is: how do they make money? Zhaopin mainly generates revenues from companies who post jobs and display advertisements on their platform. Job-seekers do not pay to use the platform and this is an important point to consider, not only for Zhaopin but for all similar companies – it’s a derivative of the many mental or business models which can be used and applied (Charlie Munger is a big fan of these, go ahead and google it, it’s fascinating). For traditional businesses, the end user would normally pay the bill, but not in this case. In this situation, you want to attract as many eyeballs as possible and let the advertiser pay. It took me some time to understand this point as I am not very tech savvy and this applies to many Internet-related businesses. A critical objective of the company is to create and maintain a major ecosystem where companies and job-seekers are drawn to Zhaopin’s platform as it is the best and most comprehensive out there. Companies must have access to the most appropriate candidates while paying a reasonable price, while job-seekers must be able to find jobs using the platform. Most of the time, Zhaopin’s customers pay for services in advance, which is a very attractive model in terms of cash flow generation. Wouldn’t it be great to get a paycheck before even starting to work? That’s exactly how Zhaopin charges its clients.

Because of the nature of the business, the marginal cost of posting one additional job ad is very low – which is not the case for offline recruitment services. Therefore, once the platform and ecosystem is in place, the business can afford to offer highly attractive prices to its customers and generate very interesting profit margins. At this stage, Zhaopin is still working on growing its ecosystem and has a relatively low take rate. According to a survey conducted by the company, employers are willing to pay the equivalent of one month salary to fill a job vacancy. At this point, Zhaopin charges only about RMB 30/job posting and RMB 20-40/resume download and estimates that customers spend only ~5%-10% of their total hiring budget on the services provided by Zhaopin. So there’s a lot of room for growth left and this is without mentioning the low penetration rate in China.

What does it cost to run such a business? Mainly, it’s all about marketing expenses. For Zhaopin it represents over 50% of net sales, which is significant. Zhaopin relies on its field salesforce (about 3,600 representatives covering over 250 cities in China) to acquire customers in cities and regions where they operate and use their two call centers (in Bejing and Suzhou) to reach out to customers in cities or in regions where they don’t have an office.

In terms of market, the online recruitment sector in China is fairly concentrated. The two major comprehensive online recruitment platforms are Zhaopin and 51job. Other players are more niche, focus on a particular vertical or are general classified websites. Based on discussions with people involved in the industry, besides Zhaopin and 51job, there is no real disruptor. As consistently mentioned by the management of Zhaopin over the years, the objective of the Company is to grow its top line and enlarge its online ecosystem. This focus has led to higher marketing expenses compared to its competitor 51job. On the other hand, 51job has recently been focusing on improving its ARPU and increasing cross-selling efforts, however this has been done to the detriment of the growth of its ecosystem, which might not be beneficial in the long term. One of the main risks identified for a business like Zhaopin, operating in a two-player industry, is the risk of a marketing (or other) war between the two, which could ultimately hit profit margins. However, the China market is extremely large and still very young and there probably is space for at least two main players, or more. As the market matures for this type of services, Zhaopin and 51job will find ways to differentiate themselves. It doesn’t mean both will be equally good though.

Besides company and industry specific factors, there was something else that made this company an interesting target – a potential catalyst. In fact, the company received not one, but two take-private offers during the first half of 2016. One offer was made at US$17.50/ADS (one ADS is equal to two shares) and the other at US$17.75/ADS. At the time of my report, the price per ADS was approximately US$15.50. As several of these take-private transactions of Chinese companies have failed in the past, many doubted that these offers would ever materialize and so the share price was still way below the prices offered. Transaction or not, to me these two take-private offers showed that there was a strong interest in the company and an indicator that the stock price was possibly lower than its intrinsic value (especially when considering the parties involved in the take-private offers).

So, in summary, here we had what appeared to be a great company, with huge room for growth and a potential catalyst in the short term. But was it fairly priced or even cheap? I will spare you the detailed calculations, DCF and reverse DCF models, but in short what I found out was that the intrinsic value of Zhaopin was much higher (>45%) than its stock price at the time. Based on my analysis, it seemed like the market was totally ignoring the huge potential of the firm in terms of growth, its leading ecosystem, its pricing power, and potential margin increases. So after finalizing my analysis, I decided to invest and got in at a price of around US$15.00/ADS. It’s important to highlight that even though there was a potential short-term catalyst affecting the dynamic of the stock price, I would have never bought the stock based only on that factor. Even with a strong catalyst, I’ll always be looking for a business with strong fundamentals and market potential. Otherwise, the downside would most likely outsize the potential upside.

Portfolio monitoring is a must and as I got into my Zhaopin position about 8 months ago, let’s have a look at what has happened since then and see if I should hold on to the stock or not.

Here is a summary of the latest developments which have affected the company since November 2016 and during the latest quarter:

  • Revenue for the nine months ended March 31, 2017 have increased YoY by over 25%;
  • ARPU went up YoY by 2.7% during Q3 FY2017, which is very welcome;
  • During Q3, the operating profit margin went down to 11% mainly due to marketing and G&A expenses. As mentioned above, it is a risk which should be monitored carefully in the future. However, at this point, in my view it is a necessary expense;
  • The overall market seems to be growing as expected; and
  • What about that short-term catalyst? Well… surprise! A third take-private offer came in on February 17, 2017. The offeror is a consortium led by the largest shareholder of the company, SEEK International. In April, Zhaopin entered into a definitive agreement with the potential buyers and the closing is expected to occur in the second half of 2017. According to a June announcement, the total offered price (including a special dividend) is set at US$18.20/ADS.

Now, the big question is: should I keep the stock, sell it, or even buy more? Interestingly, the latest stock price as of today is US$18.83/ADS, which is even higher than the third take-private offer price. Seems like investors finally believe in the story and even think that the company is worth more than what’s offered. It’s quite a reversal since the previous two take-private offers. But this makes an increase in my position quite unattractive for now. From a fundamental standpoint, the company keeps growing and is still in very good shape. I stay quite positive on the future prospects of the business in the long term. All of this being considered, I’m comfortable keeping this stock in my portfolio. Good for you Zhaopin! No promotion, but you’re being retained :P

Please see my blog for more: www.thesbeffect.com – The Snowball Effect

Additional info:

Zhaopin