Saturday, November 17, 2007

Shorting Staffing Stocks Part 2: MNST

In my prior post, I outlined the logic behind a short in Korn Ferry and how it is likely to see its value erode as unemployment rises and demand for its permanent placement services decline.

In looking for shorts that benefit this macro theme, I have tried to focus on pure-play permanent search companies, notably HSII and KFY, with strong US exposure, as I believe these are the stocks most likely to be punished by an oncoming downturn in hiring.

Another interesting way to play this macro theme is via Monster Worldwide (MNST). Monster faces supply/demand economics as the permanent staffing companies. They derive the bulk of their revenues based on the volume of job listing posted to their site, which very neatly follows generally higher patterns. In the prior downturn, MNST suffered a revenue decline despite us being relatively early in the online medium as a primary channel for hiring. Flash forward to today, and a MNST short heading into the next staffing downturn appears even more attractive--with the online hiring market having matured in the US, it is likely we will see a more magnified downturn in this next cycle.

MNST Overview:
MNST has organized itself in 3 business segments: North American MNST, Internation MNST, and Internet & Ad fees. Below is a breakdown of revenue and operating income as a % of total:

Revenue Breakdown:
2007 YTD
Monster NA 54%
Monster Int 35%
Int & Ad Fees 12%

Operating Income Breakdown:
2007 YTD
Monster NA 81%
Monster Int 13%
Int & Ad Fees 6%

Though MNST has generated 54% of its revenue from its US Monster operations, it generated a whopping 81% of its operating income from its US operations before corporate expenses. Without income from its US operations, it would be running at a loss after account for corporate expenses. Though Monster International and the internet content business may be more meaningful contributors to profit in the long term, they are unlikely to generate substantial profits in the near term, as MNST has made it clear that they are investing heavily in these businesses long-term growth potential at the expense of short term profitability. While this is good for shareholders long term, its impact in the years to come, as the US operations profitability declines, will likely not help the stock's short term performance. These divisions are also eventually likely to suffer from a downturn in the US market.

So, what kind of impact might we see in a difficult hiring environment? In the last downturn, Monster was part of TMP, which has since been spun off. I've done my best to compile the income statement for monster only (for WW):

2001 2002 2003 2004 2005 2006
Revenue $533,830 $402,543 $412,796 $516,371 $708,718 $964,331
Operating Inc $152,623 $24,550 $52,891 $101,936 $163,612 $244,625

Ouch. Operating leverage is great when it's working for you (as seen in the great run Monster has had since the bottoming out of the latest employment market), but it can be awfully painful when things turn sour, as all that revenue that was previously flowing to the bottom line suddenly dries up. It's worth noting that Monster took big restructuring charges in 2002 and 2003 which would make their earnings look prettier on a non-gap basis, but doesn't hide the fact that when the employment market swoons, Monster gets creamed.

I could go ahead and run numbers to try and get a downside estimate, but bottom line is that its much lower than what Monster is learning today. Analysts once again allude broadly to macroeconomic fears but still project increasing EPS and EBIDTA numbers off into perpetuity. When the ugliness once again reveals itself, Monster will get creamed.

Like KFY, Monster has generated some impressive free cashflow over the past couple years, which they, like KFY, are wasting on stock buybacks. Monster trades at about 26x FY07 earnings, which I believe should represent peak earnings for this cycle. As those earnings and multiples contract, the stock should see huge declines similar to what it experienced in 2002. I'd peg trough earnings her as sometime in 2009, when I think the stock will really take it on the chin. The $20 Jan 10' puts could be interesting as a small speculative position as well.

Disclaimer: Author is short MNST. Not a recommendation to buy or sell shares. Do your own due diligence.


Yaser Anwar said...

Excellent work Eric.

Can I please request that you add Feedblitz or a similar program so I can subscribe by email? Thanks.

Research Intensive Investing said...

Done! And thanks for the comments.