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Hunting The Headhunters

Posted: Sep 18, 2007 07:45 AM by Dean Lundell

Tickers in this Article: KELYA, MAN, KFY, HSII

It can take months, and in extreme cases even years, to fill a high-level executive job. The headhunting firms that specialize in this field must be meticulous and detailed. The right executive can make a company, and the wrong one can't break it.

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At the other end of the spectrum you have temporary staffing companies who specialize in filling a large number of vacancies and filling them quickly. They often deal with thousands of vacancies on a daily basis.

This sets up the age old debate. Is it better to sell a few expensive services or many cheaper ones? In this article we'll examine two companies who specialize in finding senior level talent and two who specialize in temporary workers to see which business is worthy of investment.

Executive Specialists
Heidrick & Struggles International (Nasdaq:HSII) is one of the most respected executive search firms. With a market capitalization of $790 million and revenue of $587 million, it only competes with a handful of other firms. Heidrick does business through 51 offices in 30 countries and operates on a retained basis - it gets paid even if the firm does not find a suitable candidate. The weak link in HSII's chain is its European operation, which lags its North American and Asian counterparts, generating about 33% of the revenue but roughly 20% of the profits.

The future could bode well for HSII as 19% of the workforce (i.e. baby boomers) will be retiring in five years and the firm is now offering executive coaching and professional development to help the loss of management talent. The company's revenue has averaged a growth rate of 13.8% over the past three years and grew at 16% last year. Earnings are another story - no growth at all over the prior three years and -8.6% last year. The firm manages an 8.4% net margin and a 15.7% return on equity.

Korn/Ferry International (NYSE:KFY) can boast a market cap of just over $1 billion and $689 million in revenue through offices in 37 countries. Korn/Ferry's biggest asset, however, is its database of 3.1 million executives. Like Heidrick, Korn/Ferry competes with a handful of top search firms and fills roughly a quarter of the most senior level positions from its client list of half of the Fortune 500.

It also offers executive coaching and assessment; perhaps that is why 83% of Korn/Ferry's clients are repeat customers. Aside from the systematic risks all these firms face, KFY is going to have to invest more funds in technology upgrades. Revenue has averaged a growth rate of approximately 25% over the last three years. Earnings have been more volatile, averaging 112.1% over the last three years but coming in at -6.1% last year. Korn/Ferry sees a net margin of 8.1% and a return on equity of 14.7%. (For related reading, check out Keep Your Eyes On The Roe.)

Temp Agencies
Manpower (NYSE:MAN) is the second largest staffing firm in the world. With a market cap of $5.6 billion it generates $18.8 billion in sales through 4,400 offices in 73 countries. The problem is that 34% of its revenue comes from France alone, 37% from European Union countries and only 12% from the U.S. The EU in general and France in particular have a propensity to legislate and regulate employment with these firms, making life difficult for the companies.

MAN's future focus will be on placing more people in permanent positions and trying avoid social engineering in the EU. Increased competition means the firm's clients are starting to see a little pricing power of their own. This puts pressure on Manpower's margins. Financially, Manpower's revenue has averaged a growth rate of 13% over the last three years but 9.2% last year. Its net margin is a thin 2.6% but has a return on equity of 18.2%.

Kelly Services (Nasdaq:KELYA) is learning the hard way that you can only poke the gorilla so many times before it decides to poke you back. Although Kelly Services has a market cap of $834 million and generates $5.6 billion in sales, it's now poked the industry's 800 pound gorillas (Manpower and Adecco) one too many times. This intense competition is exacerbated given the cyclical nature of this market. (To learn more, read The Ups And Downs Of Investing In Cyclical Stocks.)

Kelly's financial results are mixed. Revenue growth, while averaging 9% for the past three years declined to 6% last year and earnings growth was 124.3% and 45% for those same periods. The company’s net margin is razor thin at 1.2% and return on equity is 8.8%.

Conclusion
A glance at the market-cap-to-revenue ratio shows a large difference in how Wall Street is valueing the executive search firms versus the temporary staffers. Heidrick & Struggles is at 1.34 and Korn/Ferry at 1.46 meanwhile Manpower and Kelly Services are at a much less expensive 0.30 and 0.15 respectively.

All of these firms have seen their shares take a sizable hit since spring. The market must think the job market is starting to cool and that staffers of all kinds are in for lean times ahead. The big question is, is this a leading indicator for economic activity in general?

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By Dean Lundell

Dean Lundell is a former vice president at Merrill Lynch Capital Markets, a principal of a regional investment bank, an independent futures trader and licensed commodity trading advisor. He has written for McGraw-Hill, the Chicago Mercantile Exchange and several financial magazines. Prior to his career on Wall Street, he served with the 82nd Airborne Division in Vietnam.

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