This was originally published by Frank Voisin. Frank’s value-focused analyses can be found at http://www.frankvoisin.com
Monster Worldwide, Inc (NYSE: MWW) manages a portfolio of websites that connect job seekers with employers in approximately 55 countries. With soaring unemployment for the last few years and a dearth of job postings the company has fallen on tough times, with revenues declining 32.6% in 2009 and roughly flat in 2010.
It seems logical to suppose that MWW’s fortunes would largely tied be to that of the real economy, in that MWW benefits from increased hiring activity, which is aligned with the business cycle. For value investors, the logic often goes something like this: the market often mistreats cyclical companies, putting greater weight on recent performance almost as if any single point in the business cycle will continue into perpetuity (there are a number of behavioural biases that lead us to make this mistake), resulting in expensive valuations at the peak of the cycle, and overly pessimistic valuations at the trough. Consequently, there are often opportunities in the trough.
It appears that value investors are not alone in seeing the opportunity. According to this Bloomberg article, MWW has been the subject of “at least 20 takeover rumors” and this number increases as the company’s share price continues to fall (it fell be roughly 2/3 in 2011). Furthermore, the company was trading in the 10th percentile of US Internet software and services companies on a price to sales basis, prompting further speculation that a buyout is likely. The potential valuations thrown out in the article suggest $15 – $20 a share could be reasonable. Compare this to the actual price of $8 per share as of the time of writing, and evidently some analysts think there is significant value at MWW. The reasons given focus largely on the company’s free cash flow:
‘Significant’ Cash Flow
A private equity buyer would get a company that has a free cash flow yield of 9.3 percent, compared with the median of 4.5 percent in the U.S. Internet software and services industry, data compiled by Bloomberg show. Monster’s cash of $322 million exceeded debt of $223 million at the end of September for a net cash position that’s also higher than the industry median, the data show.
Let’s consider this free cash flow for a moment.
Here we see that, like many of MWW’s operating metrics, the company’s free cash flows were quite impressive leading up to the recession but then fell dramatically in 2009 and have been struggling to recover ever since. On a TTM basis, the company has generated approximately $90 million in free cash flow or an 8.7% yield. If we consider the average FCFs from peak to trough (for a rough approximation of normal FCFs) we see FCFs of around $120 million, or 1/3 higher than current levels. Furthermore, the company is lightly levered (it has $99 million of cash and securities net of total debt), and given that interest rates are low, it would appear that MWW could support much more debt, making an LBO possible (this is the gist of the Bloomberg article).
However, in calculating free cash flow above, I used one of the traditional equations, Cash Flows from Operations less Capital Expenditures. But it would appear that the company is acquisitive, spending approximately $110 million per year for the last six years on acquisitions (though, these purchases are lumpier than this suggests, as we’ll see in the next chart). When a company consistently spends a great deal on acquisitions, it is important to factor this into free cash flow calculations. If these acquisitions were not made, actual performance in subsequent years would be lower (by the contribution of the acquired companies) than it actually was. The best method of dealing with this is to calculate Free Cash Flows after Acquisitions, which shows the amount left over after the company has made its purchases. The following chart shows this figure over time.
Here we see how much the company has been spending, especially during the downturn. Consequently, the amount of cash flows that is truly “free” or distributable to stakeholders is far less. Rather than $120 million on average from peak to trough, the actual figure is closer to just $8.5 million!
Seen from this perspective, one has reason to question the suitability of an LBO. A potential suitor would be left with the option of diverting cash that would have been spent on acquisitions toward repaying the debt used to fund the acquisition. Unfortunately, this would mean only organic growth would remain (which may very well be negative for the near term). Alternatively, the suitor could continue funding inorganic growth by purchasing companies, but this would leave far less money left over to service the increased debt load. These are not exactly attractive options, and there are many more attractive LBO targets available.
The situation gets worse. There is reason to believe that MWW’s peak performance may be difficult to reach in the future. Over the past few years, strong competitors have emerged, most notably LinkedIn Corporation (NYSE: LNKD). LNKD has created a product that is far more “sticky” as a result of its integration of social networking, and has made significant inroads into capturing the professional-level l job market. It will be much more difficult to MWW to recapture this ground, though it is making the right steps to solidify its hold on the lower end of the market, launching the BeKnown app for Facebook in an effort to capitalize on social networking (though, I wonder how long it will be before Facebook launches its own proprietary job market for its users).
What I see here is a company that faces stiff competition that also appears incapable of responding via internally-driven innovation. The resulting over-reliance on acquisitions has led to a massive increase in intangibles to which I assign little to no value. On a tangible asset basis, MWW certainly is not cheap, and on a free cash flow (after acquisitions) it appears downright overvalued.
I see no reason to suggest MWW is a good investment opportunity, for a value investor or otherwise. What do you think of MWW?
Author Disclosure: No position.