51job (JOBS) – Merger Arbitrage – 10% Upside

Current Price: $71.72

Offer Price: $79.05

Upside: 10%

Expected Closing Date: TBD

Press Release

This idea was shared by hshane123

 

On the 17th of September, Nasdaq-listed Chinese online recruiter 51jobs ($5bn market cap) has received a non-binding takeover offer at $79.05/share from DCP Capital. DCP capital is a PE firm run by a former KKR / Morgan Stanley PE Asian team and definitely seems like a credible buyer. JOBS hired Duff & Phelps as the financial advisor/Davis Polk as legal counsel and formed a special committee to review the offer, so it seems that the proposal is being seriously considered. JOBS management always used to host a conference with quarterly earning, however, the call was skipped this quarter and the acquisition wasn't mentioned at all in the results report. The proposal comes at about 19xFCF (at 2019 figures, 2020 results were affected by covid), which seems cheap for a market-leading online business in China. Overall, I believe that negotiations are still ongoing and there is a decent chance some kind of an agreement is reached between JOBS and DCP Capital.

The downside seems limited as shares are currently trading just slightly above the pre-announcement price, while recent Q3 results were rather positive (previous revenue guidance was beaten).

 

JOBS

51jobs is a top online recruiter in China closely competing with its nearest peer Zhaopin.com. JOBS operates two segments - online recruiting (about 2/3rds of revenue mix) and HR services (training, etc.). The company is run by two co-founders Rick Yang and Kathleen Chien, who own 19.2% of the shares.

The company has IPO'ed in Nasdaq in 2004. Since then, it has been consistently growing and increased its revenues by over 8x, while net income grew 22x:

Currently, the company is overcapitalized (no debt, US$1.5bn in cash and short term investments) and generates about US$270m of FCF annually.

Nonetheless, since 2019 the growth has been slowing down due to negative macro trends, trade tensions, and an overall downturn in the Chinese economy, which have pressured Chinese companies and reduced the hiring demand. Additionally, the company has been hit by the COVID-19 outbreak. Revenues in the first 2 quarters fell by 13% and 14% YoY, however, Q3  showed a significant improvement over Q2, with revenues declining by only 8.4% YoY. Q3 revenues (RMB 906m) also beaten the previous management guidance of RMB 820m - RMB 870m. In Q2 the company stated that recovery is underway:

While economic recovery is underway in China and we have seen steady improvement in labor market activity since March, hiring tends to be a lagging indicator, and companies remain careful and selective in adding headcount amid lingering uncertainty from the COVD-19 pandemic and geopolitical tensions.

However, the Q3 release, unlike the previous quarterly releases, excluded any comments from management, had no discussions on the outlook, and no mentions of the takeover proposal.

Aside from two co-founders, other major shareholders include: Recruit Holdings - owns a 35% stake and is a royalty-based partner of JOBS (provides training and online assessment materials), and Massachusetts Financial Services with 5.4% ownership in JOBS.

 

DCP Capital
DCP is a PE firm founded by David H. Liu and Julian J. Wolhardt.

Apparently, this is the 3rd business they're doing together - previously they've been working in KKR and founded its Greater China investment business (KKR Greater China). Liu was a partner and a CEO - responsible for investment decisions for the whole Asia region, while Wolhardt served as a partner and regional leader. Both investors are regarded as "some of China’s most astute PE investors", have an excellent track record (KKR has compounded a 26% annual rate of return in China over the last 40 years), market knowledge, and connections in China. You can find more about their background and investment style here.

In April'19 DCP closed their Greater China focused US dollar PE fund with $2.5bn of total commitments (was significantly oversubscribed due to strong demand from institutional investors).

23 COMMENTS

  1. R

    Thanks for this idea. With JOBS trading back around the pre-announcement price without any debt this appears to be an attractive risk/reward to me. Perhaps the offer could even be renegotiated higher given the positive vaccine developments since September? Anyone else participating in this one?

  2. ijw

    Worth noting that USD depreciated 5% against RMB, so at same valuation this should fetch 5% more now.

  3. ijw

    Thoughts on this one? It appears an ok hold by itself without catalyst of acquisition. If adjusted for lower USD, spread is now 30%. This has been a nice trading vehicle for me.

    This traded between 18-35x earnings in the last 5 years. Now at the bottom of that range. Market is pricing this like acquisition is already called off and there will be no growth for the coming years. Anything that vaguely resembles good news will probably push up the price.

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  4. ijw

    Q4 out, I don’t see anything about merger. But seems like business has recovered nicely already. Trading at 19x likely 2021 earnings. And 12.5x EV/earnings.

    Another way to think of it is this, it isn’t all that bad to own a stock at $63, that investors that compounded at 26% for 40 years are willing to buy for $79.

  5. Platitudes

    JOBS closed today at $68ish. The spread to the offer price is still YUGE at 16%.

    1. ijw

      Arguably merger is much more secure now that insiders are in on it? Although I don’t see Kathleen Chien being in on it. So she is probably selling out her 3% stake?

    1. snowball

      Among the >$1 billion market cap Chinese companies with definitive agreements, JOBS’s spread is wider than SOGO (2.6%), but narrower than NFH (14%).

      With all the uncertainty and volatility ongoing in the sector, a high single digit spread doesn’t seem to be able to attract the attention of arbitragers any more.

      1. snowball

        I am correcting my previous statement. NFH does not have a definitive agreement yet.

        So JOBS’s spread is indeed the most attractive in this sector, risk adjusted.

        JOBS is not in the eye of the storm, as is the case for TEDU (crack down on for-profit education).

        It is not involved in a high-profile controversy, as is the case for SOHO China (HKG: 0410)’s founders.

        The most obvious risk I can think of, is that JOBS has a lot of personal data (which is a topic the authorities are targeting recently, as is in the case of DIDI), and Chinese (un)employment-related data seem to be a very sensitive area.

        Other than this risk, there seems to be a high probability that the deal will close.

        I think once the storm for the sector passes, JOBS’s spread (nearly 10% currently) will tighten to similar level as SOGO (2-3%).

  6. specialsits

    51 jobs may benefit form new education regulation as more dislocation in the workforce

  7. snowball

    JOBS spread has widened to nearly 16%, with no company-specific news.

    This is a deal with a definitive agreement and a reputable buyer consortium including the CEO.

    One potential risk the market is concerned about could be banks pulling funding. The consortium already owns 55% of the company, and will have to pay about $2.4 billion for the rest, likely funded by $600 million equity contribution and $1.8 billion bank loan from China Merchants Bank and Shanghai Pudong Development Bank.

    ======

    The Consortium includes DCP Capital Partners II, L.P. (together with its affiliated investment entities, “DCP”), Ocean Link Partners Limited (together with its affiliated investment entities, “Ocean Link”), and Mr. Rick Yan, the Chief Executive Officer of the Company. Recruit Holdings Co., Ltd. (“Recruit”), the Company’s largest shareholder, is also participating in the transaction with the Consortium.

    The Consortium intends to fund the Merger through a combination of cash contributions from certain members of the Consortium pursuant to their respective equity commitment letters, equity contributions from certain shareholders of the Company, proceeds from certain committed term loan facilities in an aggregate amount up to US$1,825,000,000 from China Merchants Bank Co., Ltd. Shanghai Branch as the sole original mandated lead arranger and the lead underwriter, and Shanghai Pudong Development Bank Co., Ltd. Shanghai Branch as the original joint mandated lead arranger and the co-lead underwriter, and available cash of the Company and its subsidiaries.

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  8. snowball

    JOBS spread has narrowed from 16% to only 3-4%, in less than three weeks, again with no company-specific news, or significant improvement in the unfavorable Chinese internet sector backdrop.

    The risk-reward doesn’t seem favorable right now.

    The upside is very limited, and the downside can’t be ignored.

    With the agreement signed before the recent further deterioration in the broader sector (Chinese internet), there is zero probability of a higher offer, and some probability of buyer/lender walking away from the deal or negotiating the offer price downward.

    Spread of 3-4% isn’t really sufficient to compensate for such risk.

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  9. ijw

    Well spread back to 16% again. Business seem to have deteriorated in H1 this year though, with gross margins declining from 71% to 63%.

    1. snowball

      What’s driving the spread volatility is likely the Chinese regulatory backdrop re personal data (JOBS has huge amount of it, by the nature of its business).

      P.S. another interesting deal was announced last month involving US-listed Chinese company (NASDAQ: ICLK). The spread is currently tight (at 4%) but has been volatile (19% at some point in late September), so an opportunity may open up in the future and worth watching.

      The two buyers (PAG and Oasis) in the consortium are both long-standing and resourceful players in Asian markets, with PAG in the same league as Hillhouse.

      https://finance.yahoo.com/news/iclick-interactive-asia-group-limited-120000198.html

      HONG KONG, Sept. 24, 2021 /PRNewswire/ — iClick Interactive Asia Group Limited (“iClick” or the “Company”) (NASDAQ: ICLK), a leading enterprise and marketing cloud platform in China that empowers worldwide brands with full-stack consumer lifecycle solutions, announced today that its board of directors (the “Board”) has received a preliminary non-binding indicative proposal dated September 23, 2021 (the “Proposal Letter”) from PAG Pegasus Fund LP (acting through its general partner, PAG Pegasus GP Limited) and/or its designated affiliates, entities and co-investors (“PAG Pegasus”) and Oasis Management Company Ltd (“Oasis”) and/or its designated affiliates, entities and co-investors (collectively, the “Proposing Buyers”) to acquire all of the outstanding shares of the Company (other than those shares held by the members of management and other strategic shareholders of the Company that may be rolled over in connection with the Proposed Transaction) for US$6.75 per ADS in cash, subject to certain terms and conditions set forth in the Proposal Letter (the “Proposed Transaction”).

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        1. snowball

          The one thing I don’t like about playing in the Chinese small-cap ADR space, is that there is very often information leak prior to events, and we outsiders are disadvantaged.

          The run-up in ICLK’s stock price prior to this announcement is one example.

          In contrast, “rumors” in the Chinese large-cap ADR space, historically tend to turn out to be pure speculations or wish-thinking by investors.

          P.S., the new buyer, Infinity Equity, is a legitimate PE shop well connected in China, even though its website design has the style of scams and/or Chinese state-own enterprises .
          http://www.infinity-equity.com/DefaultEn/Index

  10. Ilja

    Spread has widened to 21% already. Looks attractive on paper, but I still doubt the idea is worth reopening at this point as visibility into what’s happening behind the scenes is 0 and the downside could be massive if the deal breaks. A few thoughts below (some of them were mentioned in the comments above):
    – 3.5 months have gone by after the proxy and despite expected closing in H2, not even the shareholders meeting has been announced yet. The market is clearly concerned and as mentioned by snowball above, in China the news often follows the price.
    – Data issue concern. JOBS has a lot of potentially valuable data and I’m not sure the Chinese government is okay giving into the hands of (an unaffiliated) PE firm and a big $11bn market cap Japanese recruiter (Recruit Holdings – largest current shareholder, which will slightly increase its stake after the privatization).
    – Financing could get pulled. It is secured by two major Chinese banks and it wouldn’t be hard for the government to orchestrate this.
    – JOBS financials have clearly deteriorated, and especially the current H1. Revenues dropped -19% in H1’21 and 25% in Q2’21 so far. This is probably not a big thing as a definitive agreement was signed by the end of Q2, so it likely wasn’t a surprise to the buyer.

    Downside to pre-trading update in May is 6% and would’ve likely be larger if there was no deal. On top of that, Chinese ETFs have dropped about 10% since May, so basically you’d be gambling with a similar risk-reward ratio on a risky multi-billion Chinese merger with no visibility?

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    1. snowball

      Re data privacy issues:

      If there is no deal, JOBS will remain controlled by Recruit Holdings (a Japanese company), and be subject to public scrutiny.

      So it’s not clear whether a take-private by a PE firm is making the ownership/data situations worse from the perspective of gov.

      At the least, JOBS will cease to be a public company, and be owned by small number of large shareholders. It’s easier for the gov to influence/negotiate behind closed doors with a private company re its operations.

      However, if the DCP Capital’s previous exit plan involves (several years down the road) re-listing JOBS in the US market or strategic sale to a foreign company, then it may have to reassess its plan.

      However, it is not clear whether limiting exit options to A-shares market, Hong Kong market, and domestic strategic buyers is that much a deal-breaker.

      In fact, it is probably easier to obtain higher valuation if JOBS is relisted in the A shares market.

    2. hilary lea shane

      1) Recruit will have a lower stake after the merger ( read the preliminary proxy)
      2) DCP and Oceanlink will take the place of minority shareholders (both CHinese firms, so gov’t will have no problem with that)
      3) Why would financing get pulled? JOBS has $21 per share in cash
      4) Chinese govt does not need to approve merger and they can regulate the data whether listed in US or hong kong
      5) study EHIC, where Oceanlink was a buyer. This situation seems similar

      1. David

        What similarities do you see between JOBS and EHIC? EHIC was a management trying to steal the company, got a higher offer and management stonewalled until it was eventually sold for less then both offers.

        I think the most likely risk here is just price getting lowered to say $70-$72 due to worse then expected business performance. I don’t see fears of China blocking this deal as credible in this case because of the reasons you and snowball mentioned.

        1. hilary lea shane

          1) JOBS does not need approval.
          2) EHIC and JOBS have similar structure, management buyout with some private LBO participation ( Oceanlink in both deals)
          3) I agree that DCP/ Oceanlink may want a lower price justified by poor earnings and margins. This is exactly what happened in EHIC,
          “The Revised Proposal indicated, among other things, that Mr. Zhang, together with other members of the consortium under the Original Merger Agreement, which included, among others, certain affiliates of MBK Partners Fund IV, L.P., The Crawford Group, Inc. and Dongfeng Asset Management Co. Ltd. (collectively, the “Original Buyer Group”), concluded that the transactions provided for in the Original Merger Agreement could not be completed on the contemplated terms and that the Original Buyer Group was prepared to terminate the Original Merger Agreement unless the Special Committee agreed to amend the terms of the Original Merger Agreement.” from EHIC filings
          DCP is only going to end up with 13% of the company, but why not pay 10% less if they can so that so that less funds seek appraisal like in KANG.

          JOBS revenue was great. We will see if they are able to get the special committee to lower the price.

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