Seek: Interim result 2014 and acquisition

It's a truism to say that you tend to get nasty surprises from bad companies and nice surprises from good ones, and Seek provided a great example of the latter last week.

Alongside its interim results, the company announced a deal for its majority-owned subsidiary Seek Asia to take full ownership of one of its Asian businesses, JobStreet, and then merge it with the other, JobsDB (of which Seek Asia already owns 100%). JobStreet is the market leader in the Philippines and Malaysia (with JobsDB in second and third place respectively), while JobsDB is the market leader in Hong Kong, Thailand, Singapore and Indonesia (with JobStreet in second place in the last two).

The deals will see Seek's share of Seek Asia rise from 69% to 75% and are subject to Singaporean regulatory approval and JobStreet shareholder approval. Seek's share price jumped 18% the day the deal was announced (19 Feb).

The excitement around the transaction is due to a couple of things. The first is simply that it ascribes a higher value to the Asian businesses than the sharemarket was allowing. The price paid for JobStreet implies an enterprise valuation of $580m – slightly more than 10 times the company's $56m in revenue and 24 times its $24m in earnings before interest, tax, depreciation and amortisation (EBITDA).

Of course, this is a somewhat circuitous valuation because most of it is being paid by Seek itself, but it is sanctioned by two of the other investors in Seek Asia, News Corp and Tiger Global, which are stumping up $83m to maintain their 12% and 9% respective shares. (Macquarie Capital isn't contributing and its stake in Seek Asia will fall to about 4%).

Ahead of the deal, Seek itself was being valued at about 18 times EBITDA; on a pro forma, post-transaction basis, that has now increased to about 21 times.

2 2 = 5

The more important point, though, is that JobStreet and JobsDB, being the number one and two players in the biggest Asian markets, are worth more together than apart.

That's mostly because of the elimination of competition (no doubt why the Singaporean regulator is looking at the deal), but the cleaner structure will also enable the two businesses to combine their skills and make it easier for them to make use of Seek's know-how and technology.

Seek was also keen to point to the region's growth prospects, given much larger populations than Australia and lower internet penetration rates, but that was there before and/or is largely encapsulated in the price paid for JobStreet.

Australia and NZ 'subdued'

In amongst all this, the company reported an excellent interim result. Seek's portfolio of overseas employment businesses led the way, increasing 'look-through' (i.e. proportionate to Seek's ownership interests) EBITDA by 79%, but Seek Education wasn't far behind with a 62% increase. These businesses made up for a 5% fall in revenue and EBITDA in the Australia & New Zealand jobs business, which management described as a 'pleasing result in relatively subdued conditions'.

Overall, look-through revenue increased 21% to $394m, while look-through EBITDA rose 24% to $149m and underlying net profit rose 29% to $87m. Underlying earnings per share rose 28% to 25.5 cents and an unfranked interim dividend of 14 cents will be paid, up 40% (ex date 3 Apr).

The Seek Asia transaction is expected to take place in the June quarter and management thinks it will increase earnings per share slightly in the 2015 financial year and 'strongly' thereafter.

It's easy to say now, but in retrospect we were too quick to downgrade Seek when it moved past our Sell price in Seek downgraded to Sell on 13 Jan 14 (Sell – $13.17). Other than the stock's price, our main concern was with the threat from social media on the basis that human labour lends itself to networking much better than houses and cars. But this is more of a concern at the top end of the jobs market and we underestimated the strength of Seek's overseas businesses, which are focused on less developed markets.

If the overseas businesses continue to fire as they have been, perhaps with a few more nice surprises along the way, then the current price-earnings multiple of 32 (based on 52 cents of earnings for the 2014 financial year) will come down rapidly.

Dispensing with price guide

The trouble is that the stock's valuation will vary greatly with small changes in your anticipated growth rate and how long you expect it to go on for. That's not so much a problem when coming up with a Buy price: you pick some conservative numbers, give yourself a margin of safety and off you go.

Selling, on the other hand, is more art than science. How long do you hang on if the price starts rising? Obviously it depends on your confidence in the business, but it also matters how much risk you're prepared to take and what else you might do with the money. It's one thing holding a fast-growing internet stock on a PER in the thirties if it's a small holding, you have no debt and you're struggling to find other opportunities. But it's a different matter if you have a large stake and a hefty mortgage.

This makes it particularly difficult for us to publish a price guide for this type of business. As we explained recently with REA Group (see REA Group: Interim result 2014 on 6 Feb 14 (Hold – $45.01), it gives a false sense of accuracy and it makes little sense for us to keep chasing the stock up every six months while everything goes smoothly, only to be stuck out on a limb when it all unravels. With fast-growing highly priced companies, price guides also encourage the psychological trap of anchoring, which is no doubt partly what tripped us up with Seek and REA.

Where we've recommended a stock – as with Trade Me and Carsales.com, for example (which we think are better bets at current prices) – we'll obviously continue to give an idea of when we'd think of selling. But for Seek, as with REA, we're moving back to Hold and dispensing with our price guide. We'll still watch the stock closely, because at the right price we'd love to buy it – but that price is a fair bit lower than the current one, so we'll cross that bridge when we get to it.

If you do hold the stock, the most important thing is to keep an eye on your portfolio limit and take profits on the way up. HOLD.