Seek is a high quality business that has been a core part of our portfolio for a few years. We like Seek for a number of reasons. These include its dominant market position and its ability to pull the pricing power lever. The company lived up to our expectations when it recently delivered its HY17 results.
Seek has a number of key attributes. For a start, the virtuous circle of jobseekers gravitating toward the jobsite with the most job ads and employers advertising on the site with the perceived deepest pool of talent is a powerful barrier to entry that works in Seek’s favour.
The core Australian employment business posted a strong revenue result. We talk about pricing power as being a key signal of the strength of a business. Pricing power provides investors with protection against unexpected shocks to the business, as well as an additional lever to drive earnings and return growth.
Pricing power can be demonstrated through an ability to raise prices on the same product or service. While this delivers significant benefits to earnings and margins on a short term basis, it raises the risk that customers become resentful and/or competitors are encouraging to enter the market. An example that comes for mind is the significant half yearly price increases taken by the two major beer producers in Australia through the last decade. While this drove significant margin expansion and earnings growth, it eventually led to consumers looking to competitive substitutes and sustained falling beer market volumes.
A more sustainable sign of pricing power is when a company can effectively lift average product prices by providing customers with product enhancements. That way the customer perceives a benefit receiving in return for paying a little more. This is one of the strengths of REA and Seek.
In the results for the 6 months to December 2016, Seek’s Australian employment business delivered 13 per cent revenue growth. However, only 3 per cent of this came from increased volumes. The other 10 per cent came from a 3 per cent increase in price, 2 per cent from a shift in volume mix toward higher average price customers, and 5 per cent from increased uptake of premium products.
With multiple levers to drive revenue growth, Seek reduces its pure exposure to the cyclical nature of employment demand in Australia. It also reduces the impact that new revenue models such as aggregators like Indeed have on its earnings and margin.
We have discussed Seek’s reinvestment in developing value adding products in previous postings. The strong revenue growth in Australia in the first half has allowed the company to continue to step up its investment while delivering over 9 per cent operating profit growth relative to the prior year in its Australian employment business.
The key to the long term success of Seek will be its ability to leverage the data it captures on jobseekers to provide value added products into the recruitment and human resources functions of its customers. Seek estimates that the employment advertising market in Australia is a A$500m a year revenue market. However, the broader talent sourcing and human capital markets are many multiples of this, and just as importantly, currently very manual in terms of processing. This puts Seek in a fairly unique position to automate a significant amount of the functions currently undertaken by people employed in recruiters and human resources departments, significantly reducing costs and errors, and improving the speed and efficiency of human capital management in businesses.
At present, the proportion of Seek’s Australian revenue that is generated from these sources is extremely low. The primary example of a revenue generating product in talent sourcing is Seek’s Premium Talent Search product. This is a product that is primarily directed at small to medium sized businesses. PTS uses Seek’s algorithms to identify, sort and filter potential candidates from Seek’s database that are not necessarily actively looking for a new job. This highlights the difference between where Seek’s traditional job board product and where it is taking the business. The traditional job board accesses active jobseekers. Seek’s new products are designed to deliver a broader range of candidates than just those currently looking for a job.
In the first half of FY17, these next generation products contributed around 3 per cent of Australian revenue. While not overly significant at this point in time, this is 3 per cent of revenue that did not exist 2 years ago. As Seek develops and rolls out new products and build is its placements and human capital management capabilities, it will endeavour to increasingly penetrate this largely untapped market. The impressive part of the first half result is that despite carrying the cost of developing these new products, the business has been able to continue to grow its earnings base.
The company’s results over the next two to three years will be critical indicators of whether Seek’s new products are gaining traction in the broader market. While its far from a certainty that the company will realise the potential in the broader human capital market, the uptake of PTS and feedback on other products are encouraging.
If proven in the Australian market, the IP developed can be used and developed for Seek’s other international markets, providing further leverage to the operating cost and capex investment being made by the company.
The Montgomery funds own shares in Seek.
Stuart is the Portfolio Manager of The Montgomery [Private] Fund – a concentrated, All-cap Australian equity fund that aims to achieve absolute returns from a portfolio of long only Australian shares and cash. Capital preservation is paramount.