Back To School For Seek?

This story features SEEK LIMITED. For more info SHARE ANALYSIS: SEK

By Greg Peel

Seek ((SEK)) shares plunged as much at 8% at one stage in Friday's trade following an out of the blue trading update from management ahead of the company's Annual General Meeting due on November 30. It was not about Seek's core business of online employment classifieds, but about its new businesses in the education sector.

What made the downgrade such a surprise was that previous guidance was of an expectation for “strong growth in revenue and profit” in these divisions in FY11, which was provided only two and a half months ago at Seek's FY10 result release. Education was the star of the FY10 result, contributing 20% of earnings.

Seek was long ago a first mover in offering an online alternative to what had always been a newspaper domain – that of job advertising. Seek has benefited from that first mover status but online classifieds are now de rigeur and newspaper classifieds dwindling. The online market is not yet fully mature and brokers continue to expect an ongoing secular shift, but Seek's success in the field is now at the margin on the ebb and flow of the job ads cycle, rather than in growth from stealing market share from “old media”. It also has competitors.

To that end, Seek has sought to expand its revenue stream by investing in offshore online job ad services, including in China and Brazil, and also by shifting into the education space which it has done through its Learning, Think and IDP divisions. Analysts applauded these moves as providing Seek with new growth opportunities to offset the maturing of the Australian online classified market.

JP Morgan was thus particularly upset by Friday's downgrade from management. “The Education medium term growth outlook was central to our fundamental valuation and positive view on the stock,” the analysts pointed out in their report, and they suggest there are “fundamental and unanswered questions” about a growth story which the company has been promoting over the past year.

JPM believes Seek Education is coming under some competitive pressure and suggests the reasons for the sudden deterioration in Education revenues are “unclear” to both the analysts and management. Strangely, JPM seems rather alone in this view.

While other brokers were caught off guard by the downgrade, and all have made forecast earnings reductions of some 5-10% in FY11, none seem quite as concerned as JP Morgan (who downgraded from Overweight to Neutral on the news). One has to look first at Seek's core business and then at what its expanded businesses represent.

All brokers, including JPM, have offset their Education division earnings downgrades with smaller upgrades to expectations for the local core job ads business. Whether one cites Seek's own employment index, or the ANZ job ads series, or other indicators, BA-Merrill Lynch sums up consensus by suggesting the recovery in job advertising post GFC will continue into FY12-13 as Australia's unemployment rate falls towards 4%.

At the same time, Seek's investments in emerging market online classifieds are expected to start paying off soon with profits being recorded. Zhaopin in China, for example, is expected to reach profitability in FY11. That just leaves Education as the drag.

But is it really a drag?

Macquarie points out there were a couple of one-offs in the Education downgrade, including the closure of the UK business and reaccreditation costs for some courses. But more fundamentally, Credit Suisse sums up the mood by suggesting management's downgrade “gave a more negative impression of [Seek's] earnings prospects than we believe is in fact the case”.

For IDP, it's a matter of countering falling online education revenues in Australia with offshore revenues and higher investment to drive expansion, notes Goldman Sachs and others. Similarly, more investment is being poured into Think to seize future opportunities. In these two businesses it is a case of spending money to provide greater revenue opportunities down the track.

For Learning, it's a different story. The Learning division offers opportunity for those out of work to improve their prospects through education and learning new skills. It stands to reason that this business saw strong revenues in FY10 when unemployment was an issue in Australia. Now that unemployment is ceasing to become an issue, demand for Learning's services have naturally declined.

Several brokers have pointed out that Learning's revenues are thus counter-cyclical to Seek's core job ads business. Through diversification, Seek has reduced the risk of overall revenue volatility rather then providing a mutually exclusive new revenue growth source.

Hence it is wrong to assume, many analysts believe, that the profit downgrade in Education is the death of a Golden Goose, being Seek's new great hope for earnings growth outperformance. Perhaps, however, the market was focusing too much on Education in this light.

Together the FNArena database brokers have reduced the consensus target for Seek to $7.78 from $8.24 as a result of the downgrade. But only JP Morgan has downgraded its rating, leaving a Buy/Hold/Sell ratio of 4/4/0.

As Citi (Hold) sees it, the market was pricing Seek “for perfection” ahead of the downgrade despite inherent risks for new businesses, and now that the market has de-rated the stock it is still well valued. Four brokers, nevertheless, continue to see upside.

The consensus target is 15% above today's trading price.

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