Friday, February 26, 1999
Price (2/25/99): $7 3/4
HOW DID IT FIND TROUBLE?
In a search for greater market share, executive search firm LAI Worldwide has found nothing but trouble. A $23 stock just a year ago, LAI has been lost in the mid-single digits for months after experiencing difficulties integrating a major acquisition, spending a bundle to open a London office that's failed to produce results, and suffering from the turbulence in the financial services industry.
After raising $41 million in a June 1998 secondary offering (2.3 million new shares at $19 1/2), LAI appeared to be LOL. But on August 19, the firm warned that Q2 earnings would fall considerably shy of the year-ago $0.22 per share.
Although dilution played a role in that, LAI had also incurred expenses faster than expected in opening its new London office last March. Also, consolidating Ward Howell International and another company acquired late in FY98 impacted operating results as well.
More bad news came November 24 when LAI admitted that the international financial turmoil was hurting its recruitment business, especially in the financial services sector, which accounts for a quarter of its revenue. This uncertainty made it tough for the London office to ramp-up sales as quickly as expected, leaving the firm with huge operating expenses but little to show for them.
These crosscurrents produced ugly results for the first nine months of FY99 (period ended November 30). Although sales soared 55% to $71 million from $46 million a year ago, net income dipped to $2.4 million from $2.8 million. Dilution pushed the EPS figure down to $0.33 from $0.63. For the third quarter, LAI reported breakeven results, down from $0.19 per share in the year ago period.
Public since July 1997, LAI is a leading executive recruitment firm that identifies, evaluates, and recommends candidates for senior level positions, mainly at Fortune 500 companies such as General Motors (NYSE: GM), Lucent (NYSE: LU), and Lehman Brothers.
A people-centered business, LAI has 130 search consultants in 19 offices. The business is organized into 7 industry groups, including financial services (24.5% of FY98 revenue); communications, entertainment and technology (20.4%); health care and pharmaceuticals (14.3%); and consumer products and services (10.8%). It also operates a group focused on functional positions (directors, human resources, legal, etc.).
LAI works on a retainer basis, meaning the firm gets paid for job searches whether or not a recommended candidate is hired. It typically charges a fee equal to one-third of the first year cash salary of the job being filled.
In February 1998, LAI acquired Ward Howell, then the ninth-largest executive search firm in the U.S., with $26.5 million in FY97 revenues. It had acquired California-based Chartwell Partners ($3.4 million in FY97 revenue) only the month before. On a pro forma basis, then, LAI exited its FY98 with $91.7 million in annual revenue.
Until being reorganized into a holding company structure at the beginning of 1999, the company operated as LAI Ward Howell and traded as Lamalie Associates.
Competitors include soon-to-be public Heidrick & Struggles, the newly public Korn/Ferry (NYSE: KFY), SpencerStuart & Associates, Russell Reynolds Associates, and Egon Zehnder. Insiders own 9% of the shares.
12-month sales: $86.9 million
12-month income: $3.5 million
12-month EPS: $0.52
Profit Margin: 4.0%
Market Cap: $62.7 million
Enterprise Value: $40.2 million
Cash: $37.2 million
Current Assets: $69.1 million
Current Liabilities: $19.9 million
Long-Term Liabilities: $14.7 million
HOW COULD YOU HAVE SEEN IT COMING?
The highly competitive but fragmented executive recruitment industry has been growing at a 17% compound annual rate in recent years, from $3.5 billion in 1993 to $6.5 billion in 1997, thanks partly to the job-hopping that's become so common among top executives. Kennedy Information, an industry publication, expects 15% annual growth ahead, with year 2000 revenue rising to $10 billion.
As late as last June, LAI appeared well positioned to play consolidator in this space. It was a public company that could tap the financial markets for cash or use its stock to do deals. Plus, its strong reputation gave it a steady revenue stream. Its 30 largest clients had used the firm for an average of 7 years.
Indeed, LAI's revenues had grown at a 31% annualized clip between 1994 and 1998, well above the 22% compound rate reported by its 9 largest competitors over the same period.
However, integrating a major acquisition can often prove challenging. Also, secondary offerings often signal a short-term top, especially when a company issues so many new shares relative to the number previously outstanding. In this case, insiders also sold some 267,000 shares, about 26% of their total holdings.
Talk of Wall Street layoffs amidst the market mayhem should have left LAI investors even more uncertain about the short-term outlook.
WHERE TO FROM HERE?
At the end of November, the company had a total of 114 consultants, an increase of 43 in just a year thanks to 35 additions from the two acquisitions in FY98. Yet, for the first nine months of FY99, the average revenue per consultant dropped 14.1% to $0.65 million as the average first-year cash compensation for the searches LAI conducted fell 11.6% to $0.21 million. Consultants at the acquired companies were simply less productive.
Productivity gains should come over time. More important, much of the hit to net income appears due to the company's expansion overseas. Its international operations accounted for just 5% of Q3 revenue but 16% of compensation and benefits expenses and 39.1% of general and administrative expenses.
To solve this problem, Chair/CEO Robert Pearson said in January that the firm plans to take a Q4 charge to reduce the number of consultants and support staff involved in the London office's financial services business. The London office will also diversify into other industry segments. "These actions should immediately improve LAI's operating financial performance," Pearson said.
At the same time, Pearson announced LAI was in talks to acquire or partner with Neumann Holding AG, one of Europe's largest executive search firms, with about $60 million in FY98 revenue. It's not yet clear what will come of these talks, but any deal could greatly expand LAI's international presence.
The company is also planning an Internet-based mid-level recruitment initiative, having hired Richard Baird last November to oversee the division. Previously, Baird developed and implemented an Internet-based assessment process for Coopers & Lybrand.
Given that LAI's online site will compete with well-established offerings like Monster.com from recent Daily Double TMP Worldwide (Nasdaq: TMPW), it's not clear what sort of traction LAI can get in this rapidly growing area of the recruitment business. Korn/Ferry's recent IPO was a flop even though it has already got its Futurestep website up and running.
Still, a bit of insider buying last October around the current price is a modest positive. Also, while analysts have cut their numbers, the current consensus calls for $0.38 per share for FY99 (no doubt excluding the Q4 charge) and $0.58 per share for FY2000 (range: $0.46 to $0.65). Assuming LAI can hit the lowball FY 2000 number, it is now trading at just 17 times forward estimates, before backing out the mound of cash.
TMP's Web focus makes it a more interesting long-term play in this general space. But the well-respected LAI is so beaten down that it, too, deserves a closer look.
-- Louis Corrigan
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