What Investors Need to Know About ZipRecruiter

In this episode of Industry Focus: Wildcard, host Nick Sciple and Motley Fool analyst Asit Sharma break down what's going on with ZipRecruiter (ZIP -1.52%), a recently public company. Find out what ZipRecruiter focuses on, its inside ownership, its total addressable market, and more.

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This video was recorded on Sept. 1, 2021.

Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. Today, I'm excited to welcome Asit Sharma back on the show to take a look at another recent IPO. This time, we're taking a look at ZipRecruiter. Asit, how's it going?

Asit Sharma: Pretty good, Nick, thanks for asking me on today. Excited to talk about ZipRecruiter as someone who's had a little bit of experience on both sides of the fence, applying for jobs and also hiring people.

Sciple: If you look at the current macro environment, the jobs market right now, employers all really rushing to try to hire folks having a little bit of trouble there, and this ZipRecruiter, it plugs in about as perfectly to what we're seeing in the jobs environments than any other company you might see. It came public via a direct listing back in May, and says something about their capital needs coming public via direct listing rather than IPO. But just high level, Asit, for folks who aren't familiar with ZipRecruiter, maybe haven't heard 1,000 podcast ads for ZipRecruiter like I have, what does this company do? What's the story here?

Sharma: Sure. ZipRecruiter is basically a platform that connects people who are seeking jobs and people who are hiring. Their mission is to actively connect people to their next great opportunity, which I like. I think I've been primed by our friends, Brian Stoffel and Brian Feroldi, to look for a succinct and evocative mission statement, so I like that. It doesn't tell you exactly what they do, but it is inspirational and actionable, I think. The thing with ZipRecruiter that's different from other job sites is that it's a matchmaker for curating job opportunities for job seekers and candidates for employers. The curation element here is really important. The company uses artificial intelligence to feed deep learning algorithms that try to get a grasp of what employers and job seekers are looking for. You tell ZipRecruiter from the hiring side what you're interested in. As an employee, of course, they are combing through your data and trying to make sure that their artificial intelligence can form connections that might not be as obvious to you. I think this has some utility if you don't have a lot of skill in hiring, or maybe you are overwhelmed in your department. They're trying to cut that work down for you but also through this idea of curation make potentially a better match than humans could do or, I should put it this way, to have a better pool of applicants and then let the humans make the decisions. This AI layer learns employers' preferences.

I wanted to say, as somebody who myself has spent a number of years in the private sector, after some years in public accounting, both advising people to hire people and then when I was working in industry hiring people myself, I really like this part of ZipRecruiter's technology. They call it personalized recruiter assistance. It's an "Aha!" moment if you are an employer. I'm just going to read from their prospectus. After a new job is posted, ZipRecruiter's matching technology immediately presents potential great match job seekers to the employer for consideration. Employers can then directly invite the job seekers they like best to apply. For anyone out there who's sifted through hundreds and hundreds of resumes as a first exercise and trying to hire someone will appreciate the fact that after taking the data, ZipRecruiter will almost instantly start showing you candidates that you can then rank and maybe call for an interview.

Sciple: The AI aspect, I think, is a big differentiator here. One of the things that the management talks about is that often employers aren't even the best at writing a job description in a way that potential hires know what they're looking for. So the AI even helps figure out the types of candidates that are attractive to this employer and helps bubble them up through the system. Also, automatically from the employee side will automatically send jobs that get posted that are relevant to those employees and say, "Hey, you should probably go apply for this. Why don't you press the one-click apply and send your resume?" From the perspective of employers, it really helps with the sortation of potential hires. They really are improving this on a regular basis. They have hiring managers rate applicants, so rate them as the best candidate, upvote them. They use that data to then inform their algorithm and continue to improve over time. You see the improvement they've had. They put in their S-1 going back to Q4 2016, it would take 39 days on average to hire after a job got posted on ZipRecruiter to when a person was hired. Now, as of Q4 2020, down to 16 days. Really, massively increasing the speed at which folks can hire, which as a company that wants to run their business and not be constantly interviewing people, you can certainly see the attraction there in filling those jobs and also just attracting great candidates with less stress. I think that's the big differentiator for the company.

The other thing is you post your job on ZipRecruiter, it automatically goes out to essentially every job site across the board, so jobs posted on ZipRecruiter distributed well over 1,000 sites managed by their job distribution partners. From the perspective of an employer, not only do you have this one-click press that sends out your application all over the place but also starts bubbling up these potential applicants to you in a way that saves you a lot of time filtering through, hunting and pecking through candidates.

Sharma: Yes. This essentially is a platform business. I'm really fond of them, whether they're in e-commerce or maybe in payments, think PayPal, think Etsy on the e-commerce side. This has 2.8 million employers on the hiring side and 110+ million employee customers or potential employee customers. It's a pretty large platform. It's got wide breadth as you mentioned. I think that the pricing also is pretty fair. I looked on their site earlier before our show. They've got very reasonable monthly payment tiers. I think they start at $250 a month and also have a flat-rate pricing plan. You can use their services with plans that range from a day to a year on a flat-rate basis. It's also performance-based, 20% of the equation is performance-based, pay-per-click, and that is reflected in the company's revenue composition. They get, roughly, if we look at the most recent three months the company reported on in its first quarter as a public company, out of $183 million in revenue, about $152 million that was subscription-based and then $32 million that was performance-based. You can see that percentage playing out.

Sciple: One maybe context you mentioned, so they've served 2.8 million employers over time, but folks do come on and off the platform as they have hiring needs. Maybe we'll talk about that later as we get into the most recent quarter. I think one thing that stands out anytime we look at these new IPOs, we like founder-led companies, and I think ZipRecruiter falls in that category. When you look at the ownership stake and just the continued involvement from the founder, what are your thoughts there?

Sharma: I like the fact that one of the co-founders, he is the president, also the CEO, and the chairman, so you see some control there is Ian Siegel. He owned roughly 13.5% of the stock before the IPO, and I should say direct listing, post-direct listing, he owns 12% of the stock. Most of that is through a family trust. He's got another $4 million in stock that he owns personally. Now, there are some other co-founders who've left the company. They still have skin in the game even though they are not managing the company. I guess there's existential skin in the game. They're rooting for the stock but don't have a lot of influence on it. These include Joe Edmonds, who was the former secretary and treasurer. He's got 9% of the shares outstanding. Ward Poulos, the former chief design officer, has 7% of the stock. Will Redd, who's the former chief technology officer, owns 6% of the stock. Now, I want to pause here, Nick. I know we're going to come back to this when we talk about risks, but you and I were chatting about this before the show. This isn't the typical look for a business that's been closely held, has multiple founders and key employees that have come up owning stock through the private portion of the company's existence through to an IPO or direct listing. You've got three people who had very important positions here who've left the company with appreciable shares of stock. What do you make of that?

Sciple: I know, it's strange to see this. I think sometimes you see this when companies come public, folks that are more start-up-orientated managers that like to build companies up. That's probably the most innocent explanation for why folks are leaving. I will say it is a little disconcerting. Obviously, you like to see the founder still in place, the CEO, President Ian Siegel, and I have lots of confidence in him. But it does leave some question marks for me of why have these folks left. I tried to search around to see some context there, but didn't really see much. We talk about some times when there's large venture capital ownership in a stock when it comes public or when there's large private equity ownership, but there's an overhang here. These are shares that potentially could be sold into the market and create some downward pressure on the stock. I think when you look at these folks leaving as this company comes public, it raises a little bit of my antennas of maybe we see some of that with some of these founders in the company now. On the other side though, sometimes, you see founders will stick around forever and still continue to hold stock. I think Paul Allen with Microsoft may have held a number of shares for a long, long time when he hadn't been involved. It's one of those I don't know if I would say red flag, it's more of a yellow flag. I would like to investigate this more and get more context.

Sharma: Sure. I would follow Ian Siegel's holdings as time goes on, maybe check on that every year, read the proxy statement, or if you like to look at things a little more closely, you can read the SEC filings each year that reflect his buys and sells. We should say here though that current executives, Jeffrey Zwelling, who's the chief operating officer and David Travers, who is the CFO, they've actually got an appreciable amount of stock for people who were brought on in the second round. Zwelling, the COO, owns 1.3% of outstanding shares, and David Travers, the CFO, owns roughly 1 percentage point of the stock which is a lot for a company to give to newer executives. I think that's maybe something you can hang your hat on if you're looking at skin in the game for current management. You've got that 12-odd percent that Ian Siegel has. Add these other two executives, you're up to over 14%. Now, they don't have a controlling interest, but I think that's something that balances a little bit, the maybe curious exits of some of the founding members who still have an appreciable share of the company.

Sciple: No doubt that the folks running the company have skin in the game, right? When you've got the CEO owning over $300 million worth of stock and even lower-level executives owning $10-plus million. Certainly, they want the stock to go up just like me and you do as potential investors, so that creates some alignment. So one of the things you always want to talk about with these new IPOs is what's the opportunity in front of this company? Obviously, people always have a need to hire, but the market is only so big. So what did you make of the TAM numbers that the ZipRecruiter put out for us?

Sharma: Sure. Well they showed in their prospectus a market that's $205 billion in size when you take employment and recruiting agencies, adding the staffing and the temporary market. Online recruitment sites like ZipRecruiter, like LinkedIn, and many other smaller competitors, have about a $13 billion share in this market, so there's a long path to growth. If you take the proposition that eventually these online curated sites can put the other agencies out of business. I'll get back to it in just a second, but we should also mention the company has a nice graph in their prospectus. It shows how fast that online recruiting share is growing. It's growing at a compounded annual growth rate of 14%. That's over about a 10-year period, so it's a sustainable and I think really fast-growing market. I love a fast-growing market because my saying is if you can grow at least as fast as the market, you've got pretty decent growth to yourself built in. If the market's growing at 14% and you just grow with it, you've got a built-in 14% compounded annual growth rate going on. That's nice but going back to this total market opportunity, I think that the executive firms are fairly entrenched in the market, as are the recruiting agencies and I think it becomes a little harder when you look at the staffing and temp side of the market to take share away from those companies because those are companies that have relationships with businesses, ongoing relationships where they are sending staff over on a very cost-effective basis. For executive recruitment, it's a cutthroat business and many of those firms have been around for decades and have relationships with big multinational corporations.

That total market opportunity, at least in the near term, I think is overstated. But if you're looking at an online recruitment share of $13 billion that could double or triple in the next five, 10, 15, 20 years, it shows that there's still a lot of revenue and market share here for company like ZipRecruiter to grab if it can continue to grow and we should mention here they've got a very nice growth strategy. It reminds me of the way PayPal approaches its business as a payments platform, but a similar platform business. They have three key performance indicators, or KPIs, Nick, that you had brought up to me. They want to increase the number of employers on their marketplace, so they measure that as a key performance indicator. Is that growing every quarter? Increased job seekers? That's the other side of the platform as they're growing that base and they want to improve their algorithm. How effective is their artificial intelligence at finding the right candidate for the job, presenting it to the employer. They're focused on three very important big-picture items and investing behind that. So you like to see that focus from the top down. I think that says something nice about management.

Sciple: Yeah, it's a classic two-sided marketplace. I tend to agree with you on the skepticism around the TAM, although I do think we see broadly across the board, whether it's in hiring or real estate or anywhere really, we're seeing the shift from what has traditionally been offline, meeting your needs offline, whether it's demand for hiring and moving toward doing that online. I think there's a huge shift we're seeing across all industries and I don't think hiring is any different, although that the pace at which that shift happens, it's a question. Another piece of context to give here is the $205 billion number for the TAM, that's just the U.S. market, so it's worth noting. So currently ZipRecruiter only operates in the U.S.A, Canada, and the United Kingdom. So there is an opportunity to move outside of the U.S. and outside of North America and the U.K. into maybe other European markets or across the globe. That is a potential opportunity to expand the addressable market, but as of today, we're looking at this $205 billion U.S. employment recruiting agencies and staffing market of which $13 billion of that is online and growing but yes, you look at the business strategy, you really want to grow both sides of that marketplace then you use that to feed data into their algorithms and then improve the performance of the marketplace. Now, I guess is a good time to talk about how they've been performing as far as financials and bringing new employers onto the platform. As you looked through their financials, Asit, what we've seen so far from the company, what stands out to you?

Sharma: I think, for me, what stands out to me is sort of the resilience in the model. Last year, they had $418 million of revenue, but that was about a 3% decline from the year before. Of course, that has a lot and everything to do with COVID, which really impacted hiring across the board earlier in the year. I like that they were able to rebound. I will talk about that first quarter in just a second where we get the indication that the company's hitting its former growth rates. Before that year, they grew at an 18% top-line clip from 2019 to 2020. I like their gross margins. The gross margin, 87% last year, 88% in this most recently reported quarter. This is a pretty nice gross margin, very reminiscent of software companies that are really capital-light. Of course, that's just sort of the top line but gross profit and gross profitability pays the bills. If you have a high gross profit margin, over time if you get your costs in line, your overhead costs, you can start to see operating leverage, so I like that a lot.

In the first quarter of this year, they had record revenue, that I should say their most recently reported quarter, their first quarter as a public company. This revenue of $183 million represents a 109% year-over-year growth rate which is sort of understandable because they had an easy comparison to the prior year which was impacted by COVID but it's also a 46% growth rate over the first quarter of 2021. This quarter they had 88% gross margin. A little bit of improvement there, as I mentioned, and it's notable to see that R&D expense is increasing. It more than doubled this most recent quarter from $16 million this time last year to $37 million. This says to me something positive about the platform. They did not raise money from this direct listing. I want to make sure everyone understands. This was not an IPO and not a listing in which money came into the company's coffers.

Essentially, they are utilizing resources that were previously existing on the balance sheet and some of their cash flow to invest more heavily in R&D. That stands out to me. The other thing that stands out to me is that they are starting to invest more in sales and marketing to drive the top line. We don't know quite what to make of that yet, Nick, because they're such a recent company as far as public information is concerned, we just have two years of data, but that's something that I would watch. Now that they have become public, they've got access to the capital markets if they want to raise some capital in the future. Yes, we look at them as a company that's very interesting, but it's going to take several quarters to understand the relationship of their sales and marketing spend to their revenue.

Sciple: Yeah, they talked about how they are kind of scientists with sales and marketing and they've seen huge tailwinds this year as you would expect in the overall market that's led them to press harder on the marketing side than they had coming into 2021. Part of that is they turned off sales and marketing in a really huge way in 2020 because nobody was hiring and there was lots of uncertainty in the job market but you've seen that snap back in a really big way, you mentioned in the 46% growth, quarter over quarter in revenue. Obviously, that's a big tailwind of more employers coming on the platform. They had 170,000 paid employers in the quarter, which is a record high, a 120% increase year over year. You mentioned the R&D expense, there's also a big jump up in sales and marketing expense, as you would expect, right? The two KPIs for the company or the top two are we want to increase our employers on the platform, we want to increase employees on the platform.

One of the big ways to do that is to advertise, so more people are aware of you and come onto the platform. But one thing that makes it a little bit tougher to suss through what's going on with these earnings is that we've had this huge stock-based compensation expense come in with the direct listing as you mentioned back in May. The company leading up to the direct listing had changed the vesting schedule for employee restricted stock units such that once the company went public on the first day of trading, all that stock vested, which obviously from the perspective of employees, you want to be able to sell as you have this liquidity event coming into the market. But the way that it complicates things is the way the company accounts for sales and marketing expense, research and development expense, even sales general and administrative expense, all including the stock-based compensation that goes to employees that work in those various departments within the company. So you see an increase in sales and marketing.

The company is certainly pressing there but part of the increase is coming from this big, lumpy, stock-based comp expense that we got this year with the IPO and so it's kind of hard to see how much of that is what's going on in the core business and how much of that is this lumpiness we're getting from the SBC expense. I will say from my perspective, I like that they're pressing on marketing and the most recent earnings call, the CEO said, listen, we're investing aggressively into what is probably the strongest tailwind we've seen in the 11-year history of the company with the demand for hiring right now with folks probably coming back into the job market as various government protections are lifted. There's lots of demand for these services, so if there's ever a time where you're likely to get a high return on investment on your marketing spend, I would think now would be the time.

Sharma: Absolutely, and I also like that they have significant stock-based compensation expense. One of the reasons that you want to go public is to provide a more liquid market for the shares of your company if you're using a lot of stock-based compensation. This is a benefit to employees, especially the ones they are trying to recruit. We were chatting before the show, Nick, that a lot of this stock-based compensation is going into areas like R&D, so they're obviously using it to incentivize some of the data scientists and AI specialists that they're hiring, but it makes it a little murky now to know exactly what is tied to this direct listing, what that cadence will look for going forward. If you're a prospective investor in ZipRecruiter, you want to break things down, you want to trace sales and marketing and R&D expense, and general administrative expense, so three big buckets of their overhead are in their line items on the income statement.

You want to trace those from quarter to quarter, you make year-over-year comparisons, and then you want to read the notes and to see going forward, how much is related to stock-based compensation. You can also look at the cash flow statement and look at the relationship of SBC to operating cash flows, to get some nuance there. But this is something that we're not going to be able to really learn until the next few quarters have elapsed and we see what the ongoing cadence is, how much of that now are they going to keep refilling now that the company's shares are public, and that's a nice tool to attract and retain talent. It was a great point that you brought up. Just makes a little murkier here, but I will say at the end of the day, the point you made just a few minutes before is absolutely correct, Nick, that you're going to expect to see this overhead expense in general ramp up because the company is in a growth phase now. It's trying to grab market share. They're going to be spending more on R&D, they're going to be spending more on sales and marketing. At some point, the end result of that should be some operating leverage, which we've got. Just maybe a minute or two, we should probably talk about that as well.

Sciple: Yeah, Asit. What can you tell us about the operating leverage you are looking for in this company? Certainly, you want to see some ROI on this marketing expense, the brand take off and really acquire customers.

Sharma: Sure. Let's take the company's own numbers, they are targeting an adjusted EBITDA margin, earnings before interest, taxes, depreciation, and amortization of 30%. This is after all, adjustments to the income statement and some other adjustments for unusual or non-recurring items. Now, that's a long-term target, they're at around 16% as of 2020. To me, again, this depends on a couple of things, how much of the spends that I was just mentioning yield in new sales and also, how successful will the company be breaking into the markets that we talked about earlier? Breaking into that executive search market, the staffing market, maybe the temp market, moving up the food chain in some aspects and taking business away from executive recruiters, forming long-term relationships with bigger enterprise customers and multinational companies. That provides you with more stable, annualized recurring revenue. It also gives you more operating leverage and over time, maybe they can hit those margins. That would be a healthy EBITDA margin if they can pull it off, and I think it makes this company interesting. I want to follow this, Nick, going forward. I like the fact that it's founder-led. Last thoughts to you in terms of what you think about this after we've spent some hours in research, and a few minutes here talking about it this morning?

Sciple: For me, I like the founder-led nature of the business, I like their differentiation from the other folks in the market. I do think and you have demonstrated proof that they've continued to improve over time when you look at the time to hire down over 50%, just in the past several years. I think there is a long-term tailwind toward hiring online versus offline, but my question mark is, we have this big lumpy stock-based comp expense that came in this quarter trying to suss through the core business, what's going on here versus the murkiness that we get from stock-based camp, and then also, what is the normalized growth rate looks like for this company? When we're in a normalized hiring environment where there's not massive gaps between demand for hiring and the folks out in the market, what do those normalized numbers look like? That's one of those things we'll have to wait a few quarters to find out. Asit, I think that that will be it for us here on the podcast today. Thanks for joining me as always. Can't wait to have you back again soon.

Sharma: Lots of fun. Thanks so much, Nick.

Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show. For Asit Sharma, I'm Nick Sciple. Thanks for listening and Fool on.