I.        THESIS

Contrary to my initial findings, Dice Holdings, Inc. (“Dice”, “DHX” or the “Company”), an online job posting entity, possesses a fundamentally strong business model in cyclical decline, which bearish investors incorrectly believe is a business model undergoing secular decline due to the proliferation of LinkedIn and its related supplanting of the online job board business altogether.  Simply looking at industry trends, DHX’s revenues have reversed course during the current economic downturn from the early-to-mid 2000’s when the online job board business experienced secular growth in uprooting the traditional job posting business of classified print ads.  However, since 2008, as the financial system and broader economy experienced great decline, LinkedIn has simultaneously made substantial inroads taking market share from the online job board industry, which has caused bearish investors to incorrectly believe that the underlying cause for DHX’s declining financial performance between 2008 and 2010 solely reflects the obsolescence of Dice’s business model at the behest of LinkedIn. 

In reality, DHX has a sound competitive moat in the form of a two-fold network effect in both supply and demand, reaching critical mass in contract work and temporary jobs for IT and tech professionals, a niche LinkedIn is not well suited to penetrate.  Given the historically high unemployment rate in the U.S., there is sizable upside to the Company’s earnings and cash flow power once hiring returns to normalized levels, particularly as the marginal sales dollar contributes to an approximate 90% earnings margin with the marginal cost to each new sale strictly being the 10% commission paid to the Company’s sales force.  Additionally, in light of DHX’s minimal capital requirements and outsized operating margins as well as returns on capital and free cash flow generation, purchasing the Company’s equity at a 10% unlevered free cash flow yield is quite attractive, representing a low 20%’s IRR on an unlevered basis assuming valuation (EV/EBITDA) remains at its current historic low levels of 7.5x.

    II.        BACKGROUND / COMPANY OVERVIEW

BUSINESS DESCRIPTION:  DHX provides online job posting services through its sector-focused recruiting platforms: technology (Dice), financial services (eFinancialCareers), government security clearance (ClearanceJobs.com), energy (Rigzone and worldwideworker.com), healthcare (AllHealthcareJobs.com) and job fairs (Targeted Job Fairs).  The Company predominantly makes money by charging recruiters and direct hiring companies for a monthly or longer-term subscription that allows the customer to post jobs to Dice’s recruiting sites while perusing the selection of job candidates who have registered profiles and resumes on these sites at no cost.  The primary value for customers comes in the form of the candidate database and filling jobs with those candidates.  Major competitors include Monster (which includes Hot Jobs), CareerBuilder and LinkedIn Corp. (“LinkedIn” or “LNKD”) as well as other social recruiting platforms.  LinkedIn has quickly become the biggest threat, eroding a significant portion of the value proposition previously possessed by Dice and other job sites.

QUALITY OF BUSINESS:  This is generally a high quality business but with a threat from uprising competition from LinkedIn:

A)    Competitive Position (Strong but Threatened):  Dice has become successful due to its first mover advantage, becoming the first online job board, starting in 1990 with the Dice.com platform focused on contingent hires within the tech sector.  However, LinkedIn has begun eating away at Dice’s business model and competitive position with LNKD now having over 120 MM registered users.  However, Dice has a sound competitive moat in the form of a two-fold network effect in both supply and demand, reaching critical mass in contract work and temporary jobs for IT and tech professionals.  Dice has built the moat by focusing its sales and marketing dollars specifically within the tech community to attract the resumes of the highly educated and experienced professionals it desires (supply network effect), which has resulted in recruiters and hiring managers (i.e., Dice’s customers) viewing Dice as the gold standard for sourcing contract and temp workers in the IT space (demand network effect).  This is a moat that is too costly and time consuming for a new entrant to build organically as well as one which LinkedIn has not meaningfully penetrated given its broad candidate database of largely passive candidates who would not be well suited or reachable for the contract/temp IT work Dice’s customers generally post.

International Expansion: Dice.com technology recruiting business has not expanded internationally because the Company wishes to expand via acquisition as it makes little economic sense to build organically.  There is actually a meaningful competitive moat in building the appropriately focused database (i.e., on experienced IT professionals) with a critical mass of candidate resumes that requires extensive time and marketing dollars to build, which in turn generates network effects where both candidates and customers (i.e., recruiters and hiring managers) come to view the site as the gold standard for a targeted niche such as well educated IT folks looking for contract and temp work.  Not only does Dice not have the desire to attempt an organic build-out, but it has already experienced failure in an attempt to do so.  In 2004, Dice formed a joint venture with CyberMedia in India, forming Dice India, which built an online technology focused career website based in that country.  However, in Q407, DHX opted to exit out of the JV due to “ongoing economic losses and inability to survive over the long term”. 

In support of this theory, per investor relations (12/9/11), Jennifer Bewley, IR for DHX, expressed the Company’s desire to find a business where the time and money has already been spent building out a large, captive candidate database that Dice can simply acquire and scale up.  However, DHX has found no interesting acquisition opportunities to date as most international acquisition targets prove to be smaller mom-and-pop operations that lack the necessary critical mass of candidate resumes.  Jennifer’s commentary also provides meaningful insight into the Company’s acquisition prospects and capital allocation plans as management has repeatedly stated that its primary focus for excess cash flow is for acquisitions.

B)    Business Model (Strong):

1. Sales (Average): The majority of DHX’s revenues come from recruitment packages.  Clients can sign up for contracts as short as one month but many sign up for packages dating up to one year; no contract generally extends beyond one year.  The basic package costs $6,500/year ($542/month) and includes access for one user and the ability to post 5 jobs.  Long-term customers generally re-price their contracts upon expiration at a new rate.  However, DHX never assumes it has the ability to raise pricing.  In fact, while average monthly revenue per customer has consistently increased since 2006, the cause has proved primarily either the addition of a new user to an existing account or the addition of job postings, not pure pricing power, raising questions as to the strength and stickiness of Dice’s services.  That being said, Dice has a customer retention rate of 70%.

1. Costs/Margins (Very Strong): DHX has 93% gross margins and 40% EBITDA margins.  The marginal costs for the business are solely sales commissions, which generally account for just 10% of marginal sales.  Outside of G&A, which is primarily comprised of employee/management compensation and rent and accounts for ~$20 MM/yr (16% of 2010 sales), the Company has limited fixed costs.  The greatest expense is sales & marketing, which represents ~34% of sales; this cost is split 2/3 marketing and 1/3 sales, as the bulk of this line item is spent on marketing to experienced, well educated IT professional seeking contract and temp work in order to build the largest database of high quality resumes in this niche category.  Dice’s moat and outsized operating margins enable the Company to cut pricing if ever forced to for competitive reasons while maintaining ample profitability.  Likewise, cash flow generation is quite substantial as a result, and marginal sales dollars translate into 90% profit margins.

1. Capital (Very Strong):   Capital expenditures have remained below $5 MM throughout the Company’s history (less than 4% 2010 sales).  The only capital requirements include updates to computer software/hardware and Company websites.  Given that the technology platform has been built, marginal capex should remain in the $5 MM range, assuming no acquisitions. 

COMPANY HISTORY:  Originally formed as Dice Inc. in 1991, the Company was the first entrant into the online job site field, focusing on the technology sector, specifically in contingent hires, which are in essence temporary positions typically ranging from 6 months to 2 years.  Dice Inc. filed for bankruptcy in 2003, subsequently emerged from bankruptcy as a private entity in 2003, was acquired collectively by General Atlantic LLC and Quadrangle in 2005 and taken public in an IPO as Dice Holdings, Inc. in June 2007.  Before going public, in March 2007, General Atlantic and Quadrangle issued a special dividend to themselves (convertible preferred stock) of $108 MM with proceeds from Dice’s then amended credit facility, despite operating at a net loss that year; upon going public, these two investors had withdrawn $108 MM each ($216 MM collectively) in dividends and IPO proceeds.  While these investors have continued to sell down their respective stakes since the IPO, they collectively still own almost 25% of the common stock.

   III.        CATALYSTS

While DHX has a business model that is either peaking or in decline and valuation is full, investor sentiment remains very bearish, suggesting any catalysts will be to the upside.  Investor interest and therefore valuations for DHX have gyrated substantially in its young history as a public company, with price often deviating far from intrinsic value as investors have ditched valuation in favor of viewing DHX as a thematic stock that will either flourish or die.  In April 2011, investor fears focused on LinkedIn’s outsized momentum taking clients away from online job boards.  These fears then switched to the fear of the macroeconomic uncertainty in Europe and related ripple effects into the U.S. economy and DHX’s fundamentals, sending the stock’s price down even further.  Therefore, 2 soft catalysts are likely to cause a re-rating of Dice’s common equity:

1. Macroeconomic conditions – Investor interest and therefore valuations for DHX have gyrated substantially in its young history as a public company.  This will have a two-fold impact on the fair value of Dice’s common equity, as an improvement in the macroeconomic environment, particularly improved hiring, will provide substantial upside to DHX’s earnings and cash flow power.

1. LinkedIn stalls – Investors, when not overwhelmed by the macro uncertainty in Europe, have focused on the erosion of DHX’s business model at the behest of LinkedIn’s success helping recruiters and direct hiring companies source candidates in lieu of the online job boards such as Dice.  Should the momentum of LinkedIn’s market share gains decline, investors will likely shift course, believing to have exaggerated LNKD’s negative impact on DHX’s business model.

   IV.        KEY DRIVERS

The key operating metrics for Dice (under “Key Operating Ratios” in the table below) are: 1) Average revenue/recruitment package; 2) Recruitment packages/employee and; 3) Recruitment packages/$ MM of sales and marketing expense.  Item 1 above assesses a combination of the pricing power of the service with the number of users and job postings for each recruitment package and is critical not only to the short-term earnings and cash flow generation but to assessing the sustainability of DHX’s competitive moat.  Items 2 and 3 above illustrate how efficient Dice is, as this business is driven on the margin by people/employees and sales and marketing dollars allocated to predominantly reaching IT pros in hopes of garnering resume postings.  Note the strength of the pricing power (average revenue/recruitment package) throughout a very challenging employment environment in 2008 and 2009 as the number of job postings reached a trough of ~57K/yr.

The network effects drive the moat, so it is important to analyze the strength of that moat by tracking the number of resumes posted and number of jobs posted.  If competitive forces eat away at this moat, one or both of these metrics will deteriorate, and analyzing the cause of deterioration will be more meaningful once hiring, consumer confidence and the general economy are not in decline or at historic low levels such as the current environment in the U.S. 

    V.        WHAT TO MONITOR

The key to DHX’s continued success lies in the sustainability of its competitive moat in retaining the dominant collection of resumes for highly educated IT professionals seeking contract and temp work which in turn retains the Company’s dominant position for attracting the related job postings from its customers, the recruiters and hiring managers.  Otherwise, the firm’s “network effect” competitive moat will unravel, bringing down the Company’s enterprise value with it.

1. Decline in # of Resumes Posted: Track the number of resumes posted and note if the Company experiences a prolonged decline (1+ years) during periods of economic stability, namely non recessionary or stable consumer confidence periods.  The only cause for a decline in such a climate would likely be a direct result of a diminishing competitive moat as a result of either LinkedIn eating away at it or due to general decline.  Given the nature of the network effects and related brand power of DHX’s business model, a decline in the candidate resume database will have a precipitous impact on the value to recruiters and hiring managers which will create a downward spiral for the network effects, financial performance and value of the Company.

Historically, the Company has disclosed the total number of resumes posted, and as of FY 2008, has also disclosed total number of resumes posted for less than one year.  However, and this is likely a typo, but in FY2008, DHX only disclosed the total number of resumes posted for less than one year and not the total number of resumes posted.  As such, it is difficult to determine if the total number of resumes declined in 2008.  To the contrary, this omission may be a red flag signaling an intentional lack of disclosure.  That being said, historically the resume database has exhibited either growth or relative stability.  See the chart below for more detail.

1. Decline in # of Jobs Posted: Similar to the number of resume postings, track the number of jobs posted and note if the Company experiences a prolonged decline (1+ years) during periods of economic stability, namely non recessionary or stable consumer confidence periods.  The only cause for a decline in such a climate would likely be a direct result of the quality and size of the resume database diminishing.  A decline in the job postings may be a “canary in the coal mine” signaling that candidates are seeking work on other platforms such as LinkedIn.  The large decline in 2008 is in large part due to the related financial crisis and ensuing recession, but a portion of the downturn may be related to LinkedIn taking some share from the Dice. 

1. Average Revenue/Recruitment Package:  Track the average revenue/recruitment package and note any meaningful percentage declines.  This will signify a decline in either the average number of users/recruitment package, the average number of job postings/recruitment package or the average price/recruitment package.  In any event, either the Company’s core customers are using the service less or Dice has lost its consistent pricing power; both have negative implications for Dice’s competitive position.  Note that the average revenue/recruitment package only declined in FY2009, and even then, it was just 3% (whereas the number of recruitment packages declined a much greater -22% that year).

   VI.        VALUATION & FINANCIALS

1. Valuation:

Intrinsic Value: Applying a discounted cash flow model for intrinsic value purposes has obvious shortcomings with the inherent flaws of long-term projections, particularly as it tends to overstate business value, but to illustrate: 1) the impact of the exit multiple, and 2) the power of compounding (or buying back stock with) DHX’s large cash flows.  I have applied what I believe are rosy operating assumptions to the projections, which are detailed in the attached model, and even with these optimistic projections, the returns to common equity holders peak in the low 20%’s on an unlevered basis and at the current exit multiple of 7.5x.  Assuming a 33% reduction to the exit multiple of 5.0x EBITDA, returns are still positive, assuming an exit during or after 2014.  See the charts below for details.

Historical Value: DHX has traded in a very wide range of values since going public in 2007 due to the high-conflict and far flung “thematic” nature of the investor sentiment that the Company has attracted, in conjunction with the volatile time period measured starting with the financial crisis of 2008.  This provides a very wide range with which to apply a normalized valuation, but note that DHX has never traded below ~4.5x EBITDA and traded as high as 10x – 20x between 2009 and 2010. 

Relative Value: DHX’s closest publicly traded competitor is Monster Worldwide, Inc. (“Monster” or “MWW”), which trades at 4x EBITDA and 17x EPS, while ManPower trades at 5x EBITDA and 12x EPS, and Robert Half trades for 11x EBITDA and 22x EPS.  ManPower and Robert Half both focus on the executive search business, a far more specialized, higher-priced business than the online job posting business that DHX and MWW partake in.  Therefore, MWW is the closest competitor, but MWW has far lower margins and returns than DHX’s “network effect”.  Therefore, DHX should trade at a significantly higher multiple than MWW, currently valued at 4x EBITDA.

Private Market Value: In August 2010, DHX acquired Rigzone for 7.1x LTM EBITDA (8.0x including earn-out).  However, note that Rigzone acts as much as an industry data center as a career site, providing data such as real time offshore rig utilization data and a host of industry news. To be clear, Rigzone also acts as an online job site with over 4,500 job postings, but for valuation purposes, this multiple is not as directly relevant as a pure online recruiting business.

More relevant would be the February 2010 acquisition of Hot Jobs by Monster for $225 MM, which represented approximately 7.5x EBITDA and 2.8x sales.  Again, Hot Jobs lacks DHX’s network effects and outsized operating margins, but assuming a similar private market value of 7.5x EBITDA, DXH common equity is currently fully valued, but enterprise value for Dice is significantly greater than that of Hot Jobs.

 VII.        CAPITAL STRUCTURE

While DHX has $16 MM outstanding under its term loan due January 2014, the Company has a net cash position of $54 MM, over 10% of its market capitalization.

1. VIII.        MANAGEMENT

1. A.    Operating Skills – Relative Operating Skills:  To establish this, I compared DHX versus its sole publicly traded competitor, Monster (“MWW”).  The data dates back to 2007, the year DHX went public.  While this may not accurately reflect a full economic cycle, it is informative in terms of how these two businesses perform relative to one another and how each has performed on a relative basis during the recent financial crisis and recession.

This comparison proves somewhat limited, as unlike DHX, MWW does not disclose its number of recruitment packages sold, number of job postings or number of resume postings.  Furthermore, the only key non-financial operating data MWW discloses is number of employees and dollar amount of bookings (i.e., the cash taken in during the period for recruitment packages sold which is amortized from deferred revenue over the life of the contract), but MWW only discloses its bookings starting in fiscal year 2008, rendering the data less relevant.

Therefore, the best means to compare the relative operational skill between DHX and MWW without the aforementioned operating data for MWW, is: 1) Revenue - % Change; 2) Revenue/Employee - % Change; 3) Sales & Marketing Expense margin and; 4) EBIT margin.  These statistics have been selected as sales and marketing dollars (to candidates) and people generally drive the business.  Note that MWW data is for its Careers segment, which represents its online job board business, its business that most closely resembles Dice’s.

Every metric suggests that DHX has superior management relative to MWW on an operating basis (data available upon request).  The annual percentage change for both revenue and revenue/employee are generally superior for DHX between 2007 and 2010.  Also, forget that DHX has a far leaner sales and marketing expense structure; simply the annual change in both sales and marketing expense margin and EBIT margin for both firms, and DHX still comes out ahead.  Of particular interest, note that despite the sizable revenue decline in 2009, DHX’s EBIT margin remained stable, only declining by 1% point from its peak in 2007 to its trough in 2009, from 29% to 28%.

1. B.    Operating Skills – Setting & Achieving Goals:  This is a question of: 1) is management setting the right goals, and 2) are these goals being achieved?  The answer to question 1 is the true are of focus, as you can see per the “Compensation / Incentives” discussion below, management achieved its two primary goals in 2010, generating revenue above $110 MM and EBITDA above $44 MM.  In reading historical proxies, it appears management has generally achieved its cash compensation targets, implying its goals are being achieved, but revenue and EBITDA are not the best benchmarks for this business; with its high operating margins/ROICs and saturated marketplace, the Company should be focused on profitability, ROIC and value creation/share metrics.  Furthermore, it seems management may not be pushing itself too hard given its consistent achievement of the revenue and EBITDA goals.

1. C.    Capital Allocation Skills:  Management seems to understand that every dollar of cash, income and debt capacity can be allocated to any one of a number of uses including buybacks, dividends, acquisitions or reinvestment in the business, but it’s clear the Company has decided to focus its energies on finding acquisitions, which have been scarce, and eventually the Company is likely to make a poor acquisition simply to generate “growth”.  This is a risk, but this past year, for the first time, due to the outsized excess cash flow, management started to allocate up to 50% of cash flow from operations to buybacks with an authorized repurchase program of $30 MM.  However, this is likely to change once DHX finds what it considers to be a “desirable” acquisition target.  Last, Dice, irrespective of the maturity and high cash flow generation associated with the business, has never paid a regular dividend; this is not expected to change.

1. D.    Compensation / Incentives: 

Cash Incentive:  Management receives an annual cash incentive bonus tied to revenue and adjusted EBITDA targets as set by the compensation committee of the board of directors.  During FY2010, the comp committee set revenue and adjusted EBITDA targets of $110 MM and $44.2 MM, respectively, excluding the impact of acquisitions.  The bonus pool is funded accordingly:

• 30% is funded automatically.
• 35% is funded according to the % of the revenue target achieved.
• 35% is funded according to the percentage of the adjusted EBITDA target.

Each executive receives an attribution rating towards her/his contribution towards achieving these financial targets, with the bonus calculated as a percentage of base salary, capped at 2x salary.

Equity Incentives:  Management also receives restricted stock and options, but without the application of any particular performance standards, just the officer’s tenure with the Company and to what extent her/his prior equity grants have proved worthless.

See the charts below for compensation breakdown of the top officers, and note Melland (CEO) owns almost 5% of the common equity as management and directors own 15% collectively, suggesting management should be incentivized in line with shareholders:

   IX.        RISKS

Risk that would adversely impact DHX’s financial performance and fair value include:

1. Prolonged macroeconomic and employment weakness.

1. Continued momentum in market share gains by LinkedIn and other social networking firms that permanently impair the Company’s “network effects” competitive moat and revenue and cash flow power, or in the extreme case, eventually render DHX’s business model obsolete.

1. The issuance of highly undervalued stock to make a dilutive acquisition.  This is a more remote risk given DHX’s large net cash balance and limited need to raise capital for any acquisitions as well as lack of desirable acquisition targets.

1. Macroeconomic conditions – Investor interest and therefore valuations for DHX have gyrated substantially in its young history as a public company.  This will have a two-fold impact on the fair value of Dice’s common equity, as an improvement in the macroeconomic environment, particularly improved hiring, will provide substantial upside to DHX’s earnings and cash flow power.

1. LinkedIn stalls – Investors, when not overwhelmed by the macro uncertainty in Europe, have focused on the erosion of DHX’s business model at the behest of LinkedIn’s success helping recruiters and direct hiring companies source candidates in lieu of the online job boards such as Dice.  Should the momentum of LinkedIn’s market share gains decline, investors will likely shift course, believing to have exaggerated LNKD’s negative impact on DHX’s business model.