Many of you may recognize the strong brand name of Korn Ferry International (NYSE:KFY), another purchase in the quarter, but you may not have noticed the business transformation the company has undertaken anchored by its December 2015 purchase of the Hay Group. Korn Ferry is best known for its executive recruiting. It is a top brand name in this highly fragmented industry, with a strong offering on the more resilient and niche C-suite space. Most of its job searches have annual compensation of $300,000 or more.
With the acquisition of the Hay Group, Korn Ferry has leveraged this valuable network at the C-suite level and brought critical mass to its human resources advisory businesses. The goal is to engage more with its corporate clients beyond placing top level personnel and to provide a more stable revenue stream than a purely search-driven business model. When acquired, Hay Group earned an uninspiring 8% on its revenue, or $40 million in EBITDA. 11 months after the integration, the Hay Group has begun to deliver on its projected benefits and synergies. We estimate that Hay's EBITDA margin already improved from 8% to 12%, and should continue to grow to 15-16% over the next two years.
Additionally, Korn Ferry has also expanded into mid-level recruiting and recruitment process outsourcing via its Futurestep segment where it is leveraging its connections with large clients. While Futurestep is still small, contributing only about 10% of total earnings, it has high growth potential.
Korn Ferry is a strong cash generator and still retains a net cash position on its solid balance sheet. We feel that investors underappreciate the new Korn Ferry in its financial strength and in the transformation brought by the Hay Group and Futurestep, both of which materially lessen the volatility of the core search business while also supporting broader revenue growth and earnings power. At our purchase cost of about $20.50, we see the stock as extremely inexpensive, trading at 9.2X price to earnings ratio and 7.3% free cash flow yield with upside to $30 fair value NAV.
From Third Avenue Management (Trades, Portfolio)'s third quarter 2016 commentary.
