Headhunters: Poised for Bigger Game

Imagine you're chief of Korn/Ferry International (KFY ), a top executive search firm. You wake up on a recent morning in Chicago to learn that the CEO of one of that city's highest-profile firms has suddenly quit. It must find a successor. So you jump on the phone to hustle the assignment, right?

Not if you're Korn/Ferry CEO Paul Reilly, who got just that news on Apr. 8. K/F could use the fee. But the outgoing CEO happened to be Piers Marmion, Reilly's opposite number at rival Heidrick & Struggles International (HSII ). Naturally, H&S tapped itself, specifically ex-CEO Gerard Roche, to find Marmion's replacement. (Meantime, Roche is acting CEO.) In quitting, Marmion, 44, cited the toll a heavy travel schedule took on his young children. But he also noted how brutal business has been. "We have made many painful decisions," he said, adding: "You pick up scar tissue."

Anyone with stock in these two search firms knows all about pain and scars. H&S trades around 13, down from a high of 75 in 2000. K/F that year topped 44; it's now below 7. With the Internet bubble long burst and the economy in a rut, executive search firms have shrunk. Revenue at H&S, for example, sank to $377 million from $628 million in 2000. K/F's revenue plunged even more. Yet if you ask me -- and despite the uncertainty at H&S, with a vacancy at the top -- both firms are in a good spot to see fortunes rebound once the economy, and hiring, turn up. "I'm extremely optimistic," Reilly told me.

Of course, you can count on most any CEO to view the future with hope. What makes this outlook credible to me are some simple but fundamental strengths. First, both companies remain among a very few firms that are chosen reflexively by global corporations to fill their top jobs and seats in the boardroom. The latter task is one of today's few bright spots. At K/F, director searches are up over 30% in the aftermath of financial scandals at such companies as WorldCom as boards bolster their audit committees.

Another strength the search firms share is that, throughout these bad times, both have maintained formidable balance sheets. By Jan. 31, K/F had $68 million in cash, more than enough to cover its $45.7 million in total debt. H&S's position is even stronger: Chief Financial Officer Kevin Smith told me that its cash on hand is near $70 million, while total debt at last report was less than $1.5 million.

Future losses might erode these positions. Yet after vast cost-cutting, finances appear to have stabilized. At yearend, H&S had cut its consultant ranks to 337, from 585 two years earlier. The silver lining: After eating $20 million in cash during 2001, H&S's operations last year created $6 million in cash, and it expects to have positive cash flow again in 2003. At K/F, which closes its fiscal year in April, operations consumed nearly $60 million in cash during fiscal 2002. Over the last four quarters, they produced nearly $28 million in cash, and Reilly is hoping the positive trend will persist in the coming year.

Stability is one thing; growth another. Neither company will expand much until clients start hiring again. As they do, profits should follow quickly. If H&S this year posts revenue comparable to last year's $377 million, it will see a 3% to 5% operating profit margin. As revenues climb back to, say, $450 million, it expects that margin to expand into double digits. K/F, with annual revenues now near $330 million, similarly figures that revenue growth of just 15% would widen operating margins to the low double digits. Do the math, and the stocks trade at a modest five or six times prospective operating profit. When will the economy show signs of turning up in earnest? I can't say. But when it does, no one will need to recruit investors for headhunters.

By Robert Barker

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