In May 2014, Seek Limited (ASX: SEK) announced an intention to sell part of its stake in Zhaopin; the market leader of online recruitment services in China.

Proceeds from the sale are expected to be around $100 million and Seek’s stake will be cut from 79.0 per cent to 67.3 per cent. Zhaopin is expected to hold its initial public offering (IPO) tomorrow on the New York Stock Exchange.

Zhaopin has performed well from FY09 to FY13 with annualised compound revenue growth of 31 per cent per annum. Gross margins are in the order of 90-92 per cent and the firm reported a FY13 free cash flow margin of 24 per cent. Note also that the firm has yet to implement any price increases to its customer base! Zhaopin currently holds a 30 per cent market share in China whilst its nearest rival holds a 25 per cent market share. The remaining 45 per cent of the market is split between many smaller players.

As with many successful online businesses, the firm’s main economic moats include the network effect, its brand name and its scale. The CEO of the firm estimates that it would take 10 years for a rival firm to replicate its resume database which includes over 57 million individuals.

Given Zhaopin’s quality and prospects, a rational observer may question the rationale behind the 11.7 per cent sell-down. Reportedly, the proceeds of the sale will be used for organic expansion in Zhaopin and potentially some “bolt on” acquisitions.

From a theoretical standpoint, the IPO of this firm makes sense only if the future returns on the sale proceeds are higher than what it would have been had the IPO not taken place. Zhaopin was already generating strong returns and hence it’s questionable whether even higher returns can be sought from other avenues – of course Seek and its related companies have surprised the market before and very well may do so again.

As a notable caveat, Seek purchased 16.8 per cent of its 79.0 per cent stake in Zhaopin in January 2014 for $105 million. The numbers above imply that Seek is now selling 11.7 per cent of its stake for almost the same amount only a few months later – not a bad trade!

The Montgomery Fund and the Montgomery Private Fund hold financial interests in Seek Limited.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564) and may contain general financial advice that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs.