Description

Summary:

• Investment Thesis:

• Paying 11x Adjusted EBITDA and 12.5x Earnings for a software + services business with long term contracts (97% revenue retention) and mid-high single digit organic revenue growth guided to accelerate to 10% in ’23 (supported by the visibility of already contracted bookings); trades 4x-14x turns cheap to its peers on EBITDA, several of whom ALIT is taking market share from, as evidenced by large new contracts recently awarded by some of the world’s biggest companies; on forward numbers paying 9.4x Adjusted EBITDA and 10.1x Earnings

• Attractive absolute and relative valuation for an exceptional core business with embedded call options on (i) continued strategic transformation, (ii) ~800bps of targeted margin gains, (iii) multiple expansion, (iv) significant bolt-on M&A prospects, (v) ALIT itself is a rumored target, and (vi) most importantly, the potential upside inherent in its enterprise platform/ecosystem “WorkLife” which serves a captive audience of 30+ million people (further detail below in Corporate Strategy section)

• Why the opportunity exists and why does the stock trade at a valuation suggesting limited organic growth and margin opportunity?  (i) ALIT is a large established company but remains under the radar and overshadowed by the disarray in overall SPAC sector, (ii) the extent of positive transformation that has occurred at the company over the last several years is  underappreciated:  new management + completed transition to the cloud + new contract wins + strategic bolt-on M&A + organic growth revenue inflection, (iii) underfollowed by the Street, incumbent upon management to better convey their strategy and explain the business (also complicated by the fact that there are no easy/natural public comps and ALIT is not yet included in indices)

• Highlights:  (i) high-quality defensive growing software + services company with >83% recurring revenue, (ii) market leader serving 70% of Fortune 100 and more than half of Fortune 500 under sticky long term contracts (15yr average tenure and 97% retention), >4,350 employer clients and their 30+ million employees (~14% of US working population) are on the ALIT system; (iii) asset light business with strong FCF and attractive margins (Adjusted EBITDA margin currently ~22% with a plan to get to 30%+ in medium term), (iv) company was an orphaned asset that has been reinvigorated under excellent new senior management and controlled by Blackstone and Bill Foley, (v) no transition risk as the tech/cloud transformation is complete and already paid for (capex and opex has been spent), (vi) results since been public have been excellent, (vii) Adjusted EBITDA is projected to grow from guided ’22 midpoint of $656M to $768M in ’23 (details below)

Business/History:  

• ALIT provides mission critical software and services across HR / healthcare / benefits / payroll / retirement for its >4,350 enterprise and mid-market clients; this work is done under 3-5 year contracts under which ALIT is paid a per employee per month (PEPM) fee; the level of PEPM varies based on the number of solutions ALIT provides the client; the base level PEPM covers core benefits software and administration and incremental PEPM is layered on as modules are added; this is a very sticky business characterized by long term contracts, high retention and high switching costs; contracts also include ECI (Employment Cost Indicator) escalators as a natural inflation offset

• History:

• Company was built by top tier consulting firm Hewitt (HEW); AON bought HEW in 2010 and the business became a cash cow under AON ownership; Blackstone bought the company in Feb 2017 from AON and the company was renamed Alight

• The business was non-core as part of AON but under Blackstone’s ownership, several key events occurred:  (i) the technology was upgraded and moved to the cloud, (ii) completed several important bolt-on acquisitions to expand the product offering, most importantly in Navigation and Payroll (more below), (iii) implemented a material cost rationalization/restructuring program called Project Optimus, (iv) prior management had underperformed and was replaced by a top tier new team led by CEO Stephan Scholl (formerly President of Infor (where he ran a similar playbook), prior held senior roles at ORCL and Peoplesoft) and President/CCO Cathinka Wahlstrom (long tenured very senior executive from Accenture); a new CTO and CXO were also hired; the CFO Katie Rooney has been with AON/the business since 2009 and is also excellent; senior management owns material equity and their incentives/compensation are well aligned with a focus on EBITDA, earnings growth and new bookings

• The new management team (i) integrated the acquisitions and finished the cost restructuring program, (ii) completed the technology upgrade, revamped the front-end experience and finalized the move to the cloud, (iii) the entire go-to-market sales team/function/incentive structure was also overhauled, prior management fostered more of a silo-ed renewal culture whereas the new team is empowered to win more business from existing customers and a new logo team was formed (did not exist in the past); are now selling more to the C-suite vs. historically product was sold to HR

• In early 2021, ALIT announced a transaction to go public via one of Bill Foley’s SPACs and the deal closed mid-year; Mr. Foley brings his decades-long experience, playbook and track record in similar businesses to an already strong team; part of the plan at ALIT is similar to the highly successful transformation Mr. Foley oversaw at Ceridian HCM (CDAY):  take a strong legacy business with a large sticky installed base + upgrade the technology/move to the cloud + expand service offering = accelerate  growth by adding new customers and via migrating/upselling your installed base

• As further detailed below, the strategy is definitively working as evidenced by (i) accelerating organic growth, (ii) operating leverage leading to higher EBITDA margins, FCF and guidance, and (iii) most importantly, material new business booking momentum demonstrated by disclosed TCV (total contract value) backlog growth and several large high-profile announced wins (PricewaterhouseCoopers, Royal Dutch Shell, Sartorius, Navistar, Arconic, Camping World, Genworth, Dell, Walgreens, INGKA/IKEA, MercadoLibre, others)

Segment Overview:

Employer Solutions (87% revenue):

• Health:

• ALIT provides variety of complex outsourced solutions to the world’s largest companies; ALIT supports and administers its clients’ employees’ healthcare and benefit plans with a unique combination of its proprietary SaaS software platform complemented with the expertise of its client facing people and personalized support (AI, call center, email, chatbot, chat, etc.)

• Example:  multinational Fortune 500 company XYZ has multiple dozens of different health plans and benefits offered to its employee base across geographies/jurisdictions, employee level/tenure/multiple unions, eligibility, etc.; ALIT is hired as a fully outsourced provider to manage/administer/support these plans

• On the software/data side, the ALIT system is the core database holding and maintaining all longitudinal information on every employee (and their dependents) as well as the details/rules of each health and benefit plan; each company has different plans/benefits and the ALIT system has to interface with both the client’s HR/General Ledger/payroll systems as well as all of the carriers/plans and benefit providers; it does so to be able to properly determine eligibility, process claims data, calculate usage limits, credits, deductions, ensure compliance, etc.

• Plans are dynamically changing at both the employee level from open enrollment/date of hire through life changes (divorce, children, leaves of absence, etc.) through resignation/termination/retirement, as well at the plan level where various changes occur through the year; all these have to be implemented in the system and managed properly

• On the services side, health plans and benefits are highly complex to both choose from and use through the course of a year/career; when an employee of company XYZ has questions and wants to call, email, chat, etc., ALIT is at the other end with the expertise based on their knowledge of the sector combined with the data/system which holds all the information on the company’s plans and the employee’s situation

• ALIT supports comprehensive offerings across core Healthcare/Dental/Vision/Rx/mental health plans, reimbursement solutions (FSA/HSA/dependent, commuter), employee/dependent verification, retiree medical, COBRA, voluntary benefits/disability/life, etc.

• Competitive landscape:

• ALIT is by far the leader in the large market/enterprise space (serving 70% of Fortune 100 and more than half of Fortune 500), with a division of CNDT the distant #2; CNDT came out of XRX/ACS, is a perennial underperformer and market share donor (albeit a slow one evidencing how sticky the business is); the competing business is non-core at CNDT and they have become a rational actor; besides CNDT, WTW has some large clients and several large companies don’t outsource but rather do this work in-house

• ALIT is also a leading player in the mid-market particularly after the acquisition of Hodges-Mace; the mid-market is a significant area of white space as ALIT has an estimated 6% market share and a renewed focus via both direct sales and the broker channel; the comps in the mid-market are smaller and have a much more limited product offering:  Businessolver (private equity owned), benefitexpress (was private equity owned, recently bought by WEX for $275M), bswift (owned by AET, prior private equity owned), public company BNFT  

• Navigation:  

• This is one of the fastest growing portions of the market and ALIT’s 2018 acquisition of a company called Compass was a key move to establish the company as a leading provider; Navigation is a benefit service offered to clients that uses the combination of ALIT’s longitudinal database + analytics plus personalized support to help a client’s employee make the right and cost effective health decisions; at the most basic offering level, it encompasses helping employees understand their plans/choose the right providers/advocate cost on their behalf, with increasing value added services and touchpoints added up the value chain all the way to “Total Health” which is a concierge-like service with access to ALIT’s experts including doctors and nurses for advice and second opinions

• Key point here is that most of ALIT’s client base is comprised of huge companies that self-insure; Navigation is both a highly value-added offering for ALIT’s client’s employees but importantly also saves the employer client material dollars in the form of lower health care costs; there are endless use cases but some simple examples include provider matching, in vs. out-of-network choices, helping an employee get an MRI or a procedure at a center rather than in higher cost hospital settings; other simple examples include the operation of preventative programs like smoking cessation, diabetes management, monitoring prescription medication usage, etc.; Navigation is an extension and in some cases a replacement of a health plan’s member services; Navigation services are charged as incremental PEPM (increasing based on service tier) and the highest level Total Health offerings are exciting as ALIT both gets higher PEPM and in increasing cases shares in the upside from the savings created

• Comps:  Accolade (ACCD) is a $840m market cap public company that trades at 2.5x revenue and has exhibited strong growth in Navigation; ACCD targets both the enterprise and mid-market segments, has only ~100 total clients, but 3 large Fortune 500 companies make up close to 40% of their revenue and they are EBITDA negative; conversely, ALIT has similar growth, is very profitable, has a larger number of existing customers plus an installed base of ½ the Fortune 500 and thousands of mid-market clients to sell to; furthermore, ALIT has a complete offering (Health, Wealth, Payroll) that ACCD and others cannot replicate; the other sizable Navigation player is Quantum Heath, which is privately owned (Warburg Pincus) and targets the mid-market

• Payroll:

• ALIT is the #2 player in global payroll behind ADP from whom ALIT continues to win deals/take share from; ALIT comes at payroll differently; in the US, it is a large System Integrator (SI) for WDAY (see Professional Services segment below) and after they deploy WDAY at a client, ALIT has a recurring services business that operates and supports the WDAY system, including administering payroll

• ALIT’s previously US-centric payroll business was augmented with the acquisition of NGA Human Resources in 2019; this brought a large international business (>150 total countries served); NGA serves its installed base via both its proprietary HrX system as well as a leading operator/administrator of SAP/SuccessFactors’ payroll modules

• ALIT is paid for their ongoing recurring payroll services on a similar PEPM model and the key differentiated strategy is the ability to be a global payroll provider (via the combination of its proprietary software and the integration with WDAY and/or SAP)

• ALIT’s software + services strategy is also working in Payroll as evidenced by several material new wins announced (beat out/replaced ADP at Royal Dutch Shell, Sartorius, PwC, other); ALIT is winning these multinational enterprise clients by (i) combining its own platform with WDAY+SuccessFactors to be able to present a true global offering, (ii) bundling the service with Health/Navigation and Wealth where applicable, and (iii) coming at it from a software+service angle and not to take advantage of a clients’ float (a material business model difference vs. how ADP, PAYX, the legacy domestic payroll industry has been built)

• Wealth: 

• ALIT provides administration and record keeping services for 401(k) Defined Contribution (5M people, $480B AUA) as well as legacy Pension/Defined Benefit plans; the model is again similar as they are largely paid on a recurring PEPM basis

• ALIT is the #1 independent provider and is up against other large integrated providers Fidelity, VOYA and Empower; the key differentiators for ALIT are:  (i) independence/conflict free as they are not trying to sell investment products within a 401(k) plan like Fidelity and the other comps and (ii) the ability to have comprehensive bundled offering with Health/Navigation and Payroll

• This segment is also growing nicely; ALIT recently won the largest 401(k) client in the world in the US federal government TSP (Thrift Savings Plan); this new contract will add >6M covered employees to the platform, is currently in the implementation phase and is estimated to come online late 2022; annualized revenue starting in 2023 is estimated at $120-$130M+ at similar to company average margins

Professional Solutions (13% revenue):  ALIT is a top tier System Integrator (SI) (similar to Accenture, Deloitte, etc.), deploying WDAY as well as maintaining/operating the whole system (not just Payroll) once it is deployed for the client user; “Project” based work in this segment represents deployments and the “Recurring” portion of this segment is the ongoing maintenance / operation / administration of the system; the SI deployment business is a solid standalone legacy asset of AON/HEW and a good business benefiting from the growth/tailwinds at and in partnership with WDAY; the portion of this business that most strategically fits with the rest of ALIT is the synergy with the aforementioned Payroll segment

Corporate Strategy/Growth Drivers:

• Companies today are more focused than ever on employee retention, health and wellbeing; large companies have multiple dozens of silo-ed benefits/programs offered to their employees and spend a fortune doing so; however, employers are frustrated with the qualitative and quantitative return on this investment; the core problem is employee utilization of/engagement with these programs is very low as they are provided by dozens of individual point solutions that are cobbled together, hard to access and understand; as described further below, the ALIT platform is the solution to this problem which ultimately drives better engagement, decisions and outcomes for employees, and for employers saves money and helps create a happier, heathier and more productive workforce

• Core Health/Navigation, Payroll and Wealth offerings all naturally fit together and ALIT is the only company that combines the three at scale – this is why the company wins 85% of its RFPs and is taking share; furthermore, having the combination of proprietary software plus the service delivery capability is a key competitive advantage and unique to ALIT at scale

• With the tech modernization complete and a new consumer grade, UI/UX friendly front end, ALIT is able to offer a complete, one stop shop platform called “WorkLife”; this platform encompasses all the services ALIT provides and also has a full API integration layer for those it doesn’t currently do itself (e.g., at Company XYZ, ALIT may perform the Health and Wealth services but not Payroll, using the API to bring in the payroll data from 3rd party provider); over time, as the central destination/platform, Alight can replace 3rd party integrated vendors with its own solutions

• The key is that ALIT owns/controls this enterprise platform building a relationship with a captive audience of 36+ million people (pro forma for the abovementioned TSP contract) who regularly come to its interface for help and content (via the app and/or desktop); ALIT has created a network/ecosystem with its own content as well as where they are the gatekeeper / vendor management marketplace for distribution; furthermore, there is a growing B2B2C opportunity as many clients permit ALIT to sell other services directly to their employees such as voluntary benefits

• Multiple growth drivers:

• Selling more services to the existing installed base:  company estimates that in Health segment alone is room to double the PEPM, not including the cross-selling opportunity with the other segments Wealth and Payroll

• New logos in large and mid-market:  shown significant success vs. competition in last 12-18 months winning large new business across all segments (PricewaterhouseCoopers, Royal Dutch Shell, Sartorius, Navistar, Arconic, Camping World, Genworth, Dell, others); PWC was won from CNDT and Fidelity, Shell was won from ADP, ALIT beat out ADP at Sartorius

• M&A:  abovementioned Compass, NGA and Hodges Mace were all accretive and strategic deals; in 2021, ALIT completed additional accretive bolt-on acquisitions of AON’s retiree health exchange (plugging in another offering to the core platform/network) and a smaller company called ConsumerMedical (adds capabilities to the Navigation business)

• Strategic:  (i) build out the network adding offerings to the ecosystem serving 36 million people, (ii) potential for ALIT’s platform to be integrated into WDAY as a more robust Health/Benefits module than exists at WDAY today, this module can also be sold by 3rd party WDAY sellers / brokers to augment ALIT’s direct salesforce, (iii) additional data/analytics driven use cases:  company has a consistently growing longitudinal database on 36 million people, full data on employee’s payroll, insurance, health history, investments, etc.; this can lead to additional hyper-personalized products to help employees and employers

• Importantly, this is all working as evidenced by disclosed bookings/TCV (total contract value) which has driven and will continue to drive accelerating revenue growth

• Total TCV bookings for 2021 alone were well in excess of $1.1 billion, up >25% YOY; TCV is a key metric and leading indicator measuring the total contract revenue value sold in a period; contracts can vary in duration (e.g., number of years and levels of service) and time to implementation (add-on services quicker to implement vs. a large new deal like PriceWaterhouseCoopers that can take a year to implement)

• Critically, the TCV metric does not include renewals so these bookings represent 100% additive business; as the core ALIT business enjoys a 97% retention rate, the total growing quantum of cumulative TCV bookings is the key leading indicator of visible contracted projected growth as revenues/cost/EBITDA are generally recognized once implementation is complete and a contract goes live

• Cloud transformation:  management has largely completed the platform modernization and move to the cloud, this:  (i) widens the existing moat at enterprise clients and adds tools to further penetrate the mid-market, (ii) reduces support and implementation time and cost as the cloud is easier to implement/configure/run/customize = margin accretive, (iii) provides a better integrated bundled delivery of modules to further accelerate revenue growth, (iv) decreases ongoing cost to serve as an added cost benefit of the company’s improved, intuitive and more automated WorkLife platform/app is that less human support is necessary over time (e.g.  last quarter the company disclosed a 33% decrease in call center volume)

• BPaaS (Business Process as a Service):  is the terminology used by the company to define its value-add SaaS + services, higher margin bundled offering

• BPaaS TCV has become the key metric provided by management, representing the value-add higher margin subset of total company TCV in a period; importantly this metric is also a key driver in management’s incentive compensation plan

• BPaaS TCV bookings were $263M in 2020 and grew to $604M in 2021 (vs. the initial target of $395M); 2022 BPaaS TCV bookings are projected to be an additional $680-$700M in 2022 based on the company’s current pipeline

 Financials/Numbers:

• 2017-2019:  under the initial years of BX ownership, top line was driven by moderate organic growth and M&A; EBITDA dollars grew due to organic growth, M&A and cost cutting; EBITDA margin was adversely affected by mix (companies acquired were initially margin dilutive) and investment in the P&L to effectuate the aforementioned tech upgrade and salesforce hirings

• 2020:  COVID moderately affected top line as some clients had layoffs and projects were deferred; EBITDA was ~flat at $564M and continued to include cost burden from the tech upgrade and salesforce hirings

• 2021: 

• Growth accelerated throughout the year as annual top line guidance was continuously raised from 1-2% to 3-5% to 5-6%, and EBITDA was raised from $600M to $620M; the drivers of the acceleration were a combination of many of the factors mentioned above, overall the company is selling more to its existing customers plus large new TCV bookings won over the last 12-24 months are going live

• Final 2021 results:  >7% top line growth and $621M Adjusted EBITDA (largely organic as the bolt-ons didn’t close until the 4Q); the top line acceleration + restructured cloud-enabled cost base + Project Optimus + led to moderate margin expansion

• 2022: 

• Top line is guided to grow 6-7% (largely organic), driven again by already contracted bookings in TCV going live, providing revenue visibility upon implementation

• EBITDA range guided to $650M-$662M, I believe this is a conservative number as the company has several drivers to bridge to these targets:  annualized contribution from completed M&A + annualized cost savings from Project Optimus + higher incremental margins on accelerating organic top line growth; EBITDA margin is implicitly guided to ~flat in ’22 as management has characterized ’22 as the last investment year (aforementioned go-to-market and technology hires as well as the necessary spending in advance of the Federal TSP contract go-live later in 2022)

• 2023: 

• Top line is guided to accelerate further to 10% in 2023, again driven by existing TCV bookings and the first full year of the Federal TSP contract

• EBITDA guided to $768M (per initial deal and reiterated at analyst day) for 2023; drivers to bridge to this target:  the incremental EBITDA form the Federal Thrift contract + higher incremental margins on accelerated organic top line growth + higher revenue contribution from BPaaS revenues which come at a higher mix; whereas ’22 is characterized as an investment year, management views ’23 as the year to showcase the inherent operating leverage in the business; note that the $768M EBITDA target was issued before the AON Retiree and ConsumerMedical acquisitions

• These 2022 and 2023 targets do not include additional accretive bolt-on M&A and/or other uses of ALIT’s ample FCF generation

 Valuation/Metrics:

• ALIT:

• Enterprise Value:  $4.75B market cap + $2.5B net debt (3.8x leverage) = $7.25B Enterprise Value

• 2022 metrics:  11x EBITDA and 12.5x Adjusted Earnings

• 2023 metrics:  9.4x EBITDA and 10.1x Adjusted Earnings

• Comp EBITDA ’22 multiples:  there is no perfect comp as each segment has different attributes; source: Bloomberg

• Consulting/outsourcing/administration:  ACN 18x, BR 17x, HQY 25x

• Payroll: ADP and PAYX trade at 23x EBITDA

• Large brokers:  AON 19x, MMC 17x, WTW 12x, AJG 16x, BRO 18x

• Outsourcers:  WNS 14x, EXLS 17x, G 12x

• Navigation:  ACCD trades at 2.5x revenue

• Conclusion: 

• Excellent software + services business with long term contracts (97% retention) and mid-high single digit organic revenue growth guided to accelerate to 10% in ’23 (supported by the visibility of already contracted bookings)

• Attractive absolute and relative valuation for an exceptional core business with embedded call options on (i) continued strategic transformation, (ii) ~800bps of targeted margin gains, (iii) multiple expansion, (iv) significant bolt-on M&A prospects, (v) ALIT itself is a rumored target, and (vi) most importantly, the potential upside inherent in its enterprise platform/ecosystem “WorkLife” which serves a captive audience of 36 million people

• Over the next year, I believe the company will re-rate as the business exhibits inherent stability, executes upon its material contracted growth and improves upon its already strong margins; at 14.25x Adjusted EBITDA of $700M, the stock would be worth $14, up 59%; in an upside case where '23 Adjusted EBITDA guidance is achieved and the multiple expands to 16x, the stock would be worth $18.25, up 107%; over a longer horizon, I believe the stock has material further upside as the company will continue to grow at elevated levels and the multiple has room to further expand as ALIT is properly viewed as an enterprise platform

 Other:

• Takeout rumors:  www.bloomberg.com/news/articles/2021-08-10/voya-is-said-to-explore-potential-deal-for-newly-public-alight

• Russell index inclusion:  the Street expects ALIT to be included in the various Russell indices on the next Russell Reconstitution scheduled to occur in June; could have dual positive effect on the stock via creating a material technical buying driver as well as qualitatively bringing more attention to the company

• Sell-side initiations:  expect to see more sell side coverage/initiations/management road shows in the near term as company has already given annual guidance and becomes more seasoned as a public company

• Fully Diluted Share Count (as of 12/31/21):   538.8 million shares outstanding (including all common share equivalents and RSUs); excludes 15 million earnout shares issuable to BX and other selling shareholders (½ vest if ALIT stock >$12.50, ½ vest of ALIT stock >$15); all SPAC warrants were exchanged the end of ‘21, resulting in a clean capital structure

• Illustrative EPS calculation: 

• 2022: Adjusted EBITDA $656M - $115M interest - $90M Depreciation - $70M Taxes = $381M Net Income / 538.8M shares = 71c

• 2023: Adjusted EBITDA $768M - $105M interest - $90M Depreciation - $102M Taxes = $471M Net Income / 538.8M shares = 87c

• Notes:  (i) calculation does not add back/give EPS the benefit of non-cash stock compensation, (ii) cash taxes are materially below book taxes due to legacy Up-C structure and deductible amortization, (iii) calculation assumes majority of $250M of Intangible Amortization is deductible and does not assume material shareholder benefit from the TRA

• Foley stock sales:  per recent Form 4, Bill Foley sold a small amount of his controlled ALIT shares for tax reasons, I believe that the warrant for stock exchange completed last year was a taxable event and the shares were sold to fund the resultant taxes due

• Suggested reading:   investor day transcript/video (contains business overview and several use case examples) and accompanying slide deck (contains historical and projected financials); recent quarterly slide decks on the IR site; transcript from recent Morgan Stanley TMT conference (interesting discussion surrounding the platform strategy)

Risks:  (i) execution of new implementations; (ii) data security, (iii) smaller but growing mid-market comps, (iv) long cycle biz, new wins take time, (v) sponsor overhang

Important Disclaimer

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Catalyst

• Over the next year, I believe the company will re-rate as the business exhibits inherent stability, executes upon its material contracted growth and improves upon its already strong margins; at 14.25x Adjusted EBITDA of $700M the stock would be worth $14, up 59%; in an upside case where '23 Adjusted EBITDA guidance is achieved and the multiple expands to 16x, the stock would be worth $18.25, up 107%; over a longer horizon, I believe the stock has material further upside as the company will continue to grow at elevated levels and the multiple has room to further expand as ALIT is properly viewed as an enterprise platform