Description

Summary

Alight is the leading player in the benefits administration industry, providing clients with integrated solutions to manage their health, wealth, payroll, and other HR functions. The company’s combination of high-touch service with best-in-class technology, as well as its broad portfolio of bundled offerings, are strong competitive advantages vs. peers. Since coming public, Alight has demonstrated accelerating growth as the company’s proposition is resonating in the market and leading to many new client wins. Alight trades at an attractive valuation of 9x 2023 TEV/EBITDA and 12x 2023 P/E, a significant discount to intrinsic value as well as a meaningful discount to peers. Given the company’s excellent competitive position, strong management team, and attractive growth prospects (mid-to-high single digit revenue growth with margin expansion), we expect that an investment in the stock will provide attractive returns over a 5-year time horizon. The risk of the investment is also limited due to the highly predictable nature of the company’s business and its relative insulation from cyclical risks. 

Company History

• 1940: Hewitt Associates is founded. Over the coming decades, the firm specializes in providing actuarial services for sponsors of retirement plans

• 1970’s: New legislation establishes the 401(k) and other frameworks for flexible benefit programs, substantially increasing companies’ needs for administration of health and wealth benefit programs

• 1991: Hewitt introduces the Total Benefit Administration (TBA) system, the first integrated technology platform for outsourcing the administration of benefits

• 2002: IPO of Hewitt Associates

• 2010: Aon acquires Hewitt Associates, and it is renamed Aon Hewitt

• 2017: Aon sells its benefits and HR platform to Blackstone. The new company is rebranded as Alight Solutions

• 2020: Alight appoints Stephan Scholl as its new CEO

• 2021: Alight comes public via a SPAC sponsored by Bill Foley

Business Overview

Alight is a dominant company in the benefits administration sector, offering mission-critical services that assist businesses in managing their benefits and human capital expenses. The company's revenue is derived from a diverse set of sources, with healthcare benefits administration making up ~45% of the total, followed by wealth management at ~20%, payroll and HR services at ~20%, and professional services, such as consulting and software implementation, at ~15%.

Benefits administration is a core utility function for almost all employers. Benefit administration systems generally determine which benefits employees qualify for, including health, dental, disability, retirement accounts and 401(k), vacations and paid time off, sick leave, and parental leave. Benefits administration is usually one of the essential functions of an HR department – effective benefits administration can serve as a competitive advantage for many organizations in attracting, hiring, and retaining top talent, as well as cutting operational costs.  Additionally, as healthcare costs have continued to balloon in the United States, C-suite executives have paid increasing attention to solutions that help them lower overall benefit costs.

Alight has a history that spans more than 80 years. Founded as Hewitt Associates, Alight is recognized as an industry leader, serving approximately half of the Fortune 500 companies. This legacy has established Alight as a “gold standard” provider of benefits administration services. During its tenure as a division of Aon, Alight suffered from a lack of focus, investment, and strategic direction. Following its spinoff in 2017 and subsequent acquisition by Blackstone, Alight has seen a significant revitalization. This renewed focus has driven a rapid improvement in the company's delivery cost and technology stack, reinforcing its strong market position.

One of Alight's key competitive advantages is its combination of strong technology with deep, high-touch service. Few competitors can match Alight's scale and its ability to service large enterprises while simultaneously developing a robust technology stack. While some competitors have historically had more modern technology, Alight has consistently outperformed them on service delivery. 

Moreover, Alight has made great strides in improving its front-end and back-end technology in recent years. In 2021, Alight launched its new Worklife app, significantly improving and standardizing the front-end experience across all its clients. Worklife has resonated well with clients their employees, garnering high app store ratings and customer satisfaction marks. Additionally, this new approach has reduced the burden on Alight of maintaining many disparate, customized implementations. Alight has also made progress in recent years in the use of AI and machine learning across the business. With a base of 36 million members, Alight has very valuable data assets it can use to make recommendations to its customer base. The company recently shared the average savings per participant from use of its AI decision support tools is $500+, and they are doing everything they can to further increase the usefulness of these tools.

The benefits administration industry is an attractive market, characterized by high switching costs and entrenched relationships. Contracts typically span 3 to 5 years, and Alight has consistently demonstrated a high revenue retention rate, averaging between 97% and 98% over the past 5 and 10 years. Alight’s average client relationship currently spans ~15 years. This stickiness is a testament to Alight's superior service and its ability to form lasting relationships with its clients. Our conversations with Alight clients and brokers in the space indicate that it is incredibly difficult to rip and replace a benefits administration system, and companies would only consider doing so if their existing provider makes big mistakes or if someone else can offer much better breadth and depth of services.

The industry is also very fragmented, with a wide array of services typically spread across multiple providers. Clients in the past would hold separate RFPs for every service. This over time led to a patchwork of point solutions, with a large enterprise typically contracting with dozens of benefits partners. This dispersion led to significant confusion and underutilization by employees, and therefore a lack of ROI for clients’ spend on benefits. In our view, Alight is best positioned to aggregate these services, bundle products, and serve as the go-to portal for employees’ benefits needs – to the extent they can deliver on this vision, they will have significant opportunities for growth. The company's wide service offering allows it to bundle different products and cross-sell, thereby accelerating growth and providing more value to its customers. Alight recently noted that the company has an opportunity to double its revenue simply from bundling services and selling into its existing clients.

Additionally, it is worth noting that Alight currently holds only a 6% market share with middle-market sized employers, highlighting a further opportunity for growth. This segment of the market is often underserved, and Alight's comprehensive range of services and established reputation position it well to capture a larger portion of this market. While the go-to-market and customer needs are different in this space, it is certainly possible Alight will gain further momentum here.

In conclusion, Alight's strong market position, enhanced focus, and rapidly improving technology stack, combined with significant growth opportunities within the fragmented benefits administration space, make it a highly compelling investment prospect. The company's deep industry expertise and customer-centric approach will continue to drive its success in an industry characterized by high customer retention and considerable barriers to entry. 

Management

Stephan Scholl (age 52) has been CEO of Alight since 2020. Prior to his time with Alight, Stephan was President of Infor Global Solutions from 2012-2018. Infor was the #3 ERP software vendor behind Oracle and SAP and was over-levered and struggling with aging technology. Stephan was a key piece of the leadership team responsible for modernizing infrastructure and transforming to a cloud delivery system several years before this was fashionable in the broader industry. He also was responsible for improving the field sales organization and go-to-market for the company. Ultimately, Infor was a very successful investment, with the company being sold to Koch Industries for $13bn in 2020.

Stephan joined Infor through the company’s acquisition of Lawson Software, where he was CEO from 2011-2012. Before this he held various senior roles at Oracle. He is a graduate of McGill University.

We believe Stephan’s experience in the software industry is a perfect fit for the business model transformation and growth playbook Alight is executing, and that the broader management team behind Stephan is also top notch.

Katie Rooney (age 44) has been CFO of Alight since the company was carved out by Blackstone, and prior to that served as CFO of Aon Hewitt since 2016. Katie served in a variety of leadership roles in the finance function across Aon from 2009-2016. Prior to joining Aon, Katie began her career in investment banking at Morgan Stanley. She received her undergraduate degree in finance from the University of Michigan. Katie is an excellent manager of the financial and reporting tasks for the business, and also holds a broader role including strategy and sales for some key accounts.

Financials/Valuation

Since coming public in 2021, Alight has demonstrated accelerating revenue growth and strong overall results. 2023 shows this trend continuing, as the company’s outlook is for 11-12% growth in revenue and 12-14% growth in EBITDA, driven by new client wins and a full year of contribution from the Federal TSP contract. We have high visibility into results for the year, given that most of the company’s revenue is recurring, with 87% of projected 2023 revenue already under contract as of Q1.

In the current more stressed macro environment, it’s also important to note that Alight’s business model is relatively insulated from the risks of various economic shocks. The long-term, contracted nature of Alight’s client agreements has kept revenues relatively stable through downturns in the past. While Alight typically charges for its services on a per employee per month basis, there is typically a 6-to-9-month lag between when an employee is laid off and when Alight would have a P&L impact. Additionally, Alight’s customer agreements typically contain protections for inflation, most often allowing the company to pass through price increases for inflation above 3%.

Going forward, we expect the company to maintain strong momentum given its excellent competitive position in a growing end market. The company recently introduced mid-term targets for annualized revenue growth of 6-8% and EBITDA margin expansion of 400-500 bps. We believe the margin expansion targets in particular were higher than what the investment community expected, and thus deserve additional focus. The key drivers of margin expansion over the mid-term will be: 

• Care: Alight management is very focused on reducing call volumes by improving UX and increasing use of virtual assistants, and also reducing the cost per call by efficiently routing participants to the subject matter experts they need

• Technology & infrastructure: increasingly the company is finding ways to remove client-specific customizations, standardizing platforms, and making infrastructure more scalable to adapt to seasonal demand

• Delivery: Increasing automation in many key business processes today including client implementation, document management, and many other areas

• Pricing: Alight is beginning to introduce changes to its pricing model including a new platform subscription fee and tiered pricing for different care models

We believe these targets are achievable, and we would expect that the company can grow EPS at a mid-to-high teens rate annualized over our forecast period. 9x 2023 EBITDA and 12x 2023 P/E is a very attractive price to pay for a company of this quality and growth outlook, especially compared to comps like ADP and ACN, which trade at mid-to-high-teens multiples on TEV/EBITDA and mid-20’s multiples on P/E. As others have noted, Benefitfocus, a lower-tier player in the market, was recently acquired by Voya for 13.5x EBITDA – we believe at this mark, Alight would be valued at $13-$14 per share.

Risks

• Execution: Benefits administration has traditionally required continuous reinvestment in customer service levels to retain clients. Alight’s management will need to be mindful of maintaining industry-leading service quality as the company executes on its plans to increase margins.

• Technology: Alight is in the process of modernizing much of its technology infrastructure, including database systems that have been in operation for many years. While the company has executed well on these types of programs so far, they will need to continue making these improvements without significant disruption.

• Pricing: There are some areas of Alight’s business (in particular 401(k) recordkeeping) which have been subject to price competition. Alight will need to outrun pricing declines in these areas. Additionally, the company is introducing new pricing concepts across much of its book of business, including a discrete Alight Worklife platform subscription and new tiered pricing for different care & service models. Some time will be required to push these changes through across Alight’s customer base.

• Economic cyclicality: While we have noted that Alight is relatively insulated from macro turbulence, significant and lasting decreases in the number of corporate employees could be harmful to the company’s monetization.

• M&A: Alight’s management team is enthusiastic about the “platform” opportunity in front of the company, and they intend to use M&A to fill product and content gaps in the business. While this makes sense strategically, and the company has been a successful acquirer in recent years, M&A sourcing and integration naturally add a new layer of risk.

• Private equity overhang: Blackstone and its co-investors (New Mountain, GIC, and Abu Dhabi Investment Authority) still own a large stake in the business which they will continue to monetize over time. While this factor may pressure technical trading in the near term, we are seeing progress towards the issue being resolved.

Conclusion

Alight is a high quality, well-managed, and well-positioned business. We believe that the current price is very inexpensive, that the forward growth outlook remains strong, and that an investment in Alight is an attractive risk-reward looking forward over a 5-year period.

Catalyst