Description

Summary

Alight is a provider of human capital management and benefits administration solutions, focusing on recurring revenue contracts and expanding its BPaaS offerings. The company has experienced steady organic revenue growth driven by these factors, as well as tuck-in acquisitions. However, gross margins and adjusted EBITDA margins have remained stagnant since 2020, raising concerns about the company's financial performance. Additionally, management turnover and key stakeholders selling out question the stability and future prospects of the company. Accounting validation issues, such as stock-based compensation and recurring add-backs, further complicate Alight's financial standing. Taking these factors into account, we see downside to $2/share in the next 24 months in a bear case and a base case valuation of $6.

Thesis

Alight has demonstrated strong organic revenue growth with an 8.5% CAGR from 2020 to 2023, primarily driven by recurring revenue contracts and tuck-in acquisitions. The company's higher growth in BPaaS compared to overall revenue also contributes to this growth. Despite these positive trends, Alight's gross margins and adjusted EBITDA margins have not grown since 2020 due to various factors, including the acquisition of legacy companies and pricing pressure for its core services. Employer Solutions gross margins have remained stagnant since 2020 despite the BPaaS push, and adjusted EBITDA margins have been flat at 21% since 2020. When subtracting stock-based compensation, these margins decline to 16%. The company has not specified BPaaS margins, but incremental gross margins are said to be 60%+.

Risks

Alight faces risks from management turnover, with several key executives leaving in recent years, including CEO Chris Michalak in April 2020, Chief Commercial Officer Cathinka Wahlstrom in January 2023, and Chief Customer Experience Officer Cesar Jelvez in August 2023. Furthermore, pre-IPO and PIPE investors have sold a significant amount of stock since the deSPAC, raising concerns about their confidence in the company's future performance. The involvement of Blackstone and Cannae Holdings on the board of directors raises questions about their selling actions, and PIPE investors selling down just as aggressively and at a loss adds to these concerns. There have been no management/board open market buys in the stock since IPO, and the tax receivable agreement serves as a recurring dividend to pre-IPO shareholders, even after they have sold their shares. There is unlikely to be a strategic exit as Blackstone has tried to sell ALIT since 2019 so any buyers had plenty of opportunity to kick the tires.

Valuation and Target Price

Based on our analysis, we propose three scenarios for Alight's valuation and target price: (1) Bull case: EPS of $0.63 at 16x P/E, resulting in a target price of $10/share; (2) Base case: EPS of $0.40 at 15x P/E, resulting in a target price of $6/share; and (3) Bear case: EPS of $0.20 at 10x P/E, resulting in a target price of $2/share. There are no direct publicly traded comps, and previous transactions framing the valuation, such as Aon (8x EBITDA), Blackstone (9x EBITDA), and SPAC (13x EBITDA), may be too high considering the capex burden and SBC inflation. Notably, Voya acquired BenefitFocus for 15.5x Adjusted EBITDA. We see BenefitFocus as much closer to a software company than Alight as it had 53% gross margins, only 1,560 employees, and its EBITDA was affected by being a subscale public company with a high growth strategy.

Key Drivers

The key drivers for Alight's strategy include organic revenue growth, expansion of BPaaS offerings, and the ability to improve margins. The company's performance will also be impacted by management stability and the actions of key stakeholders. Alight serves a significant portion of Fortune 100 and 500 companies and has maintained stable gross margins since 2021. The revenue model is based on a fee per employee per month, with BPaaS as the latest generation of product and service delivery. BPaaS deals are 1.5x larger than the legacy deals they replace, and incremental margins on BPaaS revenue approach 60%, although not broken out in detail. The company reports a high 96% renewal rate, but it calculates it based on a net basis (customers who upsize contracts net out customers who shrink/terminate contracts), meaning the gross retention rate is likely materially lower. It’s also notable that the company hasn’t won any net new logos in the Fortune 100/500 in the last 5 years. Revenue growth has to come from either headcount growth at existing customers, cross selling new products, or pushing into the middle market where Alight has minimal share/traction today.

Accounting Validation

Concerns arise from the company's accounting practices, such as the use of stock-based compensation, recurring add-backs, and transformation initiatives. Capex has doubled since 2016, increasing from 3.4% to 5% of sales, and capex, tuck-in acquisitions, and share buybacks have exhausted organic cash flow generation, leaving net debt unchanged since the IPO. The tax receivable agreement inflates EPS without benefiting the company's cash flow, and the company points to the SPAC transaction driving elevated stock-based compensation expense. However, even with a go-forward expense expected to be "2-3% of revenue," this still equates to $100M/year or 15% of total EBITDA, potentially impacting the company's valuation and target price.

Catalyst

• Continued insider selling
• Pricing pressure and lack of real growth
• Weak accounting