Description

Gevity HR (formerly Staff Leasing) is the United States’ second largest Professional Employment Organization (PEO). It sells at a 40% discount to its unrestricted cash on the balance sheet (with no debt) and claims that the business will be net income and cash flow positive for the next year. Its dividend yield at current prices (12%) can be easily supported by the cash hoard.

A PEO is in the business of co-employing a company’s employees through providing their payroll, benefits and workers’ compensation services. PEO’s profits come from the spread between their cost of these services and what they charge their customers. Gevity got into trouble about two years ago, when its workers’ compensation insurance carrier dropped them due to poor claims history. Gevity, who had been insuring blue collar workers, took a large hit to earnings and began to bear some of the risk of this clientele. This effectively eliminated the earnings of the company and has forced them to change their business model to attracting white and gray-collar customers. This change is in full swing now and will take another 12 to 24 months to allow Gevity to move back into another guaranteed price workers’ compensation contract.

While many PEO’s have gone bankrupt in the last few years, Gevity has the cash hoard, size and infrastucture to survive and prosper. Their web-based information platform is rated the best in the industry and has increasing usage amongst the customer base. Over time, this will help to increase margins as it eliminates the layer of cost associated with data entry.

Administaff (ASF), its largest public competitor, trades at 40x 2002 earnings and 19x EBITDA based on its projected 25-30% growth rate. Assuming that Gevity can make the transition to a largely white-collar customer base within two years and have margins similar to those of ASF, then Gevity would have net income of $14.2 million and EBITDA of $25.4 million. Gevity has 20.6 million shares outstanding. Assuming a 25% discount to ASF trading multiples yields share prices of $20.67 and $17.57 for net income and EBITDA multiples, respectively.

Catalyst

1) Sale - According to analysts, Gevity turned down an offer in the $17 range last year. With its founder still controlling about 23% of its shares, we believe that Gevity will be sold as soon as its prospects improve.
2) Share repurchase – With a stock price of $1.65 and $2.75 per share in unrestricted cash per share there is pressure being put on management to buyback shares to increase the stock price. At today’s price, the operating business has a negative real value even though management claims it will be free cash flow positive.
3) Dividend increase – At a current 12% dividend yield, Gevity has the ability to signal to Wall Street its belief in its future by either keeping or increasing the dividend. A one-time dividend of $2.00 per share would leave a decent cash cushion and provide shareholders with an excellent return.
4) Earnings – Long term earnings leverage is strong. A few basis point increase in margins adds millions to earnings due to the over $3 billion in annual wages paid by Gevity on behalf of its clients.