Description

Thesis: A 10%+ Free Cash Flow Yield, high growth, asset light, franchise staffing business model led by one of the most impressive industry veterans and owner operators I’ve ever come across is 20-30% compounder for the foreseeable future. A transformative acquisition not currently appreciated by the market and a continuation of the current roll up/re-franchise strategy create long term sustainable cash flow growth in addition a clean balance sheet and access to a $60mm credit line.

*sorry sorry for the “compounder” but it really is

**earnings are out tomorrow so I am stepping ahead of those, given the jobs numbers I think they’ll be ok

issambres839 wrote this company up in 2020 and has done a fine job of cheerleading and maintaining the discussion so as usual for me, these cases, rather than reinvent the wheel I would like to contribute to it with my 2 cents with color on the company. We’ve been shareholders, owning single digit percentage of OS since mid 2019, prior to HireQuest’s reverse merger with Command Center which has led to a high quality relationship with the CEO, Rick Hermans who owns 40% (with his silent partner owning another 20%), and realistically his $120mmm holding and majority of his wealth being tied up in the company is a major part of our thesis. So I am writing from the perspective of having confidence due to regular conversations/meals with Rick in addition to the financials aspect.

HireQuest is a leading national franchisor of a diversified direct dispatch, executive search, and commercial staffing services with over $500mm in system wide sales and 400+ locations, sporting high double digit organic growth and a 6%+ franchise royalty/other fees rake which translates to 60%+ EBIT/Free Cash Flow margins. In the summer of 2020 the company did a reverse merger with a s----y “no business being public” $20mm microcap Command Center at a $70mm valuation and has since gone on to complete a dozen plus acquisitions, including 8 in the last 2 years, in diversified verticals across the staffing industry growing revenues and free cash flow over a 100%+ since 2020.

The business model: Its surprisingly simple. Buy a bunch of staffing branches whether its executive search, dental, construction etc at low single digit EBITDA multiples (in the case of MRI close to 1x); identify the right managers and give them financing to buy the branch out; provide them with back office/national accounts/cheaper, due to volume, workmans comp insurance and collect a 6.5% fee (about $31-33mm revenue run rate today) which can be leveraged on a $16-$17mm cash SG&A infrastructure. See example below. This also cuts out most of middle management stuff that other staffing companies (Kelly, TrueBlue, ManPower) have to face.  

There is a human factor I haven’t seen discussed much, but a staffing branch manager is usually a $60-70k/year small town, maybe a college degree, operator and what Rick’s business model does is make these people entrepreneurs and gives them a shot at making six figures which they realistically may not have had before. Its truly a phenomenal business play.

This business model touches 90% of a diversified $168b US staffing market and one thing I’ll mention that even in the last two years this has become a very different company to diversification and expansion of its national network which is important in context of US macro environment*(will touch on that later). I believe it makes it less cyclical or at least less sensitive to cyclical factors than in past.

So our (ex MRI) system wide revenue growth estimates of 15% will come from overall US employment growth* (again will touch on macro later), vertical expansion via more product offerings per branch; ability to win national accounts with a 400+ national branch network; and of course the continued “buy and convert” business model which is the core of my thesis. My conversations with Rick make me believe that despite the success of the last two years we might not be even in the first few innings of this (hence my compounder pitch).  

The acquisitions have mostly been self financing with $32-$33mm gross spend a year (last years net was $23mm), however the company has a $60mm credit line from BofA and a clean balance sheet ($3mm/$3mm debt cash).  The company also pays out a $3.3mm dividend (about 1.2%) which if it ever runs out of growth opportunities is likely to substantially increase. I anticipate in my 5 year projections that most acquisitions will be self funding, however the credit line may be utilized in short term.

Look I am not trying to reinvent the wheel here and pitch something complex. Its really that simple. Buy branches at low single digit multiples, convert into franchises, collect 50-65% operating margin fees and leverage the exisiting cost structure. 

Who is Rick Hermans: On the one hand, a very mild soft spoken guy that will want to have lunch in a strip mall wearing gym shorts despite tremendous wealth and arguably tremendous success. On the other hand, this is a guy that will contact the Florida AG to criminally prosecute an orchard manager that ripped him off for a few thousand dollars. Ruthless and well connected. On the connected side, I will note that the company has a never utilized but standing agreement with the Jeb Bush family office to bring it national accounts in returns for ownership. This little gem is in the original Command Center merger filings.

If you are doing research on this company, listening/reading transcripts of last few years is probably your best bet in finding out who Rick is. His discussions on the market/industry are very informative. Regardless whether you invest or not, worth while to listen to going forward.

Its hard to describe here but all you need is just to look at the value created since the reverse merger 3.5 years ago. So about 14-16 quarters worth of Qs and transcripts and you'll get a really good sense of what the play is here. 

Financials, ex MRI: I am choosing to look through short term economic fluctuations and instead focus on the business model of then next 5-10 years and hopefully I’ve provided however briefly enough data here to suggest that this is a diversified resilient business model with ample opportunities for continued growth which is unlikely to be in a straight line but should end up with a nice 20%+ Free Cash Flow growth CAGR.

Having said that, it is important to have a macro view and given that the Fed is actively trying to kill the services job market and the “don’t fight the Fed” is probably a sound business tactic I’ll add my 2 cents here. My, possibly very contrarian view, is that you can’t spend a 13 years post GFC building up an economy on easy money and ultra low rates and then hit the breaks hard (government, 2020) and then do it again (Fed, 2022-2023) without some major breakages in the economy. SVB and FR were big cracks but I think the upcoming carnage in CRE and other hidden trouble spots (debt default etc) will force the Fed to quickly capitulate on inflation which will probably stay low to mid-single digits, including wages, which will become stickier, in order to achieve stability which will likely be rocked by the aforementioned cracks. I think HQI wins in any scenario where companies will either be loathe to commit to long term employees and will opt for shorter term staffing in a bad economic scenario or will likely continue to face shortages of unreplaceable by AI labor. This will cause short term fluctuations in HQIs results in 2023-2024 but unlikely to dent the aforementioned long term CAGR. 

My 5 year base expectations in 2027 (again ex MRI) are:

• 15%+ System wide sales growth from today’s base to $900mm by 2028 due to aforementioned growth factors resulting in approximately $65mm in revenues. Approximately $250mm to $300mm of those system wide revenues I expect to be acquired, mostly self funded.
• 8% growth in cash SG&A. Hard to grow this fast without adding more services etc. $20mm  
• After some tax leakeage FCF to be in the range of $40mm to $42mm
• $650mm market cap on 6.5% forward FCF yield at mid 2027 (4 years from now) as rates will likely normalize toward 2.5% and 4% risk premium.
• At 13.7mm shares outstanding approximately $46 to $50 stock price or 25% IRR including nominal contributions from dividends

This is obviously pretty loose and I am putting out numbers out of respect for this website but realistically I think this could be substantially more. Downside is probably mid teens if the economy falls apart and system wide sales stay substantially lower.

I have chosen to present all of this EX MRI Acquisition. I believe MRI presents a substantial optionality on this thesis adding anywhere from $5 to $20 extra to my LT share price. Its such a transformative acquisition that its hard to add it to the baseline projections. Tomorrow’s call will be informative. Consider it a free option at these prices.

MRI Acquisition:

My discussions so far have been focused on existing business but mid November 2022, the company announced its acquisition of MRI (iamsabmres has discussed it at length) for $13.5mm for $1,9mm of EBITDA and $283mm system wide sales at 232 branches! Its hard to gauge whether all these revenues are real or a result of a 2020-2021 pull through employment phenomenon. With so many branches I’d imagine some will have to be chopped off or consolidated into existing HQI network. Will HQI get the same 6.5% vig on these revenues? Also tbd. So its hard to value something like this in the base case scenario. Maybe a good conservative starting point is $200mm system wide sales at 4% or $8mm extra in franchise revenues. 2023 will likely be a choppy year when you’re trying to convert $283mm in revenues into franchise revenues and chopping off SG&A. So 2023 will be messy from the account perspective I believe. Either way its transformative and will likely lead to more national account wins. Maybe Jeb! will finally help now that it has a much bigger national account infrastructure. 

Risks:

• Key man risk: Something happens to Rick, its probably down a bit
• Economic: I could be full of it and my optimistically rose colored glasses macro assessments toward HQI are way off
• Acquisition integration: MRI will be messy with accounting etc. Revenues will be up, then down, and so on. Margins will be distorted. There are likely to be other acquisitions of this size and complexity.

Catalyst

- Update on MRI numbers

- More acqusition announcements 

- Continued solid FCF growth reported on a quarterly basis

- Re-inclusion in R2K