Description

TL;DR Significant public-to-private valuation mismatch with strategic catalysts likely in the next 6-12 months to unlock value, convexity offered by tremendously cheap valuation, strong aligned management, and clean balance sheet.

Risk price: $18 (40% 2023 FCF yield to EV, 1.8x normalized EBITDA), bottom of trading range

Reward price: $64 (10% FCF yield to EV, 10x EV/2024 EBITDA in line with private comps)

Reward/risk ratio: 12.5x

Background

Hudson Global originally was a spin-out of the parent company to Monster.com in 2003, and languished in obscurity for a decade.  The business was poorly run, burning capital throughout the decade with an expensive and a heavily value-destructive M&A strategy in the HR space.  Given the decade of poor execution, the business built up a tremendous NOL, north of $400mm.  In 2013-2014, current CEO Jeff Eberwein got involved in the company.  

Jeff primarily has a financial background.  Jeff grew up in Dallas, attended UT Austin for undergrad, and got his MBA at Wharton.  He went into investment banking after b-school, and transitioned to the buyside first at Cumberland (long only), before becoming a cyclicals PM at Viking and Soros Fund Management throughout the 2000s.  Jeff founded Lone Star Value Management (LSVM) in 2013.  At LSVM, Jeff focused his time on finding small and micro-cap companies that were mismanaged but possessed tremendous intrinsic value that he could unlock with activism.  Notable campaigns included Goldfield, Ontrack, NTS and Digirad.  Hudson fit the bill, and he joined the board in 2014.  From 2014-2018, the company attempted to clean up the mess that was left by previous management, divesting several acquisitions and cutting costs.  Jeff took over the business in 2018 as CEO concurrent with the sale of the cyclical staffing businesses in APAC and Europe for $39mm.  The business by that point is a good starting point for Hudson today.  

Description

Hudson Global is a recruitment processing outsourcer (“RPO”) that handles human resource functions inside large and mid-sized companies. Think of this as a consultant that sits inside a company, fully integrated with their team, to aid hiring across the business.  Unlike a traditional staffer, HSON’s business is structured on multi-year contracts, possesses high recurring revenue and is predominantly fixed price paid by the client.  Large- and mid-size enterprises will contract with RPOs if they know they have consistent staffing needs across their businesses, as it's substantially less expensive and more user friendly for these companies. HSON's stock has been left for dead, trading in correlation with staffing peers who are much more cyclically exposed. 

RPOs in private markets trade at a substantial premium to traditional staffing firms given the different cyclicality.  Notably, the leader in the space, Alexander Mann Solutions, was sold by New Mountain Capital to OMERS for 12.5x (heavily-adjusted) fwd. EBITDA, 18x trailing in 2018.  More recently, WilsonHCG acquired Personify, a US centric staffer in Tampa, FL for 8.5x fwd. EBITDA.  Assets in private markets typically trade from 7x-13x fwd. EBITDA depending on size, growth and geographic footprint.  This is a notable contrast to cyclical staffing firms in public markets like MAN, TBI, KELYA, BBSI, HSII, RGP, etc. that trade 6-10x EBITDA depending on where the cycle is.  RPOs are attractive to private equity given the capital efficiency (low capex), strong recurring revenue characteristics, industry growth (double digits the past 10 years) and fragmented industry attributes making bolt-on M&A possible.  

Hudson is now a global RPO in orientation, with an especially strong business in Australia where they are consistently ranked in the top-5 in market share.  Since 2018, the business has grown net revenue organically at double-digits topline, while improving operating margin 2000bps+ through operating leverage, accretive M&A and aggressive corporate overhead reductions.  Management has pursued bolt-on M&A in the United States primarily in order to utilize the US NOL, acquiring Coit, Karani and Hunt and Badge to improve the offering in the United States. The business now boasts close to $100mm in recurring net revenue with strong momentum in winning new contracts across the world.

Recent Developments

The US business ran into trouble in 3Q-2022, primarily because of the Coit acquisition.  Coit was purchased in 2020 in an attempt to build out the tech vertical.  The business is a more cyclically exposed traditional staffing business, and has run into the massive de-staffing that has happened in tech in California over the past year.  The business went from $4mm in revenue when they bought it in 2020 to run-rate of $20mm at its peak, back to $3mm now.  That being said, comps lap at the end of the 2Q-23, and the business is at trough.  Although Coit likely paid back its initial capital outlay, the disruption to the underlying RPO business made the acquisition a poor use of capital. 

Hudson had to deal with the challenge of de-staffing tech, while concurrently winning business in the rest of the company that focused on RPO.  Hudson can't send a tech-staffer based in CA to Switzerland to work on the new pharma contract, so margin got compressed while they dealt with the rapidly changing complexion of their business (firing people in CA, while hiring people across the rest of the business).  Operating margin went from 14% in 2Q-2022 to 0% in 1Q-2023 as they dealt with this transition, and is now at trough.  

Valuation

The business is now trading at historical trough multiple, trough margin, and enjoys continued business momentum on the topline as they win new logos across the globe.  Mgmt. is working on getting margin back to the late-2021, early-2022, primarily on the gross margin line (salaries and related expenses should be ~70% of costs, elevated because of Coit the past three quarters).

I assumed modest net revenue growth (4%) in 2023, consistent with the annual CPI pricing escalators built into the contracts and new contract wins management indicated.  Operating margin should get back to historical average over the course of 2023, exiting the year at 29% gross margins as % of net revenues. 2024 margins I assumed modest degradation to 28.5% GMs and modest growth of 5.5%.  I think these assumptions are conservative given the commentary from management on the last few calls.

The company has $21mm in cash, no debt, and >$300mm in useable NOL worth >$20mm per share in a bankruptcy scenario.   The company trades at 3.1x 2023E EBITDA, 2.4x 2024E EBITDA.  The business is capital light, capex has been less than $0.5mm/year for the past 5 years, typically close to zero.  Given the NOL shielding the majority of income taxes, EBITDA converts almost completely to FCF, meaning the business is trading at a 31% FCF yield to enterprise value in 2023 and 41% FCF yield on 2024 numbers.  Coit related revenue will be completely cycled off from comps in the 2Q of 2023, which will represent trough revenue.  The core business ex-Coit continues to grow nicely, at a high-single digit % clip.

Strategic option value

Management has a history of unlocking value through strategic acquisitions, including the divestitures in 2014-2018, culminating in the $39mm sale of the traditional staffing business which was greater than the market cap at the time.  The CEO is also the chairman of Star Equity (STRR), where he recently divested the healthcare assets of the company for $40mm, more than the enterprise value of the company.

The NOL complicates these efforts given change in control IRS provisions (US Code 382).  That being said, analyzing prior NOL preserving transactions, Hudson RPO, the subsidiary to ParentCo Hudson, could receive an equity investment from a partner while still maintaining the NOL value.  Ample private equity interest in the space makes this a likely scenario down the line. 

Furthermore, given significant FCF generation of the business, cash balance and history of material stock buybacks, share buybacks are likely at some point.  The company has bought back >10% of the company since Jeff took over as CEO.  The CEO has been an aggressive buyer personally of HSON stock in the past year, buying >5% of the company with a mid-$20s average price paid.

Risks

Liquidity - highly illiquid, micro cap stock where mark-to-market can be a factor to investors 

382 limitations - new investors are precluded from owning >5% of the company to preserve the NOL

Concentration - two clients >50% of gross revenue in 2022, both of which are in APAC.  This is a bit misleading, as on a net revenue basis, concentration is a lot less.  The two biggest customers are in APAC, where a significant percentage of gross revenue gets passed through. Gross to net revenue goes from $118mm in 2022 to $34.3mm, making any single customer less than 10% of revenue.

Key man risk - Jeff controls the board, owns 10% of the stock and is the CEO.  What he says goes

Macro risks - exposed to broader labor trends across the globe.  Although insulated given the nature of their contracts, they are not immune.

Catalyst

• There is robust private equity activity in the space, so an exit and/or partnership is the most likely scenario in the next year
• Stock tender given $7+/share in cash on balance sheet, strongly aligned management and NTM FCF yield to enterprise value of >40%