Description

Here we go again. 

Insperity is the largest Professional Employer Organization (PEO) with LTM revenues of $6.3bn. I also think it’s the highest quality one: Organically built and founder-led. PEOs have been written up a few times on VIC, so I recommend Tim321’s 2020 write-up on Insperity for company and industry back-ground. In short, PEOs co-employ your workforce, meaning your employees are both employed by you and Insperity, and then take care of the administrative burden. They also allow you to get better deals on healthcare (basically group buying). The value proposition mostly targets small- and mid-sized businesses. 

PEOs have been nice earnings growers historically. See charts in the Appendix on historic EBITA growth and TAM. All of this comes with zero tangible invested capital. Not bad. While the margin is only low-to-mid single digit, the wages of the employee are a pass-through. I don’t think that the margin is indicative of a weak competitive advantage in this case.  

Why is it timely to look at it? Insperity has sold off 20% over the last week due to an earnings miss. It was arguably a bit cheap before as well. The reason for the sell-off is the same one that causes companies in this industry to wobble occasionally, and that tends to create buying opportunities: Insurance claims costs suddenly spike. PEOs tend to mostly self-insure, meaning that you get the odd spike in claims costs which then normalize. See chart on quarterly EBITA margin below. Also, see Tim321’s write-up from 2020 or the  write-up on Trinet from 2015. I bought TriNet back around 2015 and the situation feels very similar. In the end, healthcare costs are a pass-through. If input costs go up, it gets passed on to clients over the next couple of quarters. Instead of dampening demand, it might even accelerate it as getting savings on your higher healthcare costs becomes even more relevant. 

What else might be going on? There is no indication of changed industry dynamics. We might see some demand weakness in case of weak macro, but that should show up in weaker growth, not a sudden move in claims costs. I think the most likely explanation is that we are seeing history repeat itself here. Management seems to agree as they just ramped up the buyback from 0.8m to 2.8m shares (7.4% of outstanding). 

How much can we make? Let’s say the number of worksite employees keeps growing at a 6% CAGR to about 450k and they make an EBIT of $950 per person (see chart below for historic context; assuming a bit of inflation). That’s $427.5m; 24% tax at 20x is $6.5bn. Add $1.4bn in FCFE, that’s £7.9bn, or 2.2x (+120%) on today’s market cap. 

Appendix

Historic EBITA 

Addressable Market 

Quarterly EBITA Margin

Number of Worksite Employees and EBITA/Employee

Catalyst

Keeps compounding earnings.