Description

Note the above financials are in GBP and the stock price is in pence.

As back to school is in full swing it only makes sense to start this write-up with a pop-quiz.

Question: What is the outcome when you mix: unprecedented economic uncertainty with allegations of accounting fraud, a “gearing” issue, and a business transformation all sprinkled with a management team that acts like a deer in headlights? 

Answer: A stock that is down -86% and had to engage in a dilutive equity financing to appease banks (and, frankly, greedy investment bankers who wanted the ECM fees).

Question: Will a stock that trades at a demanding ~3x P/E (8.5x EV/fwd FCF) despite the fact that it is growing topline MSDs, will be debt free within two years, and in its 18-year history has only been FCF negative once (2011 and it was a mild loss to say the least) stay at this level?

Answer: We don’t think so, which is why we are bullish on STAF LN. Below we go through in more detail why we think it is now an interesting opportunity.  Please put away your SaaSy hats and GARPy garb as what follows is some old-school, cheap & boring business discussion.

Background:

 Staffline Group plc (“STAF LN”) is an industrial staffing company based in the UK.  STAF LN specializes in blue collar temporary staffing and it’s the largest in this niche – food represents 70% of STAF LN’s revenue.  STAF LN is active in 463 customer locations with a peak workforce of 60,300 fully flexible workers. STAF LN makes a mixed fee for every hour that one of its employees works at one of their clients’ sites.  STAF LN has two main divisions – industrial recruitment business and people plus. The industrial recruitment business is the standard staffing business and People Plus was formed from integrating three acquisitions.  People Plus was formerly a government training program which has since ended, and it has now morphed into skills training business.

STAF LN benefits in a strong economy from tight labor supply and in a recession STAF LN helps fill temporary gaps, but is by no means recession resistant (i.e. if more businesses go kaput that’s no good for a staffing company) but benefit from volatility.  As one would guess the core staffing business is very asset-light and generates nice FCF albeit at low margins. STAF LN has CAGR’d revenue at 21.4% since 2001 and in that time has only had two years of negative topline growth (2004 and 2009 – and in 2009 they only shrunk by 5%). 

What Created The Opportunity:

As mentioned STAF LN’s shares are down 86% YTD.  This is a £1.1B revenue business with £46M in EBITDA trading at an EV of £169M.  Read that sentence again to really let it sink in. What caused this implosion in shareholder value?  STAF LN encountered a perfect storm of events mixed with management ineptitude resulted in a very cheap equity. 

Here are all the recent issues STAF LN encountered:

1.       Accounting fraud allegations that delayed the FY18 audit

2.       Threat of de-listing due to lack of FY18 audit

3.       Back-wages payments resulted in an increase in liabilities

4.       Loss of the Work Programme Contract (UK gov’t ended the program) and STAF LN attempted replacement of the loss of the Work Programme Contract with the new, but struggling, apprenticeship training business

5.       Suspension of the dividend

6.       Uncertainties around Brexit impacting all UK businesses

This perfect storm coupled with pressure from creditors resulted in investment bankers swooping in and doing what they do best – charging exorbitant fees for offering value destroying advice/activities.  They advised the company to engage in a large and dilutive equity offering (£41M on what was a ~£40M market cap at the time) at £1 rather than negotiate with lenders for a one-time short-term waiver. Also, it is worth mentioning this was a £350M market cap (£410M EV) at year end.   Now I am not an expert on what has higher fees for a banker: (a) large equity financing or (b) negotiation on covenants – but I have my suspicions the bankers’ interests and shareholders’ interests weren’t shall we say aligned here. 

Where are we Today?:

Aside from the dilutive equity raise here is what happened since (numerically as listed above).

1.       Settled – no longer an issue.  No wrong-doing was found. Post Audit completion STAF LN informed PwC they would be using a different auditor for 2019 (surprise-surprise).

2.       Settled – no longer an issue

3.       Settled – no longer an issue

4.       People Plus has announced £150M in new contract wins in 1H’19 (50% win rate). 

5.       Dividend remains MIA – management has indicated they will reinstate it once net debt / EBITA is <1x which will happen in 2020

6.       Brexit uncertainties remain

Post equity raise STAF LN will end this year with around £55M in net debt.  STAF LN is targeting £23-28M of EBIT for FY19 (this will raise to £40M in EBIT in 2020 and £20M in FCF).  Along with the equity raise net debt was reduced by £30M (covenants were re-set with this raise – funny how the bankers snuck that one in there with the raise instead of just re-setting the covenants to begin with).  Given their year-end net debt at £55M against £23M-£28M in FY19 EBIT. So, this isn’t exactly a “geared” company. 

STAF LN is working to scale People Plus which in FY18 had £107.5M in revenue and £15M in EBIT.  STAF LN is achieving a 50% win rate with an average contract length of 3 years, the total apprenticeship market is £2.4B and is projected to grow to £3B by 2022.  Recruitment continues to be a workhorse for STAF LN turning in £1B in revenue with and £24M in EBIT. 

The stock chart vs the financials are a tale of two different cities. 

What is this Pup Worth?

For a growing company (that is not in the natural resources space) with a strong history of profitability, isn’t a 3x P/E a touch too low?

Management has been guiding to MSD growth with slow and steady growth from industrial staffing and faster growth from People Plus as it inflects.  If this business churns out just 5% growth and then achieves a 3.5% EBITDA margin (so down from what it achieved in each of the four last fiscal years) that results in ~£52M in EBITDA.  Then STAF LN trades at 6x EV/EBITDA (their historical multiple is 8x, but let’s ding them for Brexit + management incompetence), that results in an EV of £312M. Given that STAF LN has produced positive FCF in every year except one in the past 18, and that management is projecting that 2020 on will be quite FCF positive, it’s conservative to say that they will have no net debt by 2022.  Even if we assume some dilution for share issuance, it’s hard not to underwrite a stock north of £4 vs a price of £1.55 today. 

If a growing company that is FCF positive trading at a silly low multiple isn’t enough, there is another enticement here.  HRnetgroup Ltd (HRNET SP) – a Singaporean publicly traded public staffing company took advantage of the dislocation across the proverbial pond and now owns 25%, they actually tendered for shares at 180p (56% above market at the time of their offer (7/31) showing their enthusiasm for getting a stake).  Whether or not they choose to buy the whole enchilada is up to the soothsayers – but we can all at least agree a strategic in the industry has recognized silly pricing here and used Mr. Market to their advantage.

While we are optimistic this will work out – rarely do growing and good businesses trade at silly multiples for prolonged periods of times – with Brexit + the unknown we could end up looking silly here.  But given the facts listed above, that is a risk we are willing to take.

Catalyst

Probably two main catalysts here:

1) STAF LN continues to grow at MSD rates (or better) and profitability shows through and it becomes apparent this is a going concern and starts trading like a company with a terminal value (i.e. not 3x P/E)

2) Someone swoops in and buys the entire company at the still depressed price