Description

TriNet

 TriNet (TNET) is a professional employer organization. Its typical client is a small business with fifty people or so who hire TNET manage its human resource functions, process payroll checks and expense reports, and buy health insurance and workman’s comp. None of these tasks are high enough priorities on management’s checklist to rank as “things to do in order to succeed,” but they are vital to any company’s daily existence.

 Of all services that TNET provides, the one that creates the most tangible value for its customers is health insurance. TNET is able to save a significant amount of money for its customers by co-hiring the customer’s employees. Thus, when TNET buys health or worker’s comp insurance, it is not looking for the best price for 50 people but for 200,000. (This is how many people are on its platform.)

 Obamacare and other government involvement in US healthcare increase the complexity and bureaucracy of the system. Newly instituted penalties makes mistakes costly when rules are not followed. All of the above means more business for TNET. Over the last three years the numbers of worksite employees (industry jargon for employees under TNET’s care) it serves grew in the mid-teens.

 TNET is one of the largest players in the professional employer organization space (if measured by the number of workstation employees). Small businesses in the US employ about 50 million people, and about half of them are good candidates for TNET or its competitors. However, only a few million small businesses are using the services of TNET or its competitors. On a conference call, TNET’s CEO said that three out of four of TNET’s new customers were greenfield opportunities (were not using anyone else’s services).

 Over 80% of TNET’s business is very straightforward: the company charges a monthly fee per worksite employee. It’s a beautiful, stable recurring business model. However, about 20% of TNET’s revenue comes from insurance underwriting. In that business TNET is very similar to an HMO (think United Healthcare or Anthem): TNET insures that customer losses will be less than a certain amount. Historically, TNET had a fairly good record underwriting healthcare risk until the first two quarters of 2015 when losses exceeded the company’s and Wall Street’s expectations. The stock was halved.  (It also had higher undewriting losses a few quarters ago in workman comp biz it bought, but that issue has been corrected).  

 We have had a lot of experience investing in HMO stocks in the past, and here is what we have learned: they are not insurance companies so much as logistics companies for health insurance. They will misprice risk from time to time; but since their policies have only a one-year duration, if they misprice healthcare risk they will reprice those policies within a year. TNET’s healthcare underwriting is no exception.

 Overall there are a lot of things we like about TNET: Its business does not require much capital. Its revenues are very predictable. It is not very leveraged – it can pay off its debt in about three years if it decides to do so. The CEO who built the company into what it is today behaves like an owner-operator – we like that. He also owns 1.5 million shares. TNET’s business is not cyclical; in fact it’s somewhat countercyclical: it grew during the 2008-2009 crisis.

 TNET’s earnings power was not damaged by recent developments but was pushed forward by a few quarters. As profitability in the insurance underwriting business comes back to 2013-2014 levels, we expect the company to earn close to $1.80 to $2 a share. In addition, TNET has a huge growth runway ahead of it as the company continues to add worksite employees at a mid-teens rate. We are paying less than 10x earning for a company that should trade at more than 15 times, and whose earnings power should only increase with time. From today’s perch we estimate that the stock is worth north of $30. 

Catalyst

TNET’s earnings power was not damaged by recent developments but was pushed forward by a few quarters. As profitability in the insurance underwriting business comes back to 2013-2014 levels, we expect the company to earn close to $1.80 to $2 a share. In addition, TNET has a huge growth runway ahead of it as the company continues to add worksite employees at a mid-teens rate. We are paying less than 10x earning for a company that should trade at more than 15 times, and whose earnings power should only increase with time. From today’s perch we estimate that the stock is worth north of $30.