BARRETT BUSINESS SVCS INC BBSI
September 30, 2014 - 10:31am EST by
ruby55
2014 2015
Price: 40.20 EPS $3.10 $3.80
Shares Out. (in M): 7 P/E 13.0x 10.6x
Market Cap (in $M): 299 P/FCF 13.0x 10.6x
Net Debt (in $M): -15 EBIT 34 46
TEV ($): 284 TEV/EBIT 8.3x 6.2x

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  • Small Cap
  • HR Service
  • Restatement
  • Buybacks
  • Negative Sentiment
  • Recurring Revenues
  • Operating Leverage
  • Low CapEx
  • Magic Formula
  • PEO
 

Description

 

 

On the heels of an anonymous short sellers’ drive-by shooting, Barrett Business Services Inc. (BBSI) shares are at a 52-week low and off over 60% from the January 2014 high print.  A recently released research opinion full of misleading conclusions has given long-term investors an opportunity, at a bargain price, to buy a very high quality business in an industry sure to be increasingly in demand.  I have been a BBSI shareholder since 2008. At current prices, this is the best entry point I have seen in many years.  

BBSI is magic-formula, cash generating business in a service industry, with very low capital requirements (FCF=earnings), recurring revenue from 95% client retention, no meaningful competition, and 30% annual organic revenue growth over the last four years.  Revenue has grown 14x since 2001. 

With a low industry penetration and the recent completion of a two-year process to more than double their client serving capacity, BBSI is very likely to at least double earnings in 3-4 years.  Now, priced at 8.3x TEV/2014 EBIT and 13x PE (thanks Copperfield), BBSI owners should benefit from multiple expansion and enjoy share price upside of more than 100% over the same period.

Wait, did I mention BBSI has no net debt, tremendous operating leverage, and a track record of smart capital allocation?

 

Here is a link to the full presentation with better formatting and charts:

https://www.dropbox.com/s/p5nszd1fvws4nv7/BBSI%20writeup%20-%20final%20v1.0.pdf?dl=0

 

 

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  1. Clarification about the reserves on next earnings call, late October.
  2. Continued growth this quarter puts focus back where it belongs which is on the value of this high-quality enterprise.
  3. Annual earnings guidance starting next quarter.  Going forward, the company will offer quarterly rolling annual guidance. 
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    Description

     

     

    On the heels of an anonymous short sellers’ drive-by shooting, Barrett Business Services Inc. (BBSI) shares are at a 52-week low and off over 60% from the January 2014 high print.  A recently released research opinion full of misleading conclusions has given long-term investors an opportunity, at a bargain price, to buy a very high quality business in an industry sure to be increasingly in demand.  I have been a BBSI shareholder since 2008. At current prices, this is the best entry point I have seen in many years.  

    BBSI is magic-formula, cash generating business in a service industry, with very low capital requirements (FCF=earnings), recurring revenue from 95% client retention, no meaningful competition, and 30% annual organic revenue growth over the last four years.  Revenue has grown 14x since 2001. 

    With a low industry penetration and the recent completion of a two-year process to more than double their client serving capacity, BBSI is very likely to at least double earnings in 3-4 years.  Now, priced at 8.3x TEV/2014 EBIT and 13x PE (thanks Copperfield), BBSI owners should benefit from multiple expansion and enjoy share price upside of more than 100% over the same period.

    Wait, did I mention BBSI has no net debt, tremendous operating leverage, and a track record of smart capital allocation?

     

    Here is a link to the full presentation with better formatting and charts:

    https://www.dropbox.com/s/p5nszd1fvws4nv7/BBSI%20writeup%20-%20final%20v1.0.pdf?dl=0

     

     

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    1. Clarification about the reserves on next earnings call, late October.
    2. Continued growth this quarter puts focus back where it belongs which is on the value of this high-quality enterprise.
    3. Annual earnings guidance starting next quarter.  Going forward, the company will offer quarterly rolling annual guidance. 

    Messages


    SubjectRe: Update
    Entry05/14/2015 12:02 AM
    Memberhkup881

    and then what happened?


    SubjectRe: Re: Update
    Entry05/14/2015 10:34 AM
    Memberruby55

    Down 30% two hours after my updated post based on an announced formal SEC investigation into accounting practices regarding workers comp reserving practices.  Doh!

    OK, I accept the nomination for the Worst VIC Post Timing of the year.

    Did the market overreact?  I think yes, and I have added at these prices.

    Whatever the outcome the investigation (or the class action lawsuit which is covered by D&O policy), it will not threaten the long term viability of the business.  BBSI, with ample reserves, has never been better operationally.

    Securities laws do not allow for “fraud-by-hindsight” and there is well established case law in the context of insurance reserves that recognize the forward looking nature of actuarial judgements.  There is a wide latitude within actuarial science as to what is considered adequate.  BBSI’s external actuaries will not only support BBSI but will support each other.  The new actuary (Willis) has re-run the prior actuaries reserve calculations prior to the reserve charge and found their calculated reserve levels to be “reasonable”.   

    Additionally, the California self-insurance regulator audited BBSI every other year for two decades and never once suggested that BBSI reserves were inadequate.

    I expect a more through defense of BBSI’s position to be submitted in the form of a Motion to Dismiss with the next 30 days or so.

    There is a high bar for proving fraud and accounting irregularities even when it has occurred.  In this case I don’t see any evidence of either, and over time I expect these legal and regulatory issues to fade away.  As this happens, the only thing remaining to focus on will be the quality of BBSI’s business.


    SubjectRe: Re: Re: Update
    Entry05/14/2015 06:54 PM
    Memberhkup881

    happens to the best of us.  Have you spoken to any customers that stuck with them thru the disruption last year?  Why did they stay?  Just better service?  cost of switching?  hopefully it wasnt just pricing; which is sort of what i'm asking. 


    SubjectOver $5.00/share in 2017 and over reserved.
    Entry08/16/2016 09:22 AM
    Memberruby55

    Complications surrounding the 2014 reserve charge and missteps by the ex-CFO have masked the earnings power and a 50% market discount on this high quality business.

     

    It’s been a tough two years for BBSI.

    • A short attack, followed by a large reserve charge, which led to a class action lawsuit, followed by a SEC investigation, which triggered an auditors Section 10A letter. Then the CFO self-reported three year old non-GAAP journal entries, leading to required restatements, late financials, NASDAQ listing issues, and disclosure of material weakness in financial reporting.
    • A virtual crap-tornado of bad news for investors over the last 24 months.

     

    Why would anyone touch this company?  Two reasons:

    1. The issues from the last two years are largely resolved.
    2. BBSI is a cash flow generating machine, and worth twice the current price.

     

    Earnings power and valuation.

    • Excluding the one-time expenses associated with legal & financial reporting issues, and expected expense savings from FUTA overpayments due to the recently passed Small Business Efficiency Act, BBSI’s 2016 run rate EPS is around $4.50/share:

    2016 guidance

    $3.50

    + One-time legal & investigation expenses

    $0.57

    + IRS refund & savings from client FUTA payments no      longer required, 2016 ($5mm est.)

    $0.45

    = 2016 run rate EPS

    $4.53

    • PEO revenue has grown a minimum of 18% each and every quarter since June 2010.
    • Management is guiding to 18% revenue growth in the next 12 months.
    • Operational leverage will push EPS to an even higher growth rate.
    • Applying 18% growth into 2017, a reasonable EPS estimate for 2017 = $4.53 * 1.18 = $5.35
    • With 18% growth and recurring revenue from 95%+ client retention, a conservative multiple is 20x.
    • BBSI traded at over 30x in early 2014
    • Applying a 20x multiple to a conservative $5.00/share delivers a target price more than double the current $46.

     

    So what is holding the shares back?

    • Buyers are likely suffering a form of investor PTSD from two years of bad headlines. 
    • Shock from the 2014 charge has left many with lingering questions about WC reserve adequacy.

     

    What buyers are missing.

    • Loss trends and positive development suggest that that BBSI is now over reserved.
    • Aside from the initial 2014 charge, the bad headlines centered on legal fallout and financial reporting issues that don’t affect long term earnings.
    • Despite all the distractions, BBSI leaders in the field have remained focused.
    • They delivered a remarkable 45% PEO revenue & client growth, while maintaining 95%+ client retention and operating margins over the last two years. 
    • Earnings power has increased with revenue growth.
    • BBSI is set to completely pay off the $40mm two-year loan used to fund the 2014 charge on September 30, 2016, one quarter early.
    • In 45 days, BBSI will be debt free and released from dividend increase & share buyback prohibitive covenants.

     

    Since the reserve charge, the most important ongoing question is WC reserve adequacy.

    • Frequency of claims (which BBSI can influence via their client risk mandates) are down 7% as a percent of revenue in the last two years.
    • Consistent quarterly positive prior year development in WC reserves since the 2014 charge strongly suggests that that BBSI is over reserved.
    • BBSI is continuing to accruing reserves for future claims at a loss expectation that generated the current excess reserves.
    • This strongly suggests that (absent a future increase in frequency or medical costs) reserve levels will remain adequate or better into the future.

     

    The other remaining legal and financial reporting issues are largely behind them:

    Auditor 10A letter.

    • A dispute with their auditor in November 2015 over a redundant 2014 consulting report, led the auditor to write a Section 10A letter asking for an investigation into whether or not an “illegal act” had occurred during the period of the 2014 reserve charge period.
    • A thorough (and expensive) third party investigation concluded in February 2016 that no “illegal act” had occurred.

     

    Ex- CFO’s unsupported journal entries self-disclosed in March 2016.

    • Unsupported 2013 journal entries by the previous CFO (which didn’t affect the top or bottom line), led to an expensive forensic audit, restatements for years 2013, 2014, and 2015 (these turned out to be immaterial), late financials, NASDAQ listing compliance issues, and a disclosure of material weakness in financial reporting.
    • The board acted promptly to address this problem.
    • An engagement was signed with PWC to conduct a 3rd party forensic audit.
    • PWC reviewed every journal entry in the last seven years going back to 2009.
    • Other than a few additional non-GAAP entries (these were immaterial too), PWC found journal entries in order and gave BBSI an all clear.
    • The restatements were completed as of May 2016.
    • All financials are up to date as of June 2016.
    • BBSI is back in compliance with all NASDAQ listing requirements as of July 2016.
    • Material weakness is being addressed by, among many other things:
    1. An August 2016 hiring of a new CFO who happens to have extensive insurance experience.
    2. Upgrading to a big 4 auditor (to be announced soon).
    3. Search for additional directors with financial reporting & audit expertise to be added to the board.

    What remains is a shareholder class action lawsuit, and a SEC/Justice Department investigation likely centered on the prior CFO’s non-GAAP journal entries.

    • The lawsuit, now focusing on the prior CFO actions, is largely covered by a D&O policy.
    • A SEC fine is possible, but in similar cases, the size of the fines imposed would not be material to BBSI’s business.
    • Given that the Justice Department investigates individuals (and they opened a file right after the previous CFO self-reported his non-GAAP journal entries), it is very likely that their interest surrounds the actions of the previous CFO. 
    • The market shrugged off the Justice Department news when it was disclosed.

     

    Relevant links:

     

     

    Going forward from here.

    • BBSI has emerged a better managed company. 
    • They have demonstrated resiliency in operations, team focus, referral networks, client retention, growth, and last but not least, risk.
    • Expect a more predictable earnings stream as adequate WC reserves will avoid surprise year-end WC charges experienced in the past.
    • BBSI and the entire PEO industry are still at very low penetration rates so expect rapid growth to continue for years.
    • Expect BBSI to strengthen the balance sheet by accumulating surplus capital for the near future.
    • Ample surplus capital on the balance sheet will remove all doubts about the adequacy of WC reserves.

    Bottom Line

     

         Reserves are conservative.  The significant reporting issues are behind them.  The few remaining legal issues don’t threaten BBSI’s business.  When the market recognizes the true earnings power and assigns a reasonable growth multiple, shares will appreciate rapidly.


    SubjectOne more thing
    Entry08/26/2016 10:26 AM
    Memberruby55

    I forgot to mention that on June 30, 2016 BBSI held $300mm in money market, short term CD's, and T-Bills.  This amount will grown to $330mm by year end.  This paper will reset quickly with higher short-term rates.  100bp is worth $3.3mm/7.2mm = $0.46/share pre-tax.


    SubjectQ3 2016
    Entry11/12/2016 11:22 AM
    Memberruby55

    Highlights:

    ·         17% revenue growth.

    ·         Q3 2016 is the 26th consecutive quarter of 17%+ revenue growth.

    ·         Same customer sales of 9% underscores the health of BBSI’s client base and the effectiveness of BBSI’s co-employer offering.

    ·         200 new net clients, highest ever for a Q3

    ·         Workers comp frequency trends are down 14% in the last year, and 18% in the last two.  BBSI has influence on this performance metric through safety programs & incentives. 

    ·         Lower frequency translates into lower WC risk.

    ·         Old WC claims (2012 & prior) continue to trend positive. Since 2012 & prior was used as the basis for estimating liabilities for years 2013 and forward, positive development in 2012 & prior indicates reserve adequacy.

    ·         Class action lawsuit settled.

    ·         Deloitte & Touch appointed as auditor.

    ·         New audit committee board member appointed.

    ·         WFC credit line paid off one quarter early.  No material debt remains.

    ·         Company maintains 18% revenue growth guidance for the next 12 months.

     

    Lowlights:

    ·         One-time expenses for the recent restatement & remediation for 2016 are now estimated at $8.2mm, up from $6.4mm ($0.76/share from $0.57/share)

    ·         SEC investigation not yet closed.  I expect a fine here, likely not material.

    ·         Financial reporting remediation work still to finish.

     

    Bottom line:

    ·         Prospects for growth remain high.

    ·         FCF = Earnings.

    ·         Infrastructure in place for 18 months of 15%-20% growth.

    ·         Reserves are adequate or likely conservative.

    ·         Run rate EPS for 2016 is $3.75 - $4.00 / share.

    ·         Expected 2017 EPS around $5/ share.

    ·         With the WFC credit line at zero, the building of surplus and a strong balance sheet has begun.

     

    ·         At $52 and 15%+ growth, shares still offered at big discount to fair value of $90-$100.

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