On Assignment ASGN
April 05, 2005 - 6:20pm EST by
arc913
2005 2006
Price: 4.63 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 117 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Summary
On Assignment is a classic example of a good company losing managerial focus after making a spectacularly ill-timed acquisition outside its core competency. For 15 years ASGN operated a highly profitable staffing business focused on scientific and allied medical professionals. Faced with softer end market demand and higher competition in some lines of its business in 2002, ASGN acquired HPO, a traveling nurse staffing business, paying an exorbitant multiple just as the nurse travel business was about to collapse. Post-merger, ASGN management was so focused on salvaging HPO that its core scientific business suffered significant turnover. These personnel losses led to further revenue declines, which, in turn, led management downsize its labor force which generated further revenue declines.

In late 2004 new management came in with a turnaround plan. This restructuring plan has started to bear fruit as ASGN has posted sequential revenue growth in the last two quarters (after 3 years of declines) and stable gross margins. Increased SG&A expenses related to higher recruiter headcount have depressed EBIT. However, ASGN has the potential to generate significant operating leverage and EBITDA growth as its end markets improve and its turnaround gains traction.

Downside is protected by about $1 in net cash per share, over $1.50 in net working assets per share and a debt-free balance sheet. Additionally, ASGN would make an attractive acquisition opportunity given its high gross margins and attractive end markets. On a private market valuation basis, ASGN is worth about $8.50 per share. Upside potential is significantly higher if ASGN can reach the low end of historical profitability.

Valuation Summary
Share Price $4.63
Shares Outstanding 25.3
Market Capitalization $117
Debt -
Cash 23
Enterprise Value 94
Revenue E2005 215
Book Value 74
Net Working Assets (CA-TL) 41
EV/Sales 0.44
P-B 1.6
Net Cash (% of Market Cap) 20%
NWA (% of Market Cap) 35%

Background
Founded in 1985, ASGN is a provider of temporary staff, specifically laboratory scientists and engineers, traveling nurses and medical, financial and allied health (“MFA”) professionals to healthcare-related companies. ASGN’s main end markets include the pharmaceutical, biotech, consumer product, hospital and insurance industries. ASGN operates in the US (95% of revenue), the UK, Holland and Belgium (5% of revenue). ASGN focuses on small and middle market firms.

From the time of its IPO in 1992 to 2002, ASGN was named as one of Forbes magazine’s Best Small Companies for 10 consecutive years. During this period, ASGN beat earnings estimates in 34 consecutive quarters. For the 10-year period ending in 2001, ASGN grew revenue at 22% p.a. (16% organic), EBIT at 24% p.a. and EPS at 28% p.a. Over the same period, ASGN averaged an ROA of 21%, and an ROE of 25% and an EBIT margin of 12%. The shares traded at a high of $32 (market cap of $720 million) in 2000.

In 2001 ASGN posted its first-ever decline in revenues in response to two factors: a deceleration of economic activity (felt throughout the staffing sector) and increased competition from larger competitors. Companies like Kelly Services, Manpower and Adecco began to commoditize positions in the MFA segment and gained market share through aggressive pricing. Additionally, these competitors began to pick off ASGN’s larger Lab Support clients by offering preferred provider packages that centralized all temporary staffing needs (from janitors to scientists) through one provider.

Business Segment Revenues & Gross Margins:
Segment Revenue 2004 Gross Margin Bill Rate GP per hour
Lab Sup $ 84 ml (43%) 30% $26 per hour $8 per hour
MFA $ 29 ml (15%) 29% $28 per hour $8 per hour
Nursing $ 81 ml (42%) 20% $65 per hour $13 per hour

At the same time, the CEO and the COO (both of whom came from Kelly Services), who had led ASGN since 1989, retired. Just prior to their retirement, ASGN retained Lehman to explore a potential sale of the company. There is an unconfirmed report that Kelly made an offer at the then prevailing market price of $18 to acquire ASGN. The Board rejected the offer.

The board appointed Dr. Joe Peterson as CEO in July 2001. Given his previous experience in the medical field and the high growth rates being posted in the nurse staffing industry at the time, Peterson chose to pursue the acquisition of a nurse staffing business called HPO instead of focusing on ASGN’s core markets. In April 2002, ASGN paid $150 million (½ cash; ½ stock) for HPO. This amount represented over 2x’s EV/Sales. The transaction put nearly $140 million in goodwill and other intangible assets on the balance sheet. Almost immediately after the merger, the temporary nurse staffing market collapsed and HPO’s quarterly revenues declined from $37 million in Q2-2002 to $26.3 million in Q4 2002 to $19.5 million per quarter in 2003.

While management tried to stop the hemorrhaging in HPO, they were also saddled with the company-wide implementation of a Peoplesoft ERP system. This led to a loss of control of operating and productivity metrics across the company as the transition to new system occurred (DSO, thankfully, remained under control.). ASGN posted double-digit revenue declines in 2002 and 2003 exacerbated by poor employee morale and high rates of turnover. Management responded to the revenue shortfalls by reducing headcount and closing branches across all it business segments. From 2001 to 2003, the number of gross branches declined from 171 to 80. The number of recruiters declined from 224 in 2002 to 154 in 2003.

ASGN ended 2003 slightly free cash positive and with a small EBIT loss. Since hitting their respective peaks, ASGN’s segment revenues have declined by $140 million on an annualized basis. About ½ of that decline was driven by weakness in the nursing marking, while the rest was driven by market share losses in the core Lab Support and MFA segments. Although the spread between bill and pay rates tightened a bit, gross margins in Lab Support and MFA were relatively stable. The main driver of negative results has been revenue declines driving negative operating leverage.

Turnaround Plan
At the end of 2003, Peter Dameris was named COO (he became CEO in September 2004). Dameris had previously run and sold Metamor, an IT service and consulting company and was COO of Quanta Services. In addition to Dameris, ASGN has appointed new segment heads from Yoh Scientific and Kforce to help lead the turnaround. Management’s turnaround plan is focused on the following:

• Rebuilding the recruiting staff and regaining market share that was defaulted (as opposed to lost) to competitors
• Driving revenue and gross profit per recruiter by eliminating the time recruiters spend on non-revenue generating activities, tracking specific operating performance benchmarks & restructuring compensation towards more of a pay-for-performance model
• Increasing focus on higher level and higher margin positions
• Penetrating related but untapped scientific markets
• Stressing permanent placement fees as a margin enhancement and competitive tool to build relationships and future business

The turnaround plant has begun to show traction. Revenues in the Lab Support and MFA segments showed qoq improvements in Q1, Q2 and Q3 of 2004. Adjusting for the fewer number of billable days in Q4, the trend would have continued last quarter. The Nurse Travel segment did not show a qoq revenue improvement until Q4; however, it did report a yoy improvement in sales (it was one of only two companies in the sector to do so).

Q1-03 Q2-03 Q3-03 Q4-03 Q1-04 Q2-04 Q3-04 Q4-04
REVENUE
Lab Support 24.5 24.1 22.8 21.5 19.6 20.3 22.0 22.0
Nurse Travel 22.0 19.8 18.1 18.1 20.7 19.5 19.2 21.2
MFA 11.3 10.3 9.6 7.5 6.1 6.6 8.3 8.1
Healthcare 33.3 30.1 27.7 25.6 26.8 26.1 27.5 29.3
TOTAL 57.8 54.2 50.5 47.1 46.4 46.4 49.5 51.3
GROSS PROFIT
Lab Support 7.9 8.0 7.1 6.6 5.8 6.2 6.8 6.6
Margin 32.2% 33.2% 31.1% 30.7% 29.6% 30.5% 30.9% 30.0%
Nurse Travel 4.0 3.9 3.9 3.0 4.3 3.8 4.0 4.0
Margin 18.2% 19.7% 21.5% 16.6% 20.8% 19.5% 20.8% 18.9%
MFA 3.6 3.3 3.0 2.0 1.6 2.0 2.5 2.3
Margin 31.9%3 2.0% 31.3% 26.7% 26.2% 30.3% 30.1% 28.4%
Healthcare 7.6 7.2 6.9 5.0 5.9 5.8 6.5 6.3
Margin 22.8% 23.9% 24.9% 19.5% 22.0% 22.2% 23.6% 21.5%
TOTAL 15.5 15.2 14.0 11.6 11.7 12.0 13.3 12.9
Margin 26.8% 28.0% 27.7% 24.6% 25.2% 25.9% 26.9% 25.1%
Note: MFA & HPO are grouped together as Healthcare for segment reporting purposes

Lab Support & MFA
As a first step towards rebuilding ASGN’s franchise in its core Lab Support & MFA markets, ASGN has grown its recruiter headcount while at the same time introducing weekly performance benchmarks (client calls, candidate interviews) to monitor productivity and track revenue generating activities.

Recruiter Headcount:
2002 2003 2004
Lab Support 91 66 102
MFA 91 44 91
Nurse Travel 42 44 40
TOTAL 224 154 233

Certain administrative duties have shifted away from recruiters in order to increase the amount of time dedicated to selling. ASGN has started to broaden its offering to include higher margin areas within engineering and clinical research and expand into the chemical and agribusiness industries.

Permanent Placement Fees:
2001 2002 2003 2004
Total Revenue 195 250 210 193
Placement Fees 4.3 3.0 2.1 2.6
Lab Support 3.8 2.3 1.7 2.2
Healthcare 0.6 0.7 0.4 0.4
% of Total 2.2% 1.2% 1.0% 1.3%

Revenues in these two segments have been driven as much by reactivating clients who had not been contacted in several quarters as by winning new clients. Also, permanent placement fees grew to the highest level in almost 2 years. The sequential improvement in gross margin lends credence to management’s view that a significant portion of revenue declines were due to ASGN defaulting market share, not losing it.

As the lab segment broadens its service offering across scientific specialties and reestablishes itself with clients, ASGN plans to pursue middle market Vendor-Management-System agreements covering all scientific professions as a competitive tool against larger unspecialized staffing firms. MFA has been broadening its offering into higher margin markets as well (credentialed hospital coders, auditors and MIS managers).

Travel Nursing
Besides implementing the measure described above, several other initiatives have been adopted to improve profitability in the travel nurse segment. ASGN has put a high priority on diversifying its customer base, where the top ten clients accounted for 62% of revenue (down from the low 70’s earlier in the year). This effort is being driven by increasing the number of revenue generating recruiters and decreasing the number of non-sales personnel.

To increase the amount of time that recruiters spend on sales, ASGN has established a dedicated quality of service team that will confirm the credentials of its nurses and communicate with clients to ensure customer satisfaction. Previously this function had been executed by recruiters and occupied up to 30% of their time.

Lastly, ASGN has introduced a “local traveling nurse” concept. With this option, hospital can hire a nurse from the local labor pool for a multi-week term. This allows ASGN to avoid the ancillary expenses related to a travel assignment (e.g., apartment rent and travel expenses), generating a 500bp pick-up in gross margin.

Impact on Operating Expenses
The turnaround plan revolves around increasing the number of recruiters, increasing the productivity of each recruiter and reducing the number of non-revenue generating employees. As shown above, ASGN has increased the number of recruiters; however, they have yet to reach full productivity. As a result of the higher headcount, SG&A is likely to run at about $16 million per quarter in 2005.

Company guidance (based on a 26% gross margin, $16 ml in SG&A and 233 recruiters) implies an EBIT breakeven level of $69,000 in gross profit per recruiter per quarter or 2.5 additional temps per recruiter per quarter versus current levels. Both levels are well below peak levels according to the company and attainable in the next 6 months.

Quarterly Productivity Levels:
Current GM=26%, 233 Recruiters
Levels EBITDA EBIT
Q4-2004 Breakeven Breakeven
Temps per Recruiter 12.3 13.4 14.8
Revenue per Recruiter $212k $238k $265k
GP per Recruiter $57k $62k $69k

With end markets improving and revenues growing again, ASGN management is examining way to lower overhead expenses as % of revenues. Historically SGA has run at 20% of revenues, but over the last 2 years of revenue losses that ratio has climbed to over 30%. Management estimates that they could add $70 million in revenue without straining current capacity.

Valuation
There is significant downside protection as liquid assets represent a significant fraction of ASGN’s equity value. Net cash on the balance sheet represents about 19% of the current market capitalization. According to ASGN’s CFO, the company will be receiving a federal tax refund of about $5 million, pushing the cash balance to 23% of the company’s market value. Additionally, net working assets amount to $41 million or about 35% of the market cap.

While predicting the probability and pace of the turnaround effort is a difficult task, it is possible to arrive at a conservative private market valuation for the business of about $8.50 per share based on current levels of profitability. The prime drivers of value to a strategic buyer include:

Growing End Markets
• The life sciences industry has been a prime recipient of venture capital investment over the last several years. This has resulted in a growing number of small/mid-sized companies that have traditionally been ASGN’s core market.
• Although the nursing industry has been weak for the last 2 years, the long-term demographic trends remain compelling. ASGN’s nursing business actually grew and gained market share in 2004.

Attractive Gross Margins
• ASGN has been able to maintain attractive gross margins in its businesses while at the same time rebuilding its revenue base. This adds support to management’s contention that much of the revenue and market share losses were driven by internal mismanagement as opposed to increased competition.
• ASGN has not traditionally focused on the search (i.e., one-time placement revenue) business and this currently accounts for only 1.3% of revenue. As ASGN increases its activity in this segment, gross margins have the potential to expand. For example, in the last 3 years the gross margin in Kforce’s Life Science unit have been helped to the tune of 200bps’s as a result of search revenue running at 2.3-2.9% of revenue.

Strong Market Share in Nursing
• ASGN is the 4th largest travel nurse staffing company in the US with over 5% share. The business would be attractive acquisition for a roll-up trying to achieve scale to compete with AHS and CCRN.

The main drag on ASGN’s current results is the lack of scale to absorb SG&A expenses. This weakness would be alleviated by its acquisition by a strategic buyer that could leverage its corporate infrastructure to realize cost-savings. About ½ of ASGN’s SG&A expense line is related to revenue-generating activities at the branch level. This amount is composed of approximately:

• Recruiter Compensation- $19 million (233 recruiters at an average all-in compensation cost of $80,000)
• Marketing, Rent, IT, D&A etc.- $13 million

The remainder of the SGA expense is related to centralized corporate functions including executive compensation, finance & accounting, call centers, etc. ASGN management believes this portion of SGA could be eliminated by a buyer integrating the corporate functions into its existing infrastructure.

The most recent transaction in the healthcare industry was Cross Country’s acquisition of Medstaff, a travel and per diem nurse business. Cost-saving opportunities in the transaction were low because Cross Country intended to run Medstaff’s travel business as a stand-alone brand and the per diem business model can not be centralized. Based on the price paid and the earn-out provisions, CCRN paid 0.65x-0.87x EV/Sales and 5.5x-7.2x EV/EBITDA. Using this transaction as a proxy, ASGN could be worth just under $9 per share.

EBITDA ESTIMATE: 2005E
Revenue 215
Gross Margin 26%
Gross Profit 56
SGA (ex-centralized expenses) 32
add: D&A (related to branches) 5
Incremental EBITDA to Buyer 29

VALUATION: Lo Hi
EBITDA Multiple 5.0 8.0
EV 145 231
Cash 28 28
Equity Value 173 259
Per Share Valuation $6.90 $10.37
Mid Point of Valuation Range 8.63
Note: Cash balance includes proceeds from tax refund.

Using the EBIT estimates above while assuming a tax rate of 38%, estimated capex of $3 million (per management estimates) and a self-financing working capital cycle, results in after-tax free cash flow level of about $18 million. Using a simplistic DCF model results in a valuation range with a mid-point of just under $9 per share.

Simplified DCF Valuation:
Growth Rate
2% 3% 4% 5%
11% $ 8.68 $ 9.62 $ 10.83 $ 12.45
Hurdle 12% $ 7.92 $ 8.68 $ 9.62 $ 10.83
Rate 13% $ 7.30 $ 7.92 $ 8.68 $ 9.62
14% $ 6.79 $ 7.30 $ 7.92 $ 8.68

Catalyst

1. Successful Turnaround
The prospects of turnaround have 3 major factors going for it:

Revenue losses were self-inflicted.
• To the extent that revenue declines in 2002 and 2003 in Lab Support and MFA were self-inflicted, simply rebuilding the sales force, benchmarking their activities and structuring the right incentives will go a long way to driving revenue. In the last 2 quarters both sales and gross margin have been growing, providing evidence that defaulted market share is being regained without resorting to cuts in pricing.

The nurse staffing business seems to be bottoming-out and the hospital business is improving..
• AMN Healthcare and Cross Country have recently painted a more positive picture of the industry’s outlook. AMN has posted higher volumes in the last quarters after 2 years of declines.
• In March, HCA announced it would exceed Q1 EPS estimates by over 20% driven by higher than expected admission rates and an improvement in most other fundamental trends. This is likely to provide a significant boost to ASGN’s nursing business as it specializes in urgent, quick turnaround placements lasting 8-12 weeks versus the industry standard 12-26 week term.

Venture capital investing in life sciences has picked-up.
• The wave of consolidation in Big Pharma has led to economies of scale in marketing but not in R&D. Big Pharma has been increasing it own funding of small biotech firm to help drive their product pipeline. Small & mid-size biotech firms are a key focus market for ASGN.
• ASGN’s fortunes were highly correlated with the rate of VC investing in biotech and life sciences (peaking in 1999/2000 and suffering sharp declines for 3 years). VC investing is growing again and life science is the leading VC sector, attracting 25% of invested dollars so far this year.

2. Sale of the company
• The management is preparing the company for sale and is highly incentivized towards the stock price via stock option ownership.

3. Return of excess cash via self-tender offer or special dividend
• Once ASGN regains positive EBITDA and cash flow levels in the second half of 2005, management will use its significant cash hoard to repurchase shares.

4. Divestiture of travel nursing business
• A sale of the company in pieces might drive a higher valuation as it would increase the number of potential bidders. The nursing business is operated as a stand-alone unit to a great extent and could be divested easily.
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