Westaff WSTF
September 12, 2005 - 9:10am EST by
2005 2006
Price: 3.76 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 62 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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WSTF is a double with multiple catalysts. One of the catalysts could happen as early as this afternoon. Let me explain what I mean.

First, the business. WSTF is a staffing company with operations in the US, UK, and Australia. It has been around since the 50’s but only recently has leadership passed out of the hands of its empire-building former CEO and current Chairman, Bob Stover. After the staffing recession of 2001, the company has been taking the necessary steps to profitability—closing underperforming offices, trimming administrative headcount, and selling non-core divisions. This process is basically over, and the company is positioned for positive operating leverage once again.

The US operations have hovered slightly above break-even profitability. The board replaced the CEO in March with the woman who had led the UK division, growing it from 28m of revenues in 2002 to 45m in 2004 and increasing EBIT there from .8m to 2.2m. She has just started implementing the same procedures in the US, including trimming overhead and layering in high-margin permanent placement revenues. The UK division (6% of revenues) remains healthy while the Australian division (16% of revenues) has been growing in excess of 30% for the past 3 years, as the team there is aggressively growing the business.

Let me discuss valuation first and then I’ll highlight how the valuation might be achieved. The company has 16.5m shares and net cash (if you assume that their worker’s comp cash collateral is released in 4q05, as the company anticipates, though there are seasonal working capital needs). I believe that the international operations, with 155m of revenues for fiscal (October) 2006, should be valued at no less than $45m, which is 30% of revenues and roughly 12x ebitda, for divisions that should grow at over 15% (Australia is 70% of this and grew 45% last quarter). Note that the company recently sold its slow/no growth Scandinavian operations for 25% of revenues.

That leaves an implied valuation of $15m for the US operations, which should produce over $500m of revenues and $12m of ebitda in 2006. This places the valuation at 3% of forward revenues. Most staffing companies trade in a range of 20-50% of revenues, and the only other time I saw (and owned) a staffing company at this valuation was when Hudson Highland (HHGP) was spun out of Monster.com back in 2003 and traded at 7% of revenues (the stock is up 7x since then). I think WSTF should trade at the bottom end of comparable company valuations, or 20% of revenues; this implies a $9 price or 135% upside.

So, how does the stock get there? There are 3 paths, as far as I can tell.

1) (one year) Management delivers on the nascent turnaround. The calls I have had with local managers and others within the organization convey a strong sense of optimism about the new CEO’s potential impact. The company should earn $.55 in fiscal 2006 and 16m of ebitda by raising US ebitda margins from 170bps to 230bps (some of which is “in the bag” through already-announced middle-management eliminations) while international grows less at trend. Investors should reward these still-depressed earnings with a 16 eps multiple (8.5x ebitda), at the low end of comparable companies. Company may also get sell-side coverage by the start of 2006, as alluded to in the most recent conference call.

2) (variable timing) I initially came to research this company after a conversation with an industry insider who highlighted the company as a likely acquisition target. I have been unable to confirm or deny, but my observations are as follows:
a) management would prefer to turn the company around rather than liquidate it but Bob Stover is 84 years old and still owns half the company. I believe that this is slightly deceptive, in that he owns roughly 2m shares outright, 3m shares through a unit trust to benefit his wife in the case of emergency, and 2m shares in his foundation (see below); nonetheless, I’m sure he would be happy to realize some profit at this stage of the game.
b) with the high fixed costs of a staffing business, there are unbelievable synergies to be reaped (you only need one network of offices, management team, information system, sarbox costs, etc), so any acquisition would be immediately and enormously accretive especially at these valuations.
c) the company’s footprint would be a perfect fit for many companies, among them HHGP (that just raised capital for acquisitions and similarly has operations in the US, UK, and Australia) and MRN (which is expanding out of healthcare staffing in an effort to gain profitability and is backed by Warburg). Most staffing companies have generated abundant amounts of cash in the past few years and have debt-free balance sheets.

3) (immediate timing) Here’s where the power of VIC comes in. The recent underperformance of the stock, in my opinion, is mainly due to a large and relentless seller. This seller is a foundation started by the ex-CEO which was gifted 2.5m shares almost 5 years ago. By IRS rules, foundations need to sell all stock that is gifted to them within 5 years or face a substantial and onerous tax liability. The Stover Foundation has until December to sell its shares, and so it sells and sells and sells, with the help of a particularly clumsy Merrill broker who likes to sit on the offer with a few days of volume… in fact, it has sold more shares since the end of July than have traded! (I guess there are some unreported sales in there). You can see the pounding on Bloomberg; the question is: when does it end? Well, the Foundation still has 1.8m shares remaining. However, not all of these are subject to the deadline—of these, 1.3m shares need to be sold by the end of the year. Funds (including my own) are buying these shares, but so far supply is still greater than demand.

So what are you waiting for? Buy them! The treasurer of the Foundation is Nancy Ward, and her number is (925) 930-5344. As mentioned before, she is eager to sell her shares to avoid substantial tax penalties, and will do so at a discount to market ($3.50 is feasible from my discussions with her, at which price the US operations are valued at 2% of revenues). It is my hypothesis that should an interested party buy the remaining shares from her, the stock would go up substantially and immediately.


a) Foundation overhang of stock is lifted
b) Acquisition of company
c) Strong earnings report from new CEO and fast-growing international divisions
d) Research coverage and/or conference presentations
e) Value (getting $500m of revs virtually for free) is its own catalyst
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