New Holding – TriNet

Amelia Nunn - Equity Analyst

23 December 2020

TriNet helps small and medium sized businesses across the United States with various HR related functions, including payroll services, employee benefits and regulatory compliance.

The business operates as a professional employer organisation (PEO). A PEO is a type of co-employment model, which means that while the client remains responsible for the day-to-day job responsibilities of their employees, TriNet is the employer of record for administrative and regulatory purposes.

TriNet has approximately 18,900 clients and co-employs 340,000 worksite employees.

PEO industry expected to grow 8% per year

Small and medium sized businesses operate in increasingly complex legal and regulatory environments and PEOs offer a service that reduces the burden. In the US, as each state, county or city can have different regulations and tax codes, businesses have a considerably complex task in managing compliance. These challenges hit small and medium sized businesses the hardest as they typically lack dedicated and specialised HR personnel.

PEOs provide particular value in managing healthcare benefits, a key concern of US workers. As a PEO provides services to a large number of employees, they can access healthcare benefits that would normally only be available to much larger employers. Their economies of scale save clients money, while also providing employees with higher quality and better value healthcare benefits.

PEOs operating in the US serve a total of approximately 175,000 small and medium sized businesses with 3.7 million employees. In the US there are around 60 million people working for businesses with under 500 employees and TriNet management estimates that one third of these businesses could benefit from using a PEO. With current market penetration under 20%, there are still a lot of potential clients for PEOs to go after in the US.

Why TriNet?

TriNet is the largest standalone PEO, with around 9% market share. There are four other large PEOs, accounting for around 36% of the market, but two of these run much larger payroll software businesses and other segments which we think will be dilutive to growth and distract management from the PEO market opportunity. The remaining 55% of the market consists of hundreds of local competitors, which we believe TriNet can either out-compete or acquire.

TriNet has invested heavily in its technology platform, which is central to all its services and connects the clients and employees with TriNet. The platform includes online and mobile tools that allow clients and employees to store, view and manage HR information. It also incorporates workforce analytics, allowing clients to generate HR data, payroll and other custom reports. This technology platform means that as TriNet grows the business should benefit from operating leverage, as there are limited additional costs associated with each new employee on the platform.

TriNet management focus on client industries that have high growth, highly skilled employees who require good benefits packages and complex operations, e.g. across multiple states. This includes industries such as financial services, technology, professional services and life sciences. These typically ‘white-collar’ employees represent nearly 80% of TriNet’s employee mix. A higher proportion of white-collar employees reduces cyclicality and increases revenue per employee, as the monthly fee TriNet charges per employee is around two to three times higher for white-collar clients than blue-collar clients.

TriNet’s go-to-market strategy is unique compared to peers, as their sales team is organised by client industry, so financial services sales reps, for example, only sell to financial services companies. The sales reps become experts in their fields and are well versed in regulatory technicalities that are common to particular end-markets. Over time successful sales reps can benefit from a referral network that forms in their client industries.

Attractive valuation

TriNet’s P/E ratio has often traded at a discount to the market and we believe this is due to the perceived cyclicality of the business and the general lack of coverage and understanding from the investment industry.

Our analysis suggests the cyclicality of the business has reduced over the past few years as TriNet has increased its proportion of white-collar workers. For example, during the second and third quarter of 2020 their employee numbers fell just 2% and 4% respectively, as the brunt of economic weakness was felt by retail and hospitality sectors.

TriNet has very low capital expenditure so generates a lot of free cash flow and strong returns on capital. This, combined with the long-term growth opportunity of the PEO industry and a low starting valuation multiple provides an attractive entry point to build a new position in the fund.

Funding the purchase

Positive inflows to the fund as well as recent sales of West Pharmaceuticals and Varian Medical Systems provided the cash for us to add TriNet to the portfolio.