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Barrett Business Services (NASDAQ:BBSI) is one of several HR services companies currently on the magic formula list, a sign of the market’s pessimism regarding the economic outlook. We believe investors misperceive BBSI, however, as only 15% of revenue comes from staffing, while 85% comes from HR outsourcing (professional employer organization contracts), a business that is characterized by recurring revenue and, in the case of BBSI, 90% client retention. The PEO business deserves a meaningfully higher multiple than a traditional staffing business, which is why we view BBSI as quite attractive at current prices.

BUSINESS OVERVIEW

BBSI provides human resource (HR) management solutions to small and medium-sized businesses primarily in the Western U.S. BBSI derives 85% of revenue from professional employer organization (PEO) contracts and 15% of revenue from temporary/ supplemental staffing, with 50% gross margins in each segment. The HR industry ($170 billion size) breaks down into 35% PEO, 52% temporary/supplemental, and 13% search and placement. BBSI target clients in the PEO segment are businesses with 20 to 200 employees; in the staffing segment, the company targets large employers with seasonal fluctuations. BBSI operates out of 45 branch offices in ten states.

BBSI PEO SERVICES (85% of revenue)—VALUE PROPOSITION

HR responsibilities without BBSI:1

HR responsibilities with BBSI:1

INVESTMENT HIGHLIGHTS

  • Outsourcing HR function allows clients to reduce the liability of being an employer, focus on the core business, develop a “just-in-time” workforce, and improve efficiencies. BBSI addresses workplace safety, lowers workers’ comp premiums, recruits and screens employees, manages turnover, handles employee claims, implements benefit programs, and complies with regulatory filing requirements.
  • Recurring revenue stream. PEO contracts are annual with automatic renewals (30-day cancellation). BBSI has a 90% client retention rate.
  • HR function becoming more critical, complex. Employment regulations have grown 60% over the past couple of decades, and small businesses spend up to 25% of time on HR paperwork. Homeland security concerns have also increased HR burdens.
  • Organic and acquired growth. BBSI intends to expand the geographic footprint by following the expansion pattern of key clients. Recent staffing acquisitions also contribute to growth.
  • Hands-on client approach. BBSI serves each client from a nearby branch office. Offices provide both HR and risk management professionals.
  • Experienced management. Each top executive has at least a dozen years industry experience, with CEO Bill Sherertz in the industry for 37 years.
  • Strong balance sheet, with $51 million of cash and investments and no debt as of September 30.

INVESTMENT RISKS & CONCERNS

  • Operates in cyclical business, the recurring revenue nature of PEO contracts notwithstanding.
  • BBSI’s workers’ comp loss reserves may be inadequate to cover claims. The company may suffer from adverse developments related to medical and administrative costs, inflation, and legislation.
  • M&A integration. BBSI has acquired three firms with combined sales of $60 million since mid-2007 (5 offices in Utah, 2 in Colorado, 2 in Arizona).

MAJOR HOLDERS

CEO Sherertz 26% │ Other insiders 2% │ Royce 13% │ Heartland 5%

1 Source: BBSI.

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Source: BBSI: Unjustly Lumped With Traditional Staffing Firms