Seeking Alpha

Copperfield Res...'s  Instablog

Copperfield Research
Send Message
Copperfield Research is the pseudonym of a research team focusing on publicly traded equities. As of the publication date of our articles, we may have long or short equity positions in the companies covered. We do not discuss unpublished reports, or provide any advanced warning of future reports... More
View Copperfield Research's Instablogs on:
  • Barrett Business Services (BBSI): Throwing Good Money At Bad

    Today we share a follow-up to our original BBSi report. We believe the analysis herein is even more impactful than our original report. Below are the highlights of our second report, which concludes BBSI may have as much as a $135 million funding gap (as well as revealing another crippling reserve charge is likely). Our analysis, based on a plethora of new disclosures and data points suggests an updated fair value for BBSI is between $0.00 and $8.76 per share, representing 65% to 100% downside.

    Our full report can be found here: tiny.cc/5885ox

    Barrett Business Services (NASDAQ:BBSI) has suffered a precipitous stock price decline over the last two months as the confession process has begun. Despite a stock price down nearly 75% from its highs, we believe the risk speculating in BBSI's common stock has never been higher. Simply put, a $100 stock that goes to $25 generates a smaller percentage loss than a $25 stock that goes to $0. Uninformed investors/traders appear to have fallen victim to the dangerous temptation of assuming the worst is behind BBSI, declaring the bottom is in, the bounce is at hand, or as the irresponsible sell-side has proclaimed - the decks have been cleared. This follow-up report, based on new information and disclosures since our first report, unequivocally concludes the worst has yet to come for BBSI.

    On 9/16/14, we shared a lengthy BBSI report titled, "Barrett Business Services (BBSI): A Tick-Tick-Ticking Time Bomb" (it can now be printed to accommodate many requests).[i] Following BBSI's third quarter financial release and disclosure of an $80 million reserve charge (10/28/14), we briefly shared updated thoughts in "BBSI: Tick-Tick Boom."[ii] In short, substantial downside still exists and making money owning BBSI's stock appears to be effectively capped.

    It is our opinion that the $80 million reserve charge is just the beginning. Based on management's recent disclosures, our analysis suggests BBSI will be required to take another reserve charge of at least $55 million. We believe the company is not only aware of this probability, but management's bizarre actions are an attempt to prop up the stock price long enough to minimize the dilution of an eventual distressed equity raise. (To this point, we are admittedly surprised BBSI's management has not yet "hit the road" to meet with institutional investors).

    Our first report accurately analyzed BBSI's systematic reserve deficiencies. In this report, we provide an equally concise, and perhaps irrefutable argument supporting our belief that another reserve charge is on the horizon. We can not stress enough that the recent $80 million charge does not "clear the decks" as some interested parties have argued. In fact, per BBSI's own admission, the $80 million charge only targets reserve deficiencies for accident years 2012 and prior, leaving the severe workers' comp under-accrual from 2013 and 2014 unaddressed. This begs the question - Did BBSI ignore Willis' recommendation of a larger reserve charge that would have covered the 2013/2014 under-accruals, but also would have effectively wiped out the common equity in the process?

    The same sell-side analysts that were politely excused from prior culpability (due to their lack of insurance expertise) have failed to think independently, suggesting the bad medicine has been taken. Our analysis herein unequivocally concludes BBSI is still massively under-reserved. By extension, a common equity raise appears to be a question of "when" not "if" which explains management's token buyback, dividend increase, and immaterial insider buying. In this report, we cover a number of topics, including:

    1) BBSI Appears Unprofitable; Another Large Reserve Charge Is Inevitable (& Management Knows It); ACE Risk Grows

    BBSI's reserve charge only addresses reserve deficiencies through calendar year 2012. As such, 2013/2014 reserves require significant strengthening. Based on an accident year model allocating the $80 million reserve charge and prior period development, we estimate BBSI's core business lost money every year between 2009 and 2012.Our analysis found the strengthened 2010 - 2012 reserves are approximately 45% and 26% higher than 2013 and 2014 reserve levels respectively. To bring 2013/2014 reserve levels to parity with 2010 - 2012 reserves, we estimate another $70 million charge is required. If BBSI management took the 2013/2014 reserves to a level consistent with updated accrual guidance, a $55 million charge would be required. We believe management's carefully worded press release and prepared remarks on its Q3'14 call means the actuarial rigor used to establish accident year reserves for "2012 and prior" was abandoned for determining 2013/2014 reserves. While management may try to buy time, hoping the actuarial data magically improves, we believe ACE may reconsider the fronting agreement in the interim. BBSI has changed materially since the fronting agreement was announced. Further, ACE's trusted partner Willis was used for the reserve study (as we predicted), suggesting ACE may not be comfortable with BBSI's reserves/underwriting. In our opinion, BBSI would likely go into run-off should ACE non-renew its fronting agreement.

    2) Debt Alone Can Not Bridge BBSI's Funding Gap, Which Appears Much Larger Than Disclosed

    BBSI is required to collateralize its $80 million reserve charge on a dollar-for-dollar basis to stay in compliance with State requirements. Under new law, California regulators have the discretion to require a security deposit greater than 100% of reserves in cases resembling BBSI. Management has proclaimed $32 million of the required funding can be met through a tax refund. But based on our analysis, the anticipated refund (40% of the $80 million charge) represents 55% more than the $20.7 million of cash taxes BBSI has paid since 2009. Insurance companies are typically limited to debt-to-capitalization ratios of 20% to 25%. Should Wells Fargo view BBSI in the same vein as other insurers, BBSI's debt capacity may only be $8.5 to $11.5 million. If BBSI somehow raised $65 million of debt (on just $34.4 million of equity), its leverage ratio would be 65%, higher than any solvent insurance company we could find. BBSI's 2014 cash flow has failed to cover the required funding of the ACE trust account. Year-to-date, BBSI has contributed $31.1 million to the ACE trust account representing more than 100% of its already overstated cash flow. We believe an additional $20 million to $50 million is needed to fully collateralize the original ACE funding agreement. The ACE funding burden will be concurrent with the State level funding requirements on legacy reserve levels, at the same time BBSI will also be struggling to fund current and future reserves dollar-for-dollar. According to BBSI management, the company has $15 million of unencumbered cash, $14 million on an undrawn credit facility, and our estimate of a $21 million tax refund from cash taxes paid. We estimate BBSI has $185 million of near-term capital needs with only $50 million of identified sources. The result is a $135 million capital hole. Considering the expected hole, we find management's actions in the wake of the reserve charge irrational and irresponsible. As recently as September 2014, BBSI wasted precious capital to buy back stock at prices nearly 100% higher than the current price. Instead of prudently rightsizing exposure through re-underwriting and re-pricing its business, BBSI management announced it would grow same store sales in 2015. Finally, BBSI increased its quarterly dividend by 22% (which it will not be able to cover based on our 2015 estimates), despite requiring $80 million of near-term capital.

    3) Irrationally Aggressive Pricing and Outlandish Marketing Claims

    We believe BBSI has materially underpriced its workers' compensation insurance to grow in a highly commoditized industry. BBSI's own marketing materials claim to offer "lower workers' compensation premiums [due to] aggressive claims management." Amazingly, we have obtained BBSI marketing slides stating their California loss ratio is just 10% - 14%. This compares to standard market carrier loss ratios between 50% and 75%. BBSI's own marketing materials suggest it would be 600% - 700% more profitable than the industry average cited by the California Department of Insurance. Further, we question what BBSI means when referring to "aggressive claims management." Public lawsuits shed insight into the challenges individuals have had obtaining settlements, while also leading us to question why BBSI accepted a workers' compensation client one year after being charged with defrauding the California State Compensation Insurance Fund.

    4) Stock Still Significantly Overvalued on Estimated 2015 EPS

    At a 12x earnings multiple on our generous set of 2015 earnings estimates, BBSI's fair value would be $8.76 per share. Our estimates generously exclude increased costs associated with changes to the ACE fronting agreement (which mathematically appears impossible). With the combination of another reserve charge looming for 2013/2014 business, uncertainty about its funding/capital ratios/leverage, and the pending ACE fronting agreement renewal, we see numerous scenarios, and a growing probability that BBSI's equity will be worth zero.

    IMPORTANT Disclaimer - Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.


    [i] www.scribd.com/doc/239934271/Barrett-Bus...

    [ii] http://seekingalpha.com/instablog/890075-copperfield-research/3409505-bbsi-tick-tick-boom

    Disclosure: The author is short BBSI.

    Tags: BBSI
    Nov 11 1:02 PM | Link | 16 Comments
  • BBSI: Tick-Tick Boom

    After the close on 10/28/2014, BBSI reported a net loss of $5.27 per share, driven by an $80 million pretax increase in workers' comp reserves. In our previous report "Barrett Business Services (NASDAQ:BBSI): A Tick-Tick-Ticking Time Bomb" we highlighted the systematic overstatement of earnings due to persistent under accruing of workers' comp reserves. We also highlighted the consistent trend of prior period adjustments, which in our opinion, blatantly violated U.S. GAAP accounting rules. The result of the accounting irregularities was a further overstatement of earnings. BBSI's $80 million pretax charge effectively wipes out the past five years of pretax earnings. Further, the charge represents a 70% increase in workers' compensation reserves compared to Q2'14. Said another way, our thesis that BBSI has been writing economically unprofitable business (despite reporting accounting profits) over the past few years, now appears incontrovertible.

    As we highlighted in our original report, most of BBSI's sell-side analysts had minimal insurance experience. As such, it our understanding the sell-side has been relying on management's commentary to shape responses to our original report. We believe the sell-side has been suggesting to institutional clients that a charge between $5 and $10 million was a possibility. Considering the $80 million bombshell BBSI just dropped, it is understandable that the previously promotional analysts may feel slightly misled. Further, in no way, does this charge reset past mistakes.

    Demonstrating management's condescending treatment of the investment community, they provided an "adjusted EPS" figure that excludes the all-important reserve charge. Make no mistake, the reserve charge reflects a true-up for years of pre-tax earnings that were overstated. To "adjust" out the most important and volatile cost of BBSI's business is akin to a utility excluding its cost of generating electricity.

    Even more disturbing, management provided a 12-month revenue outlook that included high single-digit same store sales growth, despite apparently having minimal basis to conclude the business they are underwriting is even profitable. It is clear to us that this management team has limited visibility into its insurance exposure. Management's suggestion that they will continue to grow exposure despite having no ability to ensure that exposure is even profitable, unequivocally tells us BBSI management is more concerned with investor perception than right-sizing its future liabilities.

    On top of the catastrophic reserve charge is BBSI's disclosure that "several quarters" of "normalized" claims data will be necessary to "provide a clearer indication of potential liability." Despite a previously unimaginable $80 million charge, BBSI management appears to be confessing that future reserve increases may still be needed. The culmination of all of this "sudden" bad news appears to be BBSI's disclosure that it has entered into discussions with its bank to "meet the liquidity needs of the company." Based on our analysis, much of which was shared in our original report, we would not be surprised if BBSI had insufficient cash to collateralize its business with ACE. By extension, we believe the $80 million charge (with more seemingly to come) could result in ACE re-evaluating its fronting arrangement with BBSI. Despite the concerning statement regarding liquidity, BBSI still had the audacity to buy a token amount of stock, for reasons we can only guess are perception-based.

    After the $80 million reserve charge, BBSI's shareholders' equity has been reduced to a paltry $4.80 per share, while tangible equity declined to a NEGATIVE $13.4 million. While we look forward to hearing their strategy to address any liquidity challenges, it is our opinion that BBSI may ultimately require a distressed equity raise.

    It seems clear to us that management was very much aware of the implications of its reserve deficiencies. Between its "pro-forma" report, token buyback, completely irresponsible growth projections, and "off-line" discussions with sell-side analysts, our guess is that many investors will see through the ruse. Unfortunately, investors were not given the opportunity to sell after-hours. Past earnings reports had been released by BBSI approximately 10 minutes after the market had closed (4:10 PM ET). Perhaps a mere coincidence, but with a high probability of pissed-off analysts and distraught shareholders, we believe management again displayed poor judgment by waiting until 8:17 PM ET to release its report - after most investors had gone home and after-hours trading had stopped.

    In our original report, we generously reached a $29 fair value estimate for BBSI, which assumed BBSI DID NOT take a massive reserve charge. With an $80 million charge, an opaque suggestion of liquidity issues, and shredded credibility, it would not surprise us to see an SEC accounting inquiry and/or justifiable class action lawsuits. Considering all of our past concerns, combined with the possibility of legal woes, we think the probability of BBSI being a zero is now well north of zero.

    Disclosure: The author is short BBSI.

    Tags: BBSI
    Oct 29 9:19 AM | Link | 9 Comments
  • Barrett Business Services (BBSI): A Tick-Tick-Ticking Time Bomb

    Today we shared our research and opinion on Barrett Business Services (NASDAQ:BBSI). Highlights of our opinion/report are below, with our full opinion found here: www.scribd.com/doc/239934271/Barrett-Bus...

    IMPORTANT - Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented "as is," without warranty of any kind - whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.

    ------------------------------------------

    We believe Barrett Business Services (BBSI) operates with a precarious business model and substantial reserve deficiencies, which has created immense blow-up risk for public market investors. The combination of aggressive growth into the pernicious California workers' compensation market and minimal transparency regarding a recently disclosed reserve study has created an un-investable stock. Our work suggests BBSI has systematically under reserved, which has resulted in materially overstated earnings and a high probability of a massive reserve charge. With only three covering sell-side analysts (none of whom appear to have any insurance domain expertise based on a collective coverage universe that includes movie theatres, executive staffing, water dispensers, and ecommerce solutions), the combustible issues at BBSI have largely escaped investor scrutiny. That should change with our report, which includes a compendium of forensic issues, as well as background on BBSI's model and end markets.

    Based on our analysis of 2013 incremental adverse development (applied to 2012 claims expense), we believe BBSI may have overstated earnings by 57%. Depending on the degree to which BBSI's reserves may be inadequate, there are scenarios discussed herein which would completely wipe out BBSI's previously reported profits. In addition to arguing our belief that BBSI has overstated past earnings, we outline why BBSI appears to be in blatant violation of U.S. GAAP accounting. Our accounting concerns are amplified by a 2014 lawsuit brought by a long tenured branch manager accusing BBSI C-Suite executives of "effectively cooking the books to create inflated profit margins to entice interest in BBSI stock in violation of SEC regulations."[i] Unsurprisingly, we have been unable to find any disclosures in BBSI's public filings about the existence of the lawsuit and associated incendiary charges. BBSI's auditor is tiny Moss Adams, who does not even list insurance as an area of expertise on its website.

    It is well understood that insurance companies can hide long-term economic liabilities for extended periods of time. However, a recently announced reserve study should act as the catalyst to publicly expose the magnitude of BBSI's reserve hole. The dramatic shift in IBNR and case reserves are additional red flags, with the latter inexplicably increasing from $51 million to nearly $93 million in BBSI's most recent quarter. Based on our analysis, if BBSI simply matched the reserve coverage of other PEOs and insurance companies, a charge between $69 million to $280 million would be required. For perspective, BBSI's shareholder equity at 6/30/14 was just $74 million. A reserve charge representing just a fraction of our estimate would likely eliminate years of pretax earnings, while creating uncertainty over BBSI's profitability and ongoing business model.

    Adding even more asymmetry to BBSI's stock is the new fronting agreement with ACE. Should the reserve study (or other issues discussed herein) cause ACE to non-renew its fronting agreement, BBSI's corporate profile could be impaired with no replacement to renew its California business.

    Under a rosy scenario analysis that assumes BBSI is somehow able to delay reserve charges, we still believe the stock will revalue significantly lower to account for balance sheet risk and incremental earnings pressure from regulatory changes occurring on January 1, 2015. Generously assuming benign outcomes for many of the issues identified in this report, we still believe fair value for BBSI's stock is $29.00 per share, which is 50% below its recent price. The $29.00 per share scenario assumes the company is NOT required to take significant reserve charges to address its thin reserve position, has no negative changes in its ACE fronting agreement, and no restatement of past results for inappropriate reserving practices occur. On the other hand, if we are correct about the considerable hole in BBSI's reserve, we believe there are a plethora of long-tail scenarios that could cause the stock price to go much, much lower. We encourage all shareholders (and sell-side promoters) without insurance expertise to consult an insurance expert to independently verify our analysis and conclusions.

    Our report contains several sections focused on relevant background information on BBSI, workers' comp, as well as the California PEO dynamics. Other sections are specific to the problems we have identified at BBSI, including detailed analysis examining BBSI's reserving practices and business/financial models. For those with time constraints, we would encourage you to jump directly to sections 4, 6, 7, and 8, which provide the most specific analysis and discussion into the significant risks and "meat" of our BBSI opinion. If you can only read one section in its entirety, please see section 6 ("Severely Inadequate Reserves May Require a Significant Charge"). Sections 1-3 provide relevant, yet admittedly boring background. The following segments are covered in this report:

    1) Investors Should View BBSI as an Insurance Company - BBSI is a PEO with a small staffing business. The PEO represents approximately 95% of gross revenues. BBSI competes in the challenging market of providing workers' compensation insurance for blue collar employers. Further, most of its exposure growth has come in California, which now represents roughly 74% of net revenues. Over the past three years, the new management team more than doubled the company's exposure to this risky market.

    2) A Brief Background on the Seedy History of PEOs - The PEO industry has a tumultuous history that is marred by extensive fraud. In recent months, officials tied to several PEOs were sentenced in one of the largest insurance fraud cases ever, misappropriating $133 million of their clients' money. According to the FBI, "Workers' compensation insurance accounts for as much as 46 percent of small business owners' general operating expenses. Due to this, small business owners have an incentive to shop workers' compensation insurance on a regular basis. This has made it ripe for entities that purport to provide workers' compensation insurance to enter the marketplace, offer reduced premium rates, and misappropriate funds without providing insurance."[ii]

    3) California Bans PEOs - Under Senate Bill 863, all California PEO licenses, including BBSI's, will be revoked on 1/1/15. This provision passed due to concerns related to the financial stability and/or solvency of the industry following PEO bankruptcies in the State. BBSI's core PEO business will effectively be banned on 1/1/15, likely resulting in a significant growth and/or earnings hit.

    4) BBSI Losing Its License = Possible Collapse of Growth and/or Earnings - In response to getting its license revoked, BBSI entered a fronting agreement with ACE, a rated and admitted insurance company. We believe management has misled investors on the financial impact of this fronting agreement. After initially describing it as "earnings neutral," management recently revised the estimated potential drag to 25 to 30 basis points. A 25 to 30 basis point hit relative to gross revenue would have cut 2013 earnings by as much as one-third. BBSI's second quarter 10Q suggests the fronting costs may already be 2x management's updated estimate, with approximately 66% of its clients still not transitioned to the more expensive policy forms. We expect significant earnings pressure as the remaining two-thirds of clients transition to the ACE fronting arrangement.

    5) A "Reserve Study" By Any Other Name Would Smell as Rancid - On July 30, 2014 BBSI's management disclosed that a third party actuary had been hired to conduct a reserve study of its insurance reserves. Two similar reserve study announcements (GNW and TWGP), both with similar workers' compensation exposure, resulted in significant stock price declines. It is unclear why BBSI is conducting a reserve study now, but we believe ACE, BBSI's new fronting partner, may be the driver. While management has provided minimal transparency or detail into the reserve study, based on our reserve analysis, we believe it is reasonable to assume ACE may not be comfortable with BBSI's existing reserve. Our suspicion is that one of ACE's preferred actuaries (Milliman or Willis) is conducting the study. If the third party actuary results are not addressed appropriately, it is possible ACE will not renew their fronting agreement with BBSI. A non-renewal could shut-down BBSI in California post SB 863.

    6) Severely Inadequate Reserves May Require a Significant Charge - We believe the ongoing reserve study will reveal a large hole in BBSI's reserve position. Our in-depth review suggests BBSI may be required to recognize a material charge to substantially increase its loss reserves. We analyzed five significant red flags at BBSI: 1) persistent prior year reserve development, 2) exposure, revenue, and claims payment growth well in excess of reserve growth, 3) irreconcilably low short-term reserves, 4) extremely thin IBNR levels, and 5) reserve levels well below paid claims. Each of these red flags suggests BBSI has severely inadequate reserves. Further, our analysis suggests BBSI met their earnings guidance in the second quarter 2014 by dramatically under accruing claim expenses. Based on BBSI's low level of short-term reserves, and the decline of short-term reserves as a percentage of overall reserves, we believe BBSI will need to take a charge of at least $30 million. Our analysis concludes a charge of this magnitude would be required to simply increase short-term reserves to a level that would cover claim payments over the next twelve months. Additionally, BBSI's SEC filings illuminate a dramatic shift in IBNR and case reserves, with the latter inexplicably increasing from $51 million to nearly $93 million in the most recent quarter. Generally, IBNR makes up a substantial portion of long-tail insurance reserves. However, IBNR constitutes just 24% of BBSI's reserves. BBSI will need to take a charge of approximately $63 million to move its IBNR inline with a comparable group of workers' compensation insurers. We show how BBSI's run-rate of paid claims would deplete their reserves significantly faster than the comp group, despite BBSI's rapid exposure growth (and the backward looking nature of paid claims versus the supposedly forward looking nature of reserves). According to our analysis, matching the reserve coverage of other PEOs and insurance companies would require BBSI to recognize a charge between $69 million and $280 million.

    7) BBSI's Reserving Practices & Accounting Appear to Violate GAAP Resulting in Overstated Earnings

    Management's public description of its reserving practices appears to violate U.S. GAAP accounting, specifically FAS 60. Management recently explained its accounting approach, which indeed matches BBSI's historical financials. Neither their explanation, nor the historical financials appear to conform to U.S. GAAP. We clearly analyze how reserve accruals related to prior accident years constitute an inexplicably large percentage of the total reserve accrual. The consistently high accrual for prior years is inconsistent with other PEOs and insurance companies. As a result of its unorthodox accounting, we believe BBSI has dramatically overstated past earnings. Applying the incremental adverse development in 2013 to claims expense the prior year, suggests that 2012 EPS was overstated by 57%. We believe an accounting restatement may be required, which would result in substantially lower historical earnings. BBSI's auditor is Moss Adams, who does not appear to audit other insurance companies, or even list insurance as a practice area.

    8) Insurance Subsidiary Inconsistencies & a Lawsuit Accusing BBSI of "Cooking the Books"

    Results within a BBSI statutory insurance subsidiary show deteriorating growth, earnings, and a miniscule reserve position. These results filed with state insurance regulators are inconsistent with reported consolidated trends. Ecole Insurance, which is wholly owned by BBSI, discloses contact information and addresses that do not appear to match any of BBSI's disclosed offices. Further, it appears Ecole shares an address with a Home Warranty Insurer, while listing a "Statutory Statement Contact" that appears to be a Beecher Carlson employee based in Hawaii. Further adding to our overall suspicion, a recent lawsuit filed by a 10-year branch manager accuses BBSI's CEO and the company of "manipulating the bottom line to avoid paying bonuses to managers," and "effectively 'cooking the books' to create inflated profit margins to entice interest in BBSI stock in violation of SEC regulations." We have been unable to corroborate these accusations, however taken with numerous other management misrepresentations that we believe exist, the litigation raises incremental flags.

    9) California Workers' Compensation Destruction (brief background) - The California workers' compensation market has a treacherous history, with numerous stock market examples of investor losses in companies tied to this market. In the last downturn, carriers representing nearly 1/3 of the market failed due to significant reserve issues.[iii] More recently, investors in TWGP, MIG, EIG, and QBE AU have experienced steep losses following reserve issues tied to California workers' compensation. We believe BBSI investors will follow in these footsteps.

    10) Deterioration of California Loss Trends Should Pressure BBSI - California workers' compensation insurers have reported a deterioration in underwriting results. A recent state insurance authority report found ominous trends in frequency and severity of loss costs. EIG recently took a large reserve charge related to its California workers' compensation business, warning, "We believe these [deteriorating] trends are an issue for us and for any workers' compensation insurance company doing business in California." BBSI has 74% of net revenues in California, with a heavy risk concentration in the exact areas experiencing increasing adverse claim trends.

    11) ObamaCare & California State Fund = Risk of Large Client Departures and Negative Growth - It is unclear if the employer mandate under the Affordable Care, which goes into effect 1/1/15, will define large employers (50 or more) at the PEO level or the client level. If at the PEO level, we believe BBSI could lose a significant number of its clients. We are unable to reconcile BBSI's assertion that a high percentage of its clients offer healthcare. Our rudimentary analysis leads us to believe management may be taking liberties with certain qualitative commentary. After nearly eight years of contracting premiums and ceding market share, the California State Fund appears to be increasing its competitive positioning. After a major restructuring and new tiered pricing, California's largest workers' compensation insurer grew premiums by 23% in 2013. With a more competitive State Fund, insurance companies and PEOs focused on the low end of the market (like BBSI) should find growth much more challenging.

    12) Normalized Valuation Suggests Substantial Downside - Sell-side analysts and investors utilizing cash flow and/or EV/EBITDA multiples to value BBSI are fundamentally erring in their valuation approach. These irresponsible valuation methodologies, which ignore the long-tail of workers' compensation coverage and are wholly inconsistent with traditional insurance valuation analysis, have been used to justify BBSI's lofty valuation. If we apply aggressive growth assumptions, generously assume BBSI can lower its fronting costs from the implied Q2'14 levels, and apply a 15% premium to the earnings multiple of a comparable insurance group, BBSI would trade at $29.00 per share, representing 50% downside. Our $29.00 fair value estimate assumes none of the myriad of long-tail risks discussed in this report materialize, which could create substantially more downside to our $29.00 estimate.


    [i] Todd Krug vs. Barrett Business Services Inc. (14-2-00405-6)

    [ii] fbi.gov/stats-services/publications/fina...

    [iii] rand.org/pubs/monographs/MG949.html

    Disclosure: The author is short BBSI.

    Tags: BBSI, ACE, MIG, TWGP, GNW, TNET, NSP, EIG, AFSI
    Sep 16 12:41 PM | Link | 72 Comments
Full index of posts »
Latest Followers

StockTalks

More »

Latest Comments


Posts by Themes
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.