Has Barrett Business Services Inc. Found A Sweet Spot?

| About: Barrett Business (BBSI)
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A "sweet spot" is a place where a mix of factors results in the ultimate response to an easily-expendable amount of effort. Barrett Business Services Inc. (NASDAQ:BBSI) may well now be in just such a spot. Barrett Business offers services to over 3000 companies from offices in 12 states conducting business in 23 states. Barrett Business boasts 20%+ annual revenue increases every year from 2009.

To understand the sweet spot, we first have to define and understand the industry. Employment services in the United States will be among the 20 fastest-growing industries through 2020 according to the Bureau of Labor Statistics. According to MarketLine, the world's human resource and employment services industry should exceed $454 billion by 2015.

Traditionally, temporary staffing services represent more than 70% of the overall market. The economic recovery from 2003 to 2006 found the temporary job rate at 6.5%. By comparison, from March 2010 to September 2012, the rate was 13.2%. This recovery is building an unprecedented flexibility into staffing models worldwide. Businesses are adopting the strategy that only full-time jobs require full-time staff. Until recently, there was no such thing as temporary professional personnel in China, India or Brazil.

Another leg of the industry is human resource outsourcing (HRO) services. According to Global Industry Analysts, the world's HRO market will reach a worth of $162 billion by 2015. HRO services include payroll processing and HR benefits administration.

Forbes estimates the worldwide recruitment processing outsourcing (RPO) market is over $130 billion. Elements of the RPO service include applicant tracking software, assessments, recruitment services providers, candidate relationship management systems, social referral systems, interviewing tools and sourcing. Sourcing is the difficult and often highly secretive process of "finding the right candidate." LinkedIn (LNKD) is now the most powerful tool on the web for sourcing. It is the fastest growing public provider of corporate recruiting solutions. LinkedIn is disrupting the market as recruiting tools shift away from resume management and workflow toward new tools for sourcing, talent analytics, assessment, interview management, and search.

Surviving in business today requires adopting two main approaches:
1) Businesses cannot waste money.
2) Businesses must focus on core competencies.
This often means spending less time focusing on human resource (HR) requirements and responsibilities. HR outsourcing (HRO) companies usually provide only one or two quality services. An alternative to this is a professional employer organization (PEO) that offers a comprehensive approach to managing a business's cumbersome and time-consuming human resource responsibilities. Factors such as employment laws, health care concerns, tax legislation, and benefits administration are complicated which make opting for a PEO a viable solution for small to mid-sized companies. It's important to differentiate PEO providers from temp firms, staffing agencies and payroll administration companies.

The employment services industry in the United States has among its ranks household names such as Manpower (NYSE:MAN), Robert Half International (NYSE:RHI), Kelly Services (NASDAQ:KELYA), Paychex (NASDAQ:PAYX) and Automated Data Processing (NASDAQ:ADP). Manpower is the global leader in RPO. It has 400,000 clients in 80 countries and generated 85% of its revenues outside the U.S. Robert Half International is a specialized staffing firm providing project consulting. Kelly Services primarily provides staffing solutions. These businesses are mature. Net profit margin for staffing and outsourcing services is 1.3%. Likewise, Paychex and ADP are mature HRO industry providers for payroll processing. Paychex processes payroll for over 500,000 businesses and ADP serves over 600,000 clients.

Though the employment services industry has embedded business names in our world, there is a steep learning curve associated with understanding what a PEO is all about. And, that is true despite that PEO offerings are at least 30 years old. The service, to a large degree, is complex. The separation of HR responsibilities and liabilities that occurs when utilizing a PEO is called co-employment. In this type of business relationship, employees work for both the hiring company and the PEO. These reasons have limited industry penetration on a national level in the U.S. to less than 2%.

Yet, there are already over 700 PEO providers, most of them private firms. PEO services are a complementary transition for traditional payroll processors like Paychex and ADP. The Paychex second quarter ending November 30th, 2012 found PEO service revenue of $364.6M had increased by 10% YOY as well as increased to 32% of total revenues. ADP's first quarter reporting on November 1, 2012 found PEO service revenue of $448.9M had increased by 13% YOY and increased to 17% of total revenues. Insperity (NYSE:NSP) is a focused, publicly-traded PEO provider seeing high single-digit YOY revenue growth since 2009. Insperity is projecting five-year EPS growth of 22%+ as it targets becoming the dominant player providing PEO services to the top 10% of small and mid-sized businesses. Insperity currently operates in 26 markets.

Barrett Business Services Inc. describes its business in its third quarter earnings report:

"To provide PEO services to a client, the Company enters into a contract to become a co-employer of the client's existing workforce and Barrett assumes responsibility for some or all of the client's human resource management responsibilities. PEO services are normally used by organizations to satisfy ongoing human resource management needs and typically involve contracts with a minimum term of one year, renewable annually, which cover all employees at a particular work site. Staffing services include on-demand or short-term staffing assignments, long-term or indefinite-term contract staffing and comprehensive on-site management. The Company's staffing services also include direct placement services, which involve fee-based search efforts for specific employee candidates at the request of PEO clients, staffing customers or other businesses."

So the question remains - is Barrett Business Services Inc. in its offerings of HRO and PEO services as well as recruiting and staffing services actually sitting in an industrialized sweet spot?

From its third quarter 2012 earnings release, BBSI saw a 43.5% YOY increase of HRO and PEO service revenue from $136.7M to $196.2M. The $196.2M represented 68% of YTD total revenues. This is an increase from a 59% rate of YTD revenues through the third quarter of 2011. Barrett Business has a proven, scalable operating model enabling rapid growth. Having recently used $25M to repurchase shares, it currently has $22M in cash and no debt. BBSI is looking to acquisitions to provide entrance to new markets beyond its existing footprint in the western third of the U.S. 40% of its new business comes from referrals and it maintains an industry standard of 90% retention. Historical averages support that clients will stay with a PEO at least five years.

Barrett Business Services Inc.'s 50-day moving average is $34.07 within 15% of the 52 week high of $39.49. Barrett Business is projecting a 5-year EPS growth rate of 35% putting the YPEG measure at $76.30 - making BBSI look very undervalued. In the past 90 days, 2013 EPS estimates have risen from $1.82 to $2.18 - a staggering +19%. (info from Yahoo Finance)

Investors should decide for themselves if a market with just 2% penetration where companies provide PEO services to offset increasingly complicated business processes is worth their investment dollars. If so, Paychex, ADP and Insperity are good places to start performing due diligence. For the investor interested in a company who may just have found a sweet spot in the HR and employment services industry, Barrett Business Services Inc. should be added to that list. Short-term investors should be aware that BBSI is expected to experience first quarter losses due to the seasonal liability of employment taxes. Long-term investors looking for an attractive entry point may want to take advantage of a likely-predictable dip in share price after first quarter reporting around April, 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.