- Sterling Check has seen a solid public debut, as investors like the strong momentum.
- Part of this momentum comes from the reopening of the economy past Covid-19.
- Valuations appear reasonable, yet I fear that momentum has been lifted by the pandemic.
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Sterling Check (NASDAQ:STER) has seen a solid public debut as investors like the long-term potential and current momentum for this "check" business. I like the momentum and potential as well and while momentum appears reasonable based on current earnings, I fear that the reopening of the economy has pulled earnings forward quite a bit.
Create Safe Feelings
Sterling believes that people, the most crucial resources of any business, deserve trust and safety, with everyone having the right to feel safe. The tech-enabled suite of services focuses on identity verification, background checks, credential verifications, drugs & health screening, onboarding, monitoring, with various sub-services performed within these categories.
The proprietary technology platform is mostly based in the cloud, providing a seamless user experience, robust platform integration and automated fulfillment processes. The company covers many countries across the globe, providing 75 million screens annually, serving more than 40,000 clients, and having an average tenure of 9 years for the top 100 clients.
With the labor market becoming more global, dynamic and people working more remotely, the company sees increased demand for its services which it believes are mission-critical for its clients, certainly with compliance, KYC screening requirements on the rise. Covid-19 has inspired more workers to work remotely, as the number of gig workers continues to be on the increase and voluntary turnover has been rising as well amidst a competitive labor market, driven by a rapid economic recovery as well as the impact of continued aging of the workforce.
Valuation & IPO Thoughts
Management and underwriters of Sterling Check aimed to sell 14.3 million shares in a preliminary price range between $20 and $22 per share, as final pricing was set a dollar above the high end of the price range. With nearly 4.8 million shares sold by the company, and thus the vast majority of shares sold by selling shareholders, this makes that gross proceeds approached $110 million.
With nearly 94 million shares outstanding, equity of the company is valued at $2.16 billion. Given a pre-IPO net debt load of around $512 million, I peg the net debt load at around $420 million. That values the entire business at $2.58 billion on an enterprise basis.
The company generated $497 million in sales in the year 2020 on which a GAAP operating loss of $13 million was reported. That loss was on the back of nearly $94 million in depreciation & amortization expense. Given the actual very modest asset base, I guess the very vast majority of the expenses comes from amortization expenses. Pegging these at $90 million, adjusted operating profits would come in at $77 million. The company furthermore posted adjusted EBITDA of $119 million and adjusting for some other items, I think that earnings of around $100 million per annum look reasonable.
Revenues fell nearly 9% to $454 million in 2021 on the back of the pandemic with adjusted EBITDA falling from $119 million to $100 million in the same time frame. The company has seen a very, very strong recovery in the first half of this year. Revenues were up more than 43% to $299 million for the six-month period as a GAAP operating loss of $20 million turned into a profit of $23 million, in part because D&A charges fell a bit to $41 million. Adjusted EBITDA of $84 million was solid.
Based on the run rate, the company is on track to generate $600 million in revenues and $170 million in EBITDA. This shows that leverage is no concern at all, as realistic operating profits might even approach $150 million this year. After accounting for some $12-$15 million in pro forma interest expenses and a 20% tax rate, I see net earnings potential of around $110 million, translating into earnings of around $1.15-$1.20 per share.
Given these trends, I am not surprised at all that shares rose after the offering. Shares have risen some $3 dollars to $26 per share, as based on the earnings power calculated above, I see earnings multiples at around 22 times earnings.
With second quarter sales already trending at $159 million, the run rate comes in at nearly $640 million, as this momentum might actually make that earnings discussions above are a bit conservative, although the business might have benefited a bit from a re-opening of the economy as well, resulting in a hiring spree in recent quarters.
Truth be told is that I like the prospects quite a bit. Sterling Check trades at a multiple in the low twenties amidst very modest leverage, as current momentum is hot, but likely driven by the re-opening of the economy. Operational risks include potential liability on the back of poor information, privacy laws, regulation, services which are not living up to the standards.
Momentum now appears strong as that might justify a small premium over the market multiple, but I fear that the reopening of the economy is the driver of current growth and thus comparables might be more challenged in the coming time period. Nonetheless, overall valuations appear reasonably valued, but I would like to see a bit more evidence of these growth trends before getting onboard.
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