HireQuest
Part 2
By Manuel Maurício
September 3, 2021
Last week I wrote about HireQuest, a staffing company with a unique franchising model.
This week I wanted to go through all the information that I had already gone through to confirm if I want to become a shareholder of the company.
First, I wanted to go through the recent acquisitions and strip out all of the one-time costs and gains from the financials so I could get a better understanding of the underlying business.
As far as I can tell, Snelling was a good business, generating around $3.5 million in Operating Income, but it was hemorrhaging cash due to high debt.
HireQuest bought it free of debt (for $17.5 million) so we don’t need to worry about that anymore.
Link wasn’t such a good business. It had really low margins, even without accounting for the interest payments. HireQuest paid $11.1 million for it.
The fact that both companies had declining revenue in 2019 gives me pause and makes me wonder if the management will be able to turn them around.
The good thing is that HireQuest bought them really cheap, around 6x normalized earnings, so not a lot has to go well.
Add to that the fact that the California market is really hard for staffing companies due to the regulation and prices for the Workers’ Compensation Insurance. It looks like the previous owners of Link were losing a lot of money in California but didn’t want to let go of those stores.
Right after he bought Link, Rick sold the California stores to a local operator in exchange for a perpetual royalty fee of 9% of the gross margin.
This is the type of CEO that I like. He understand what needs to be done to make the business better and he goes and does it.
A CORRECTION TO MY PRIOR WRITE-UP
After reading my write-up from last week, Rui Andres was a little suspicious of the fact that the company had no debt, especially while its competitors have debt on their balance sheets.
Thank you for that Rui.
It got me thinking.
The company used debt to finance the Snelling and Link acquisitions. It then sold the stores to the franchisees. BUT the franchisees don’t pay the company right away. As I wrote last week, HireQuest finances that acquisition for 5 years (called Sellers financing), meaning that the franchisees will be paying back the full amount over that period.
So, how can the company repay the debt immediately if the franchisees will take 5 years to repay their loans?
It turns out that HireQuest sold the right to collect the future payments from the franchisees (called Notes Receivable) to an affiliated entity owned by the CEO and another insider. By doing this, it brought forward the collection of that money, thus using it to pay down the debt immediately.
This and other related parties’ transactions are something to keep under close watch for minority shareholders.
For instance, the CEO’s family, together with another insider, own interests in 57 of the total 212 offices. Investors can look at this from different angles. They can chose to think that the CEO can “game” the system, or that he’s highly incentivized to make the business successful.
A RISK WORTH MENTIONING
The fact that the company self insures is something that one also needs to bear in mind. I am yet to fully understand the potential risks arising from this.
STRATEGY
There are other things that I want to research deeper, but I’m willing to learn as I go.
I believe HireQuest has a long runway for growth, be it organically (by opening its own stores) or through the acquisition of regional competitors who can’t scale.
There aren’t that many buyers for these competitors to sell their business to. That’s why Hirequest can buy them on the cheap. It reminds me of RCI Hospitality and Redishred.
On the other hand, investors tend to ascribe a high valuation to publicly traded franchising businesses.
So, by going public, the CEO expects to take advantage of what is called valuation arbitrage. Hopefully, he will able to issue shares at a premium only to use them as currency to buy cheap private businesses.
If executed correctly, this can be a great strategy. And I am of the opinion that Rick can execute it correctly.
On the video interview I shared last week, while referring to the Snelling and Link acquisitions, he mentioned that he had also looked at a third, larger, company. But although the revenue was high and alluring, there was a lot of stuff that would make it a bad acquisition. Rick was aware of that and didn’t buy it.
Although we’re only hearing his side of the story, this is the discipline that I want to see coming from an acquirer.
ACQUISITIONS HAVE RISKS
A word of caution is needed. The company just bought 2 companies, 1 “good” and 1 “bad”. Acquiring other companies to turn them around is a strategy that is fraught with dangers. We can’t be sure that the management, just by changing the business model of the acquired companies to a franchising model, will be successful.
ILLIQUID COMPANIES ALSO HAVE RISKS
As an added “risk”, there are only 14,6 million shares outstanding, of which insiders own 65%. That means that there are only 5 million shares to be traded (also called the free float). At the current $20 per share, that equates to roughly $100 million. This is not much, which means that we can expect high volatility, both up and down, on any news.
Not only that, but if something goes wrong with the business, given the illiquidity of the stock, investors might be stuck with a stock that they don’t want for a long time before they can sell it for a reasonable price.
ESTIMATES AND CONCLUSION
The management has guided for system wide sales of around $450 million, even without getting to pre-Covid levels (which, by my estimates, could be around $500 million).
They’re also guiding for net margins to be in the 3.5-4.5% range. That would mean something like $1 or $1.2 in earnings per share. At today’s price of $20, the stock is trading in between 16 to 20 times earnings.
Is that cheap?
If we take into consideration the potential of this business and the quality of the management team, I believe so.
That’s why I’ll be buying €5.000 worth of HireQuest stock on Monday, stated that it closes around the current price of $20 per share.
The €5.000 is currently equivalent to roughly 4% of the Portfolio. If this business is as good as I believe it is, I will likely be buying more in the future, but I still need to see confirmation that the Link turnaround is successful and that my estimates for the earnings power of the business are right.
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