Editor's Note: Our Industrials analyst Jay Van Sciver added TriNet Group (TNET) a Best Idea Short on 9/1/19. Shares were trading around $65 at the time. The company reported last night and the news was obviously not good. Shares are down 14% to around $50 today. Below is a brief note Jay wrote originally outlining his concerns about the company. If you are an institutional investor interested in accessing Jay's research email firstname.lastname@example.org.
TNET, NSP INVITE | ADDING TNET AS A BEST IDEAS SHORT
HRA Simplification, Slowing Employment Growth, Confidence Driven Utilization
The passage of tax reform in late 2017 created incentives for employers to adopt PEOs, driving a stronger market environment in a competitive business. That tailwind is now in the comparison, coinciding with decelerating employment growth. PEOs have pitched investors the low penetration long thesis for decades, directing attention away from the underlying drivers of typically high earnings volatility. One of those – benefit costs – is likely to turn much more adverse in coming quarters as weakening confidence drives higher utilization. Perhaps more importantly, 2020 brings a rare simplification to employee benefits, with use of HRAs to reimburse employees for the payment of individual health insurance premiums – an underappreciated headwind to PEO adoption (h/t Hedgeye Healthcare Policy team). We expect the valuation of TNET shares to return to more historically average levels as growth headwinds become evident and the PEO margin story encounters cost and competitive realities. We see the potential for greater than 50% downside, with several key catalysts over the next 3 to 4 quarters.
Many valuation metrics for PEOs shot higher following the ACA and TCJA implementation.
With confidence easing, benefits utilization is likely to move higher, increasing PEO costs (h/t Hedgeye Macro).