TriNet Stock: Integrated Model A Great Bargain (NYSE:TNET)

What is a PEO?

A Professional Employer Organization (P.E.O.) is a Human Capital Management company that provides health and other insurance, payroll processing and human resources management under its own umbrella to several companies. Its biggest distinctive competencies and product differentiators are:

a. Cheaper and wider choices of health insurance, which it gets for its clients because of it sheer size and bargaining power.

b. Compliance with state laws across various states because of work from home.

c. Compliance and implementation of federal and state government incentives and credit, which have dominated the payroll landscape since COVID 19.

d. Payroll and health insurance customer support for even small and medium size businesses at a reasonable cost.

TriNet (NYSE:TNET) is one of the largest players in this space with competitors such as Insperity (NSP), and the PEO arms of ADP (ADP), and Paychex (PAYX).

Strengths and Competitive Advantages

Cheaper Health Insurance

Because TriNet is the employer of record for all its clients, it is able to procure health insurance at much cheaper rates than a small or a medium sized company. In 2021, TriNet had about 360,000 employees spread over 16,300 clients, an average of 21 employees per client – where its sheer size ensures economies of scale and bargaining power, which it passes on to its clients. Sometimes, for even companies with just 10-12 employees the difference in health insurance costs is as high as 30%. Of course, they make it up by charging more for payroll processing but overall, companies save substantially. Anecdotally, over many years of dealing with several payroll providers I’ve seen average net savings of 15 to 20% from PEOs with companies who have at least 10 people and more when the number of employees increases.

Vertical Business Segments

What also works in TriNet’s favor is segmenting its business by vertical, to get more homogenized and standardized rates for insurance and similar processes for businesses.

TriNet’s six segments are:

TriNet Financial Services, TriNet Life Sciences, TriNet Main Street, TriNet Nonprofit, TriNet Professional Services, and TriNet Technology, of TriNet Technology is its largest.

TriNet also focuses on non profits, which is a division often ignored by other providers. TriNet’s biggest vertical is technology – it has a firm foothold with startups, which gives it a competitive advantage. Insurance rates are cheaper because the insured are often younger and single, coverage is simpler and claims are fewer. This is in turn helps TriNet’s flywheel – insurers naturally prefer insuring those with fewer conditions and claims.

Wider Coverage

With the acquisition of Zenefits in February 2022 it has gone a step further, allowing employers to offer multiple health insurance providers to its employees; it also allows employees to keep their existing insurance. This helps employers in several ways a) attract new talent on the strength of their insurance coverage – an added incentive when you’re coveting scarce talent. b) it allows them to recruit nationwide where insurance plans sometimes don’t extend beyond their home states. c) It incentivizes prospective employees to join companies with TriNet, because it lets them keep their existing plan and not have to choose a new insurance plan from the new employer.

Compliance

One of the biggest advantages of having a large payroll provider is ensuring that employers don’t fall behind on compliance. State Laws and reporting requirements are complicated and always changing. Laws are different for hourly employees, salaried ones and interns as are the required payroll periods for each.

With work from home becoming a norm, companies have different employees in different states and most employers really appreciate their PEO partner guiding them through all the requirements.

In September 2022, TriNet acquired Clarus R+D, to simplify R&D tax credit process for SMBs adding another arrow to their compliance quiver.

Additionally, during the 2020-2022 Covid-19 years TriNet was very successful and proactive in processing PPP’s, ERTC and other government subsidies and incentives, often when laws were not clear.

Cost Advantage of an Integrated Model or a One Stop Shop

Besides the health insurance cost advantage, it’s also the cost of compliance and human resource management that make TriNet appealing to SMBs (Small and Medium sized Businesses). It would be extremely expensive to pay for all this in house or pay multiple vendors. Worse, most SMBs would simply ignore it, fall behind and pay fines when it came to state regulations and workplace violations. Having a PEO, especially a PEO of TriNet’s size and scale to take care of all these is a big incentive for SMBs to come on board. The sheer relief of talking to a dedicated expert is a big product differentiator for employers looking for a payroll provider. A company with 20 employees will not get that kind of service at TriNet’s price.

Only pay for what you need – Think of TriNet as the AWS (Amazon Web Services) for Human Capital Management.

Focus on Technology

Last month I wrote about ADP and Paychex, highlighting why tech innovation and integration was so important for this industry – with younger and more tech savvy employees, clients reject providers that don’t have the tech chops or easy to use platforms and TriNet too has been very proactive in building solutions keeping this factor in mind. Here’s a quick overview of their platforms.

Challenges

The technology vertical, which is TriNet’s largest is going through big layoffs and management spoke of higher attrition from some of the larger clients. I believe this will be a significant headwind in 2023, and will only improve in 2024.

Short term headwinds from the integration of Zenefits and Clarus and health insurance credits will crimp net income growth in 2023, but are a necessary evil compared to the longer term benefits from the two new acquisitions.

An enrollment shift to lower-cost regions from higher-cost TriState area will also reduce net revenue since TriNet usually makes about 15% net of total enrollment volume.

Fellow Seeking Alpha contributor, Kempano Investor talks about increased competition from Rippling and Just Works, which again underscores how important getting new technology is crucial to winning clients and increasing market share.

Investment Case and Valuation

TriNet had a solid run in the last 3 years, growing net revenues 14% and earnings 28%. However, post Covid this is likely to slow down to about 7% and 9% over the next 5 years — more in line with the industry and prevailing trends of a slowdown in employment caused by interest rate hikes, with a likely recession in 2023.

Net income will continue to reduce in the next two years as a result of higher integration costs from the two acquisitions Zenefits and Clarus, besides increased spending on rolling out various Enrich product offerings. Seeking Alpha consensus estimates indicate earnings reducing to $5.3 in 2023. The low valuation because of the decreased earnings next year is an opportunity for longer term investors.

My main reasons for investing in TriNet are:

This is an under-penetrated market. SMBs will shift to PEOs to take advantages of cheaper and wider health coverage, compliance, a full suite of human resource management tools and full service at a fraction of the costs.

TriNet has the scale to continue moving with technology trends and focused acquisitions to increase market share. The initial barriers to entry are not so high with 480+ service providers in niches or geographical locations and their inability to scale nationwide serves to TriNet’s advantage.

Switching Costs: Switching costs are a big competitive advantage for PEOs. The cost of switching providers is often prohibitive for the amount of time consumed, the compliance needs, and the pain of onboarding employees onto a new system. Most competitors don’t offer compelling bargains to switch.

Switching becomes even more difficult when you’re bundling Health Insurance, payroll and human resource management together and now with the addition of Zenefits, which allows you keep your insurance coverage or choose from a wider range of providers it is even more so.

ADP grew its PEO segment at 15% in Fiscal 2022 – almost double its payroll processing segment. This trend should continue – that the PEO segment will get a larger share of Human Capital Management industry at the expense of plain vanilla payroll processing.

TriNet’s integrated model should be a better choice for employers from a services and cost point of view

TriNet has grown revenues both on volumes and price increases and for the most part health insurance demand is inelastic – it’s not just death and taxes that are certain, you can add insurance to that! Sure, the next year or two will be flat on a higher base, but overall I do expect revenues and earnings to grow steadily at 7 and 9% in line with ADP and Paychex.

Even though TriNet will grow earnings over the next 5 years at 9% compared to 12, 10 and 13% for ADP, Paychex and Insperity respectively, its PEG of 1.5 is the lowest – half of Paychex and 58% of ADP and slightly cheaper than Insperity. That makes it a huge bargain and a great buy at this price.