SI Review: December 2013

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The Eye of the Investor: Why private equity firms are interested in staffing

By Sona Sharma

Lately, private equity firms are showing more and more interest in investing their dollars in the staffing industry. The year 2012 saw some big investments from firms such as Ares Management, which acquired Insight Global, an IT staffing and services firm. Ares also partnered with Leonard Green to buy CHG Healthcare, a healthcare staffing firm with estimated revenue of $597 million.

The list is long. Just to name a few more deals from 2012 and 2013: Morgan Stanley Private Equity invested in Creative Circle; Tenex Capital Management bought Medical Solutions; IT staffing firm Addison Group struck a deal with Trilantic Capital Partners; Orchard Holdings Group bought executive search firm Lucas Group; Locum Leaders was acquired by holding company OGH LLC, whose principal shareholder is New York-based private equity firm Welsh, Carson, Anderson and Stowe; Georgia Oak Partners announced an investment in TeamOne Logistics; and CIP Capital acquired professional employer organization CoAdvantage Corp., which ranked No. 12 on Staffing Industry Analysts’ list of largest PEOs.

Staffing Industry Review spoke with two private equity investors to understand what’s fueling their interest in the staffing market and what they look for in staffing firms before they invest.

Sasank Aleti, LLR Partners

What makes for a compelling staffing firm for you to invest in?

We are a $2 billion private equity firm based in Philadelphia. We primarily focus on growth-oriented midmarket businesses. We are typically putting from $25 million to a $100 million of equity capital into any one of our transactions. If you carry that over to the staffing space, it requires a certain level of scale and a more established player for this kind of investment. For instance, investing $50 million into a $10 million business … the economics doesn’t really work well then. This tends to eliminate a lot of smaller players in the space.

Then from a macro level, there are a couple of broader themes that have gotten us interested. I think this cycle in the staffing industry is going to be longer than historical cycles. The first element to that is we need to get back to the pre-recession employment level. That’s still a ways away. Then there are some structural changes in terms of how employers look at a variable workforce coming off the backs of this past recession. That is going to be a longer-term trend when the companies say, “that was pretty painful. Last time I was not able to shed my workforce or fluctuate as much as I would like to with demand.” Or, “there are certain categories of the total jobs that I have that are better suited for more project-based, more niche, targeted type of assignment that we can bring on and bring off as we need.”

That point in the cyclical shift and structural shift are two elements that we are interested in.

How do you differentiate between the different investment opportunities that you come across?

The first cut is to have enough scale that supports the size of investment we are looking to make and where we can add most value. If you dive into it a bit more, there are a couple of areas that stand out and help differentiate companies and make the ones that are stronger rise to the top. First, I look at whether the company has a growth culture, or an organizational structure that enables rapid growth and rapid deployment of branches, for example. Or do they have a highly repeatable model. So, if they are successful in the Atlanta market, can they replicate that success in Boston? Have they boiled it down to a formula to know exactly the kind of people they will need to recruit? Do they know the right numbers of managers to recruiters, specifically the functions that the recruiters will be doing? We look to see whether they have the model down operationally in order to scale up and do it in a way that’s repeatable.

Second, we look for gross margins that are higher than the industry average. That is an indication to us that there is some operational discipline within the company. This means the company knows to focus on areas with higher demand, so they are able to get a bit of a premium. And the fact they are able to fill those positions means that they have their operations down in a streamlined fashion that allows them to execute quicker. It means that they are managing all the business KPIs in a very scientific and repeatable manner.

Are there any particular segments within the staffing industry that are more attractive from an investment point of view?

In a large $120 billion industry, there are some segments that are more interesting than others. We focus on growth companies. That tends to push us toward the professional staffing firms. Our interest is more in IT and engineering and the more professional areas. We prefer the professional staffing segment because the growth is higher and there is less risk in terms of workers’ compensation. I think the professional staffing arena will also probably be the biggest beneficiary of the cyclical and structural shifts that I had talked about earlier.

Any other considerations?

Being in these growth segments, from the industry perspective, a job or skill perspective and also in terms of geographic markets. Some markets are better than others and add to the attractiveness of the platform.

The last thing is that this is a fragmented industry, so to the extent that we can invest in a platform that can then opportunistically do some acquisitions that allow it to enter new geographies, gain some additional capabilities or enter into different vertical markets and do it in a way that they can be integrated seamlessly. We are not looking to do a rollup, but I think it’s always a plus if you have a well-run company that has scale, that has these operating metrics down to a science, has a good back office and a management team that is capable of integrating an acquisition and adding scale in such a way that it does not disrupt the growth of the business.

So generally, when we are looking at an investment, some companies have one of these qualities, some have a couple. It’s not common for an investment to have all of these different criteria, which is why we try to find investments that have the highest probability of excelling in each of these different metrics.

Ryan Kelley, Shore Capital Partners, LLC

You mentioned that Shore has made some investments in the healthcare industry. What got you interested in the healthcare staffing industry?

We have worked with the healthcare industry in general. We have a home infusion business that’s in the pharmacy niche. We have an urgent care company that uses a lot of nurse practitioners. We have a lab business that uses a lot of lab techs and pathologists. So, through these other businesses we saw the need for staffing and the role it plays, and that’s how we developed our thesis to invest in healthcare staffing firms. A lot of it really started with the urgent care company that was staffing nurse practitioners. We thought it would be interesting to look at staffing companies that place nurse practitioners because we thought that was the wave of the future. We think with healthcare reform, care has to be delivered by cheaper alternatives.

What kinds of healthcare staffing firms would be of interest to your firm for investment?

We are looking at small companies, from $15 to $50 million in revenue. That’s usually earnings of $1 million to $4 million a year. That’s our ideal range. For us those are smaller companies that are moving toward professionalization, not mom and pop companies, and right in the middle. A lot of these companies recognize the need for additional capital, the need for additional leadership talent and that makes for a good partnership with us.

We are looking at areas such as therapy, pharmacy, school therapy staffing, nurse practitioners and physician assistants. All of our other companies have big reimbursement risks. Staffing is more of a contract model.

Do you see some challenges or opportunities with shortage of talent? That usually bodes well for the staffing industry.

We definitely see those challenges but I think that creates opportunities. I think in healthcare, jobs are very portable. If you are a pharmacist in one area then you can go be a pharmacist at another hospital. It’s very plug and play. A pharmacist at Walgreens can be a pharmacist in CVS. When you look at society in general, people are not really anchored to one area as much as they used to be. They know that they want to work for a couple of years and then they need to move. It used to be that people move somewhere and be there for many years, or retire from one employer. Whereas now people move jobs a lot more. That’s what makes healthcare staffing so interesting — it’s mostly contract labor and some permanent placement. The state certification helps … these are very certifiable skill sets. That’s part of what makes healthcare staffing more interesting than light industrial.

The challenge is that tide can turn pretty quickly. You have to be ahead of the curve and have your fingers on the pulse to continue to grow.

Have you looked at companies that are providing or placing professionals in the health information technology? That’s pretty hot right now too, especially with the Affordable Care Act.

A lot of people are interested in that area and that’s driving the evaluations up. We tend to be pretty disciplined around that. We are not going to pay more than a certain multiple. We have our ceiling on the multiple that we are willing to pay. Companies in HIT are trading at a multiple above what we are willing to pay.

What do you feel about companies that are doing majority of their business through VMS or MSPs? Would those be of interest to you?

What we have found that there are some companies that work with VMS and can still make good margins because they don’t take everything. They are able to pick out the good pieces of VMS. But clearly, you pay a premium for companies that have direct and proprietary relationships and you discount the VMS work a little bit. It’s not that we won’t do business with a company that works with VMS, but we will place a higher value on non-VMS work. So not a hard and fast rule that we won’t touch it.

Are you getting close to finalizing some investments in healthcare staffing firms?

We have a couple of letters of intent out. Our goal is to finalize an investment in the fourth quarter 2013 or first quarter of 2014.

Sona Sharma is a senior research analyst at Staffing Industry Analysts. ssharma@staffingindustry.com 

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