As the human resources outsourcing sector continues to evolve, end users should benefit from the formation of new segments as well as the advancement of existing ones, experts say.
The human resources outsourcing sector has experienced significant levels of merger and acquisition activity, and this trend should continue based on the sector?s favorable fundamentals.
The global HRO market generates revenue exceeding $500 billion according to IBISWorld, which projects annual sector growth averaging 5 percent through 2015. With more companies searching for external solutions that reduce costs and improve productivity, growth in the HRO market should be driven by additional outsourcing of labor-intensive HR activities and further adoption of advanced technology to create efficiencies in the sourcing and management of talent, particularly the expanding contingent workforce.
As the HRO sector continues to evolve, new categories will form, existing segments will advance, and technology should be introduced at an accelerated rate. This article explores the dynamics of M&A activity in four segments with attractive growth prospects and continued consolidation ahead:
* Managed services providers that handle relationships with contingent labor suppliers on behalf of their customers,
* Vendor management systems that are proprietary technology applications used to manage contingent labor, frequently in conjunction with MSP programs,
* Recruitment process outsourcing firms that manage recruiting processes for clients, and
* Professional employer organizations that offer comprehensive HR outsourcing for small and mid-sized companies.
These HRO segments have witnessed robust M&A activity, and we anticipate further consolidation, with strategic acquirers and financial sponsors attracted to business models with strong growth potential, large market opportunities, recurring revenue and scalability.
Most of the thousands of global participants in the HRO sector lack the capital, resources and technology necessary to remain competitive as corporate customers demand broader, more sophisticated service offerings. Many such firms will make acquisitions to build scale and capabilities or will serve as viable acquisition candidates for larger, more diversified entities.
With opportunities remaining for acquirers to create value, M&A transactions in the HRO sector are being fueled by the strategic push for service offering expansion in higher-growth segments, economies of scale and scope, and cross-border capabilities, supported in many cases with private-equity financing.
Ultimately, these deals should benefit employers by simplifying the selection process and offering a more comprehensive menu of services.
Service offering expansion
M&A can bring complementary offerings, add new services necessary for further penetration of current customers, and allow entry into additional categories. Acquisitions that help build a comprehensive set of services enable companies to gain relevance with existing and potential clients. A more extensive offering aligns with customer preferences for partnering with a select group of service providers that can address many HR functions. Acquisitions often are an appealing alternative to internal growth due to the substantial time and resources required to establish a viable new business line.
Adding customers and services through M&A allows companies to leverage the existing customer base through cross-selling, resulting in incremental revenue opportunities for the buyer and the target. Providers with large client lists have a crucial edge in securing new and replacement business, as current customers are attractive prospects for cross-selling acquired services. Firms with a broadened scope of services have multiple ways to expand relationships with clients, facilitating growth.
In the quest to provide a wide range of services across end markets and geographies, large HRO companies have built a presence in higher-growth categories, including through acquisitions. For example, leading global staffing companies are using M&A to play a larger role in the MSP and VMS categories. The TAPFIN MSP and Econometrix VMS subsidiaries operate within COMSYS IT Partners, which was acquired by Manpower in 2010. In the same year, Adecco purchased MPS Group and its Beeline business, a leader in the MSP/VMS space. These acquisitions enhanced the capabilities of Adecco and Manpower, which at the time were already in the market with an MSP offering.
Acquisitions have also served as an entry point into HRO segments for major firms. In 2011, Randstad acquired SFN Group and its SourceRight division, whose established RPO and MSP businesses gave Randstad a foothold in these categories. Earlier in 2012, ADP acquired top-tier RPO firm The RightThing. While The RightThing generally services large enterprises, ADP intends to deploy its services across its extensive middle-market client base. In addition, the financial strength of ADP should boost The RightThing?s win rate by increasing the confidence of prospective customers. The acquisition is the latest in a series of deals that differentiate the recruiting solutions of ADP relative to other HR processing providers.
Acquisitions have also facilitated portfolio expansion in the PEO category. Over the past two years, market leader Insperity made three acquisitions of HR technology companies (in time and attendance, expense reporting, and workforce analysis) in order to round out its offering and increase cross-selling avenues with sales prospects.
Economies of Scale and Scope
HRO companies continue to make acquisitions that enhance scale and scope in response to the pervasive trend of vendor consolidation among larger clients. Service providers with sufficient capabilities and a record of crisp execution often are rewarded with additional business from multi-national customers seeking to prune their vendor lists.
For outsourcing firms that have become larger through acquisitions, scale advantages include:
* Greater purchasing power,
* Leverage on overhead,
* Ability to service larger contracts,
* Capacity to reinvest in the business,
* Recruiting and retention of talent, and
* Access to growth capital.
M&A transactions can be the most effective means of enhancing capabilities as needed to secure the biggest pieces of business with customers. Adding scale and scope through acquisitions puts service providers in better position to win larger client contracts.
Scalable platforms based on technology allow for operating leverage as customers are added, thereby reinforcing the strong competitive position of leading players. Superior resources enable selected providers to make adequate human capital and technology investments, which are essential to maintaining customer satisfaction and promoting client retention. Buyers with large, established HRO businesses have greater ability to reduce costs for acquired firms via the integration process.
The trend of adding scale among larger firms has resulted in a barbell dynamic within the HRO sector. Frequently, mid-size firms are either being acquired by bigger companies seeking to satisfy the demands of the marketplace or are combining with other mid-tier players in an attempt to gain adequate scale. As a result, categories increasingly consist of a combination of big, diversified companies and many smaller, specialized firms.
The push for scale has been apparent in the acquisition activity of the PEO segment. Diversification and scale through a large base of customers and worksite employees are highly beneficial in the PEO business for a variety of reasons, including the necessity of pooling risks related to workers? compensation insurance. Category leader TriNet, which combined with GevityHR in 2009 in order to enhance its scale, acquired smaller competitor Accord Human Resources from Virgo Capital in April 2012. In 2010, Madison Capital Partners acquired and merged two PEOs, Global Employment Solutions Professional Employer Organization and CoAdvantage, in order to capture scale economies.
Cross-border M&A activity allows providers to develop the broad global coverage needed to secure national and multi-national accounts. Many participants have developed worldwide resources in order to service clients around the world. MSP/RPO leader SourceRight (a Randstad subsidiary) has noted global capabilities as the most important requirement of buyers.
Global expansion has driven acquisition activity, as companies looking to add foreign locations often find acquiring existing, local firms more efficient than establishing new operations. In addition, certain customers prefer service providers with local knowledge and presence to meet regulatory mandates, specialized needs, or service requirements. HRO providers also expand geographically in order to mitigate risk in any single market and to enter emerging markets that offer above-average growth. M&A can be the most cost-effective means of achieving these objectives.
As an example of a cross-border M&A transaction, in May 2012 staffing and recruiting services company Allegis Group announced the planned acquisition of Talent2, a leading RPO and HRO firm based in Australia. Allegis and Talent2 have worked together under a strategic alliance since 2010, establishing broad-based solutions in the RPO and MSP segments along with a geographic footprint covering 60 countries. The transaction is designed to enhance joint capabilities and extend the coverage of Allegis to the Asia Pacific region.
Private-equity firms remain attracted by consolidation opportunities in the fragmented HRO space, which features business models with global scope, long-term customer relationships with recurring revenue, and strong growth potential amid ongoing increases in outsourcing. In addition, financial investors are drawn to the scalability of technology-enabled service models with significant growth prospects. Some sponsors have targeted a platform for consolidation, while others have domain expertise and positive investment experiences in the HRO sector, leading to add-on deals for existing holdings. Financial sponsors may focus on building scale in a particular niche or service format, an approach that facilitates an eventual exit to a buyer looking to meet a certain need.
Key variables currently are conducive to private equity M&A activity. Despite a series of global shocks, the credit markets remain generally accessible for M&A financings, and reasonable terms are available to high-quality borrowers. Private equity firms remain well funded, with high levels of committed capital supporting increased equity contributions to buyouts. Due to the substantial number of sponsor-owned companies in these sectors, private equity firms often stimulate M&A by seeking an exit for a portfolio company. Selling opportunities can come via other private equity firms, active public and private company consolidators, and other strategic acquirors.
Private equity firms have shown strong interest in the MSP segment. In December 2010, Snow Phipps Group purchased ZeroChaos (a.k.a. APC Workforce solutions). ZeroChaos appears to be serving as Snow Phipps? platform for consolidation in this category based on its mid-2011 purchase of Sweden-based MSP Madeo Sourcing Group and the early 2012 acquisition of highly regarded MSP WorkforceLogic from Nelson Staffing. In late 2010, ABRY Partners acquired COMFORCE, which operates an MSP (PrO Unlimited) that is independent of its IT staffing business. In terms of future exit opportunities for private equity holdings, larger MSPs could be suitable IPO candidates or acquisition targets for an enterprise HRO firm.
Financial sponsors have also invested in VMS companies as a potential consolidation play. For example, GTCR bought highly rated IQNavigator in 2008. More recently, leading VMS company Fieldglass was acquired by Madison Dearborn in 2010. In terms of an end game for private equity owners of successful VMS businesses, the potential buyer universe includes large enterprise software firms (e.g., Microsoft, Oracle) looking to increase their HR exposure, as well as HR technology leaders such as Peoplefluent, SilkRoad Technology, and Kenexa, which prefer recurring revenue models to those sensitive to employment levels. Indeed, private equity firm Marlin Equity Partners sold leading VMS player Emptoris to technology giant IBM in early 2012.
Benefits for End Users
The employer community should ultimately benefit from successful acquisitions in the HRO sector. Many M&A transactions are designed to satisfy client preferences for a more comprehensive set of services, including international reach. Deals that expand service offerings should simplify the selection process for buyers through the creation of a select number of well-capitalized full-service providers.
M&A transactions can enable smaller enterprises to transform into larger organizations that are more attractive outsourcing providers for employers due to best of breed technology capabilities, the resources to expand with clients, sufficient scale to price aggressively, deeper management talent, and enhanced ability to withstand economic cycles. To the extent these providers offer superior performance, end users should gain increased confidence in outsourcing to HRO firms due to their favorable cost/benefit value proposition.
We are optimistic that M&A in HRO will remain healthy over the balance of 2012 and beyond, based on such benefits for end users, as well as recent momentum, continued consolidation opportunities, robust corporate balance sheets, greater financial sponsor activity and accessible credit markets.
Bret Schoch is a managing director in the business services Investment Banking team and J. David Cumberland is the director of mergers & acquisitions research in the investment banking department at Robert W. Baird & Co.