One of our points of differentiation versus many peers relates to our ability to invest across the size spectrum. Consider that, at the time of writing, Montaka’s long position with the largest market capitalization was Apple (NASDAQ: AAPL), at US$700 billion. Meanwhile, our long position with the smallest market capitalization was Insperity (NYSE: NSP), at just US$1.7 billion. And interestingly, Insperity has been our best performer in Montaka’s long portfolio to date, with the stock nearly doubling since we first bought it about one year ago.
The company recently delivered its 4Q16 results with an outstanding performance in terms of both: (i) growth in the size of the business; and (ii) operating leverage on its cost base (which results in expanding profit margins). A strongly growing top line combined with expanding profit margins is a potent mix: Insperity’s earnings-before-interest-and-tax (or EBIT) grew at a staggering +54% year-on-year in the quarter.
For a reminder of what Insperity does, please review our blog on the topic from last year (here). In short, it is a professional employer organization which assists small and mid-sized businesses across the US in managing their employees. Whether it’s payroll, health insurance or compliance: Insperity collects around US$214/month per employee to manage these aspects of HR on behalf of their clients.
Now, as Insperity has invested heavily in its marketing and distribution capability in recent years (not to mention its sales force which is growing at around +12% year-on-year), the company has become highly proficient at adding new clients and retaining existing clients. And this second point is key: historically, Insperity’s year-end churn would run at around 10-12% as some clients discontinued their service. But in 2016, the business got this rate of year-end churn down to just 6.8%!
A big part of this reduction in churn relates to Insperity’s expanded offering. Historically, Insperity target just small businesses (i.e. those with 5-100 employees). So, of course, as these businesses grew, Insperity could not historically service their needs. After years of investment, Insperity now has a genuine mid-sized business HR services offering. So Insperity can grow with its customers.
And Insperity can add new mid-sized customers they have not even worked with before. Said another way, Insperity’s total addressable market has increased significantly as a result of its expansion into the mid-sized market (i.e. those with 100-2,000 employees). There is a subtle further benefit to this expansion: as Insperity’s mix evolves to include more mid-sized companies, its growth rate of employees under management receives a huge tailwind. Each new mid-sized client brings with it many more employees than an equivalent small-sized client. In a company filing, Insperity stated that:
- “Our average number of worksite employees per month with our middle market clients increased 19.6% over 2015, representing approximately 24.5% of our total paid worksite employees during 2016.”
Now, readers of this blog will be aware that high business-quality is a necessary but insufficient condition for us to own a business. What is even more important is that we are owning a business at a price that implies a set of future expectations that we deem are unreasonably conservative. (Or said the more common way, the business is cheaper than it should be).
In the case of Insperity, we continue to believe the business is undervalued. When we calculate the expectations that are being implied by the current stock price, we believe these expectations can easily be met – and likely exceeded. And this all assumes an ongoing 37% effective tax rate the business currently pays. If President Trump comes out with his “phenomenal” tax plan that includes any major reduction to the US Corporate Tax Rate, then the upside in the stock is even more significant.
Montaka owns shares in Insperity (NYSE: NSP).