Violeta Stoimenova
In November last year, I called Kelly Services, Inc.NASDAQ:KÉLYA) a story of turnaround at the beginning. The company abandoned its operations in Europe, thus contributing to the company’s recovery.
Amidst a story of poverty long-term performance, including stagnant sales and no clear evolution in margins, I have been cautious, although the sale of the worst-performing European businesses could contribute to a turnaround.
What followed was another decent earnings report, but amid progress in the turnaround, I’m surprised that Kelly announced a large acquisition, which additionally involves some debt, when few financial details were announced. This means management has something to prove, as I approach this issue with caution.
Recruitment company
Kelly Services claims to have invented the staffing industry after the Second World War, as she mentions half a million people working every year. Already worth $30 in the 1980s, the shares traded at similar levels throughout the 2000s.
The 2010s were for naught, as revenues largely moved around the $5 billion mark, down minimally in nominal terms, but in a context of inflationary pressures, of course, down more significantly in terms real. With no clear margin movement and a stagnant stock count, Kelly has been a real underperformer.
For the year 2022, Kelly Services increased its sales by one percent to $4.97 billion, with GAAP operating profits posted at just $15 million, although these GAAP profits were affected by impairment charges of $41 million as well as a loss of $19 million on disposals. Adjusted earnings were reported at $1.33 per share.
The company operated with some 38 million shares that were trading at $18 in spring 2023, giving it a valuation of nearly $700 million. This even included a substantial net cash position of around $150 million, implying that operating assets were valued just north of half a billion.
The company recorded a slight decline in revenue and experienced margin pressure in the first half of 2023, but over the summer the company announced a new transformation program. The goal was to increase margins and create job growth initiatives. In November, concrete action was seen when the company sold its European staffing business to Gi Group Holdings. The company would receive consideration of €100 million at closing, with earnouts likely to add a further €30 million to the transaction.
Following the transaction, I expected pro forma net cash to be around a quarter of a billion, at a company valuation of half a billion. I thought the European business would post revenue of around $860 million, implying that this valuation was largely at par relative to Kelly’s overall, while those businesses likely have lower margins.
With pro forma sales estimated at $3.5 billion or more, I thought the company could improve its adjusted earnings to between $2.00 and $2.50 per share, which seemed compelling given the pro forma net cash position. was about $6 per share. This made me cautiously optimistic, with shares trading around the $20 mark in November, while operating assets were trading at just 6-8 times earnings.
This was a bit too simplistic, as some margin expansion would be necessary, while the company has generally priced in a lot of restructuring charges.
Amid all of this, I’ve taken a wait-and-see approach as stocks have seen solid momentum so far this year.
Recover more
Since November, shares have fallen from $20 to current levels of around $24 per share. In January, Kelly farm on the sale of its European operations, as it indicated that the transaction would increase pro forma EBITDA margins by approximately 30 basis points, indicating that these activities were barely profitable on an EBITDA basis.
In February, Kelly reported a 0.1% decline in fourth-quarter sales to $1.23 billion. Although not reflected in the GAAP numbers, the company has seen significant progress under the hood, as quarterly adjusted earnings increased from $0.18 per share in the fourth quarter of 2022 to $0.93 per share, then that adjusted earnings for the full year came to $2.20 per share. with GAAP earnings posted at $0.98 per share.
The company expects to post EBITDA margins near 3% in 2024, which, based on pro forma sales of less than $4 billion, indicates a full-year EBITDA target of around $120 million. dollars, compared to the 109 million dollars posted on this front in 2023.
The 36 million shares now trade at $24, giving the company an equity valuation of $864 million. This includes a pre-divestment net cash position of $125 million in Europe, with pro forma operating asset valuations here estimated at $640 million.
A surprising affair
Amid company restructuring, Kelly announcement a substantial deal in May this year. In early May, the company announced a $425 million deal to acquire Motion Recruitment Partners from private equity firm Littlejohn. Motion Recruitment Partners is the parent group of Motion Recruitment, Sevenstep and TG Federal.
The transaction value for the specialized talent solutions business could increase up to $485 million, following a potential earnout of an additional $60 million.
This means that pro forma net debt is estimated at around $200 million, but this should be manageable given that EBITDA tends to exceed $10 million, ahead of the contribution from Motion Recruitment Partners itself. The problem is that no financial details about the acquisition have been announced, which is notable given that a $425 million deal equates to about two-thirds of Kelly’s company valuation before the transaction !
And now?
Kelly Services shares have barely reacted to this substantial acquisition, which is a surprise, especially amid modest news.
Frankly, I’m surprised by the scale of the problem at hand (in the midst of corporate restructuring), the fact that some net debt is being incurred, and that few financial details have been announced. This makes me very cautious about Kelly Services, Inc., even though the fourth quarter results were very strong.
The proof here therefore lies with management. I look forward to learning more about the implications of this agreement. For now, I am very cautious about getting involved with Kelly Services, Inc. now.
