JOB - GEE Group: Solid Balance Sheet Consistent Cash Flow And 31% Discount To Peers

2023-08-22 18:39:32 ET

Summary

• Stock price is trading at a 31% discount to fair value without inclusion of rollup plan catalyst.
• CEO and Board have built a billion dollar staffing business before.
• Recently implemented a shareholder centered capital allocation plan.
• Activist investor joins board doubling insider ownership alignment.
• 12 consecutive quarters of positive EBITDA and 8 of positive free cash flow.

In GEE Group (JOB) we have an opportunity to join an experienced management team, a solid balance sheet, consistent cash flow, and a shareholder friendly capital allocation plan at a 31% discount to their staffing industry peers.

History

The GEE Group is currently an undervalued employment and staffing agency led by an experienced executive team. The CEO, Derek Dewan began his career at Coopers and Lybrand, now PricewaterhouseCoopers (PwC), and was eventually recruited by a client to lead Accustaff. Under Dewan’s guidance as CEO, Accustaff (becoming MPS Group later) went public in 1994 and grew revenues from $139M/yr to $4B. In 2009 Dewan had grown revenues 29x through organic growth and 100+ acquisitions leading to the sale of MPS Group to Adecco for $1.3B .

While figuring things out post sale, Dewan consulted and worked in private equity until he met his current COO, Alex Stuckey who at the time was running Scribe solutions. Stuckey convinced Dewan to join him and they soon raised friends and family capital to pull off Scribe’s reverse merger with the General Employment Group in 2015. After closing they immediately went to work acquiring additional staffing firms , Agile in August, Access Data in October, Paladin next January and then SNI in April of 2017.

Growing as a startup was the one area Dewan did not have previous experience in. Accustaff was already a +$100M revenue business. This made the acquisition roll-up plan more difficult and the smaller GEE Group did not have the same roll-up synergies available as they do today. I believe this may have played into the mistake of over extending and paying up for SNI.

That said, Dewan and Alex immediately went to work and Kim Thorpe soon after integrating, restructuring and deleveraging the company after the addition of SNI. The deleveraging happened in two phases, first they negotiated a settlement with subordinated debt and mezzanine preferred holders in the first half of 2020. This took out approximately $47M in debt at favorable terms as GEE Group recognized $37M in gains on these transactions, after expenses. Second, in 2021 they paid off their remaining $56M of outstanding debt through a follow-on offering of $57.5M in which they issued 95,833,332 shares at $.60 (84% of what is outstanding today). Although I believe this was the right action to take after overpaying for SNI, investor consensus appears to disagree.

Dewan has shown that he has built deep and strong relationships and can work through adversity. He brought over three MPS Group veterans as independent directors from his prior successful exit and he recruited Thorpe, a highly capable CFO who had prior CFO and founder experience. Thorpe is another long standing relationship as he had met with Dewan previously at Coopers and Lybrand.

This is not the experience you typically find in microcap land.

Dilution and Alignment Cloud Clears

It’s safe to assume no one liked being diluted in 2021 (Stock price sank from $1.89 to $0.50).

The material issue I found with the dilution was not that it wasn’t necessary but that it reduced insider ownership to 6% (as of 6/30/2023). Since GEE Group controls its own board, 6% likely isn’t enough skin in the game as a microcap for all of us to be assured our interests are unequivocally aligned. On top of the insider ownership their compensation structure doesn’t necessarily ensure alignment due to the majority (85%) of their compensation being paid in cash and not stock. See 2022’s compensation for Dewan, Stuckey, and Thorpe in the figure below.

Insider Ownership Increases

This potential misalignment has recently changed and the clouds are lifting. David Sandberg of Red Oak Partners and two more independent directors recently joined the board bringing insider ownership up to 13%.

Another large shareholder, Goldenwise Capital Group (5.2%) is publicly stated to be engaging with management and in support of improving governance, implementing a share repurchase program, and potentially putting the company up for sale.

Shareholder Value Front and Center

On April 27th, 2023 GEE Group announced a $20M share repurchase program of which I had thought was long overdue. I have since adjusted my thoughts (on it being overdue) after speaking with Thorpe this past week. He informed me that they could not initiate the repurchase earlier due to the restrictions associated with the repayment of their PPP loans and thereafter they had information that could be construed as material insider information. April 27th was the earliest date they could implement a buyback plan and then on August 15th they adopted a 10b5-1 plan to aggressively purchase stock throughout future blackout periods.

With this in mind I estimated GEE to repurchase shares with 100% of next year's free cash flow, resulting in the repurchase of 3 - 13% of their outstanding shares in my valuation below. This clears the final cloud that may have been hanging over management as to why they were not committing to a shareholder friendly capital allocation strategy earlier.

Acquisition Strategy - Potential Catalyst

It is clear in Dewan’s history at MPS and GEE’s investor presentations that acquisitions are a core part of GEE Group’s strategy. That said, it is not forgotten how poor execution and bad timing (COVID) can lead to a stagnant stock price and lasting consequences (basis for our opportunity today), but I believe the fragmented staffing industry is ripe for value-adding acquisition roll-up strategies as Accustaff, MPS Group and now GEE has laid out.

The roll-up strategy is harder to implement as a startup but since GEE Group is now over the size hump, future tuck-in acquisitions should provide mutual accretive value for both GEE and the seller. The additional value can be brought forth through cross-selling, leveraging talent databases across clients, centralizing and streamlining back office functions, and brand recognition to name a few.

GEE is also overcoming the drying up of bank financing for micro-caps and acquisitions through their increased size, earnings consistency and cash holdings.

• $160M annual revenue

• Cash Flow Consistency

  • 12 consecutive quarters of positive EBITDA

  • 8 consecutive quarters of positive cash flow

• $0 debt

• $20M in cash

The impediments GEE Group had to implementing a value adding acquisition plan previously have recently been lifted.

Valuation and Price Target

Staffing Industry Relative Value

To discover the reference valuation point for GEE Group I built out the industry average and median value metrics across 50+ publicly traded staffing and employment firms (see list below).

The staffing and employment services relative valuation results came out to:

Due to a few outliers I chose to take the median rather than the average and because of GEE Group’s consistency in free cash flow across the last 2 years I integrated the EV/FCF median of 12.98 into my price targets.

I may be conservative as I used the median EV/FCF of 12.98 for my high case and 10.91 EV/FCF for my base case. The improved governance and share buyback plan support GEE re-rating higher and GEE still being a micro-cap and the clouds not having fully lifted support the lower rating.

Normalizing the financials - Low, Base, High Case

In order to normalize the enterprise value and forward looking cash flows for the three cases I made the following adjustments. 1.) removed all one-time revenues, expenses, and net operating losses 2.) allocated 100% of next year’s future cash flow towards share buybacks. 4.) extrapolated the $4M estimated cost savings implemented in Q1 of 2023 by annualizing 2023 Q1 and Q2’s P&L. 5.) I did not include value adding growth from acquisitions in any of the cases. I consider this a potential catalyst (or risk) alongside the potential sale of GEE Group.

Low, Base, High Case Inputs

The low case is based on a 2024 recession and holds a reduction in revenue and cost of goods by 10%. GEE Group re-rates to an EV/FCF of 8 if FCF is positive and if not it reverts to the 52 week low of $0.37.

The base case estimates 0.5% annual growth (based on USA Employment Projections ) and a re-rating to 10.91 EV/FCF, a 16% discount to the staffing industry median.

The high case estimates a 5% annual growth and a re-rating to the median of 12.98 EV/FCF. I project this to be driven by professional contract services IT growth and direct hires picking back up.

Normalized Financials

Please note that GEE Group does not go on a standard calendar year but my normalized financials do.

Base Case Price Target of $0.75

My estimated GEE Group's base value comes out to a share price of $0.75, a 31.5% premium to the current (8/18/2023) stock price of $0.57. The low case price is $0.37 and is based on the 52 week low. The high case that incorporated 5% growth and the median valuation came in at $1.08, an 89% premium to present value.

In Conclusion

I estimate GEE Group to be at a ~31% discount to its industry peers and the valuation gap to close as Dewan and his team execute on their capital allocation strategy. If more investors do not buy into the improved governance structure and aligned incentives then GEE Group can do it themselves through their stock buyback plan. Kim Thorpe confirmed in my last chat that he believes their stock is undervalued and predicts that they will continue to repurchase stock aggressively, and at a minimum through the price of $.80/share.

The $0.75/share estimate does not include the potential for GEE Group to accelerate growth by growing organically and executing their acquisition roll-up strategy. I believe this to be a realistic outcome and potential positive catalyst.

I currently own GEE Group and look forward to seeing more free cash flow, share repurchases, and the execution of a value adding acquisition program.

Additional Risks

GEE Group is a microcap and has all of the typical risks associated with investing in a small and illiquid stock. In times of turmoil it may be difficult to close your position at a reasonable price and the spreads may widen.

GEE Group's acquisition strategy could be a risk just as much as a catalyst. If they overpay and or over leverage themselves the result could be the stock going to $0.

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