Analysts Private Equity Firms to Make a Play for HROs in ’07

Private equity firms have been busy in 2006 acquiring companies with the hopes of flipping them in a few years in order to make a big profit.

But when it comes to HR outsourcing firms, it seems that private equity firms have stayed clear.

“A lot of the private equity investors we have spoken to haven’t quite convinced themselves that you can make money in this space,” says Stan Lepeak, managing director for research at EquaTerra, a Houston-based advisory firm.

As the market matures, private equity investors are becoming more comfortable with the idea of investing in this space, analysts say. Many industry experts predict there will be several high-profile private equity-backed deals in the HRO market in 2007.

“I think we will see at least one big private equity-backed merger in the HRO space in 2007,” says Phil Fersht, an analyst at Everest Group.

London and Dallas. But the valuations have been too high, he says.

Earlier this year there were talks among a number of private equity firms, such as Blackstone Group, Bain Capital and Texas Pacific Group, to acquire Affiliated Computer Services, but those discussions fell through.

But now as some companies see their valuations fall, private equity firms are wooing them.

Many cite Hewitt Associates as a prime target for private equity investors. Hewitt’s HRO business has been struggling during the past few quarters as it has had problems absorbing some of the big deals it has won.

The Lincolnshire, Illinois-based company recently announced that one of its biggest HRO clients, BP, is not renewing its contract. In the fourth quarter, earnings fell 43.3 percent to $22.9 million, or 21 cents per share, compared with $40.5 million, or 37 cents per share, a year earlier.

“Hewitt is obviously trading at a level below some of its peer group,” says Sean McCarthy, vice president in the investment banking division of RBC. “I’m sure there are private equity guys that are busy running the numbers [on a possible deal].”

An ideal situation for Hewitt would be if private equity firms came in and took the company private, analysts say. Hewitt went public in June 2002. The price of its offering was $19 per share. In early December, the stock, which is traded on the New York Stock Exchange, was hovering around $25 per share.

Going private could give Hewitt the opportunity to focus on fixing its business outside of Wall Street’s glare, analysts say.

“Hewitt’s major challenges right now are the overhead associated with being a public company and the distraction for trying to make quarter-to-quarter earnings goals,” Trowbridge says.

The company could be attractive to private equity investors given its strong brand name and customer base, Yankee Group analyst Jason Corsello says.

Hewitt spokeswoman Jennifer Frighetto declined to comment on whether the company is in talks with investors.

On a smaller scale, private equity firms also are taking a look at investing in privately owned mid-tier HR outsourcing providers, like payroll providers and professional employer organizations, which service employers with 500 and fewer employees, McCarthy says.

“If you are a CEO of a mid-tier benefits administrator, you probably are getting between five and 10 calls a week,” he says.

Jessica Marquez