Description

First Advantage (FA) is an out of favor 2021 IPO that is a solid well-run business with a favorable competitive landscape and offers a 2 year double opportunity due to recent temporary top line weakness and a significant private equity overhang. The company shares this perspective, having returned 15% of the market capitalization to shareholders in the past 12 months. We believe once US hiring momentum resumes, the business will trade back to a level more typical of high quality information services players given the strong growth opportunity ahead and the stickiness of the customer base.

First Advantage is a leading provider of employment background screening and verification services. They help their customers invest behind hiring, brand and safety. FA performs more than 100mm screens annually for its 33,000 customers.  The company offers a full assortment of background options, but the most selected include criminal background checks, drug and health history, employment history and identification verification. Customers typically determine a provider based on their reputation for speed, accuracy and the comprehensiveness of the offering.  Products can be sold individually but are more often bundled given customer size and usage frequency.  FA’s data platform is extensive, combining proprietary internal databases with external data providers. The internal engine has more than 730mm criminal, education and work history observations, and is combined with a network of more than 900 automated and/or integrated 3rd party data providers. What was once a labor intensive BPO industry has become increasingly automated, leading to improved accuracy and throughput and offering considerable advantages to the scale participants. The company was taken private by Silver Lake out of Symphony Technology in late 2019 for $1.5bn and taken public in Summer 2021 at a significant premium to where it is currently trading.

We believe the investment is attractive for the following reasons:

Strong financial profile and free cash generation, and management has been aggressive in taking advantage of the multiple compression in the shares

• Historically, the company has shown consistent high single to low double digit top line growth with low 30’s EBITDA margins and low customer churn in the ~3% range
• In the past year, the company has repurchased 5% of its shares and paid out a one-time 10% special dividend.
• The company has deployed capital selectively into M&A when they can source accretive product or geographic add-ons and accelerate the growth of the business
• Growth accelerants from here include further M&A, biometrics identification, higher penetration of employee monitoring once they’ve been onboarded and servicing international markets which have historically used limited screening processes

Limited float and private equity overhang - Silver Lake continues to own 60% of the company, so FA’s float is less than $1bn causing many investors to shy away

Weak macro hiring environment shortly following the IPO offering has put the stock in the penalty box

• Historically, growth from normal hiring patterns averaged ~2-4% a year, but has been down double digits for the past year
• Massive layoffs and hiring restraint in most technology and certain services industries and financial services markets has slowed hiring growth dramatically, though recent data and commentary suggests a trough
• Despite an aberrational slow hiring market, 2023 should be a flattish top-line year for the company given strong execution on cross- and up-selling existing customers and new customer wins

Rational industry structure with 3 primary players

• First Advantage, HireRight and Sterling Check all went public in 2021 and are roughly the same size in terms of revenue
• FA is the best of the group with the strongest, most consistent top-line growth, best margin structure, is ahead of the curve on platform and automation investment, has the lowest financial leverage (1.6x) and lowest exposure to the technology space which may have further erosion in hiring trends from here
• In our customer conversations, it is clear that pricing behavior amongst the big three is disciplined and that there is ample opportunity for them to grow by capturing share from smaller players rather than attacking one another’s turf

Industry has evolved from labor-intensive BPO and to being heavily tech driven with significant automation; scale players have a large runway for market share gains from mom & pops over time

• This industry used to be a time intensive labor-oriented process of going to courtrooms, etc to hunt down the right documentation
• FA now spends approximately $50mm annually on technology spend to improve the depth and breadth of the product and accelerate the automation process, dwarfing smaller competitors who simply cannot catch up
• The big 3 have roughly 1/3 share of the US industry, and it is very fragmented beneath them, offering a long runway for growth both organically and through M&A

Valuation and Upside Potential - trading at a ~9% FCF yield and just north of 8x ebitda, we believe First Advantage offers substantial upside potential. As historical hiring trends resume, we believe high single digit top-line growth and further margin opportunities should drive free cash flow closer to $1.50 in a couple of years’ time.  For frame of reference, the company has organic long-term targets of 8-10% top line and 14-18% bottom line and is operating below its desired 2-3x leverage level. At a high teens multiple in line with many other information services securities, the stock would double from its current level.

Catalyst

Improvement in US macro hiring environment

Reduction in PE overhang

Accelerated use of balance sheet towards M&A