How Will HR Outsourcing Acquisition Impact Paychex?

Over the last few years, Paychex (NASDAQ:PAYX) has reported double digit growth in HR Outsourcing and Services, which has been driving most of its revenue growth, unlike its core Payroll Processing business which has grown in low single digits. In order to further capitalize on the growth potential of the HR outsourcing industry, the company recently announced the acquisition of HR Outsourcing Holdings, Inc. (HROI), along with all its operating subsidiaries, for an undisclosed sum.

HROI primarily provides HR solutions to small and medium-sized businesses, which is also one of Paychex’s key areas of focus. As the focus and operations of the two companies are largely aligned, the deal is a strategic fit and is expected to strengthen Paychex’s leadership position in the HR outsourcing market.

We currently have a price estimate of $57 per share for Paychex, which is in line with its current market price.

See Our Complete Analysis For Paychex Here

Source: Google Finance

Significant Market Opportunity

Over the last decade, companies across the globe have found it cost effective to outsource their HR functions, including payroll and benefits administration, to PEO companies such as Paychex to get full administrative support without having to invest in either technology or employees. This, coupled with the growing regulatory burden on small and medium-sized businesses, has magnified the growth in the HR outsourcing industry. For this reason, Paychex has witnessed strong growth from its HR outsourcing operations over the last few years. The company’s HR outsourcing clients have grown at a CAGR of 10% between 2012 and 2017, while its retirement and insurance clients have increased at a rate of around 5-8% during the same period.

As more and more companies opt for outsourcing of their non-core functions, the growth potential of the HR outsourcing industry is substantial. According to Paychex’s estimates, there are around 12 million small and medium-sized businesses in the U.S. that form a large portion of the company’s addressable market, of which more than half are still untapped. Also, per a report by Technavio, the global market for HR outsourcing is estimated to expand at a compound annual growth rate (CAGR) of around 12.7% between 2016 and 2020. Thus, the acquisition of HROI should enable Paychex to expand its HR outsourcing operations and enlarge its client base, which will likely help boost its top line as well as bottom line in the coming years.

Continued Focus On Small And Medium Businesses

For more than 20 years, Paychex has been a market leader in the HR outsourcing market, particularly for small and medium-sized businesses (less than 500 employees). Given the company’s strong presence and reputation in the industry, subsidiaries of Paychex Business Solutions (PBS) received the new IRS certification to provide PEO services under the Small Business Efficiency Act (SBEA).

With the certification, Paychex should be able to offer better benefits, in the form of tax credits, to its clients. This new advantage, coupled with the HROI deal, should not only allow the company to expand its presence in newer markets and offer better HR solutions, but will also enable the company to increase its footprint in its key market – small and medium businesses.

Cost Optimization Could Boost Bottom Line Growth

Though both companies have refrained from divulging many details about the deal, one of the most logical reasons behind an acquisition is the cost synergies derived from the deal. Since the two companies operate in the same industry and target similar clients, we expect the deal to result in a fair amount of cost synergies in the coming years. This is likely to boost the company’s bottom line in the coming years. Further, as mentioned previously, the HR outsourcing industry still has a huge untapped market. Consequently, Paychex is expected to introduce new and better HR solutions, using HROI’s experience, and attempt to capture a larger share of the market. Since many of the costs associated with HR outsourcing are fixed, a sharp growth in revenues could result in a significant jump in earnings and EBITDA.

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