TriNet: Potential Revenue Growth Inflection In 2024 (NYSE:TNET)

Investment Thesis

My investment thesis for TriNet Group, Inc. (NYSE:TNET) hinges on customer growth, particularly in Worksite Employees (WSEs). Zenefits has opened up a new market for TriNet while improving the PEO business. New sales growth and retention improvement will be the foundation upon which TriNet can deliver market-beating returns. The company continues to optimize its per-client efficiency and could be poised to experience an inflection of revenues once the hiring market recovers in its industry verticals. Investments in growth have begun to pay off for TriNet, and 2024 could be the year that the company inflects revenue growth higher. Whenever this happens, investors may want to make sure they are a little early to the party.

All indications are that TriNet has successfully executed its three pillars of PEO growth: improving its new sales annual contract value (new sales ACV) and retention, and showing signs that its Zenefits acquisition is beginning to pay off. WSE users have improved marginally and appear to be on an upward trajectory, with reason to believe this turnaround will continue for the foreseeable future.

Risks include macroeconomic concerns, the addition of long-term debt to repurchase and retire over 16% of outstanding, and the retirement of its CEO of fifteen years, Burton Goldfield, who has helped deliver market-crushing returns. However, TriNet just initiated its first quarterly dividend and remains serious about returning 75% of Corporate Operating Cash Flows to shareholders, which has grown by a CAGR of over 15.6% since 2015.

WSE Growth Is The Most Important Metric

Following a year of impressive new sales and retention performance and a pivot towards more efficient growth for 2024, it appears that TriNet’s investments in growth are paying off. The company may be on the verge of WSE growth.

TriNet’s WSE users are the most important metric to track because they represent the lion’s share of the company’s revenue. After peaking in Q4 of 2021, WSE user count declined, bottoming out in Q1 of 2023. As WSEs declined, TriNet gradually witnessed its revenue growth decline and only achieved 0.8% of total revenue growth in 2023 on the strength of its insurance cost ratio and new sales. However, WSEs will need to return to growth for TriNet to accelerate revenue growth and maintain its mid-double-digit normalized Free Cash Flow CAGR.

WSE users have improved marginally since Q1 and appear to be on an upward trajectory, with reason to believe this turnaround will continue for the foreseeable future. Note that these numbers do not include the new classification of Incremental WSEs implemented during Q4 and provide an apples-to-apples comparison.

In 2023, the company successfully executed all three of its company KPIs for WSE growth, dramatically improving its new sales annual contract value (new sales ACV), improving retention to near-record levels, and showing signs that its Zenefits acquisition in early 2022 is beginning to pay off. TriNet outlines its three pillars of PEO growth in its investor presentations and often discusses these KPIs in MD&As.

The early results of TriNet’s growth investments have materialized, as end-of-quarter WSE users have grown from 328,999 at the end of Q1 2023 to 335,543 at the end of Q4.

In 2019 and 2021, TriNet was able to accelerate revenue growth during years of increasing WSE counts. Given that there are signs that WSE counts have already bottomed and are beginning to increase, waiting for a significant increase in WSE users to be evident may leave investors on the fence, as revenues will likely have already accelerated.

New sales will be critical for TriNet investors to analyze, these new customers will drive WSE user growth. Let’s take a closer look at TriNet’s new sales performance.

New Sales

TriNet knocked its new sales ACV metrics out of the park in 2023, thanks to its strategic investment in growing its sales rep count by 19% in 2022. This trend is expected to continue as the sales reps mature within the company.

With new sales ACV accelerating throughout 2023 and into 2024, the company is well-positioned for WSE growth in 2024 and beyond. The recent trend in new sales ACV and WSE count is shown below. All data is based on management commentary and financial data.

Considering that a whopping 40% of its annual new sales come during Q1 each year and that TriNet achieved 56% growth in new sales ACV in January 2024, it once again looks poised for a good year. I expect another spike in WSE users during Q1 and Q2 of 2024, as long as retention remains healthy and hiring in TriNet’s installed base doesn’t weaken significantly.

The company’s management is confident in its strategy and plans to continue investing in its sales force while keeping overall costs relatively flat. During the Q4 2023 conference call, outgoing CEO Burton Goldfield answered an analyst question about its investment in sales,

“We will continue to invest significantly in the sales engine and growth of sales reps. So, the way you phrased it is exactly where we’re headed. We need additional capacity. The additional capacity is coming on board not only at the same efficiency but at a higher efficiency. And as long as that’s the case, we will invest in the sales organization. We’re doing that at the same time keeping overall costs relatively flat.”

If new sales remain strong, and its other growth initiatives aimed at improving retention and capturing market share play out, I expect TriNet’s investments in growth will lead to long-term revenue benefits and accelerate revenue growth sometime in 2024. The integration of Zenefits is an opportunity for TriNet to improve all of the above and enables the company to pivot toward user growth in 2024.

Pivoting

TriNet Group is undergoing a strategic shift, pivoting its focus towards expanding Professional Service Revenue rather than Insurance Service Revenue. This shift began with the acquisition of Zenefits, completed in early 2022. TriNet is reaching outside its niche PEO market to capture new customers in the Human Resource Information System (HRIS) market and is focusing its current growth strategy on maximizing its overall customer growth, whether it be WSE, incremental WSEs, or HRIS customers.

This strategy has three main benefits:

1. Adding an integrated PEO and HRIS platform provides TriNet with a new market to serve and new customers to chase. This will allow growth in non-PEO business.
2. As HRIS and Worksite Employee (WSE) user growth occurs, insurance revenue will naturally increase as the company converts some non-PEO clients into PEO users.
3. As some customers grow out of the PEO model and bring benefits and HR in-house, there will be options to continue utilizing TriNet’s Denali platform for custom HR products that can evolve with a company’s changing needs.

I was initially a big fan of the Zenefits acquisition, and have only gotten more bullish on the potential it offers TriNet. Zenefits expanded TriNet’s total addressable market and provided an enhanced technology platform. The successful integration of TriNet’s legacy PEO platform with Zenefits’s HRIS platform resulted in the creation of the Denali platform. This API-first platform allows customers to transition seamlessly between HRIS and PEO as their needs evolve, and businesses to easily integrate TriNet’s platform into their own ecosystem.

I anticipated that the acquisition would help drive new sales and improve retention by providing greater flexibility, enhancing service offerings, and acting as a new sales funnel for the PEO construct. Now we have evidence of its effectiveness. Management has reported impressive growth in new sales, near-record retention, and improved Net Promoter Scores (NPS). I think it’s no coincidence that the Zenefits integration preceded these improvements, especially considering that the macro environment did not aid TriNet in 2022 and hiring was muted in its installed base.

The PEO construct also received a boost from a new classification of WSEs, referred to as ‘incremental WSEs,’ increasing its count by 11,999. This is a new source of revenue that I had not anticipated. This category accounts for customers using at least one part of its PEO platform but who are not part of its co-employment PEO model, and was first included in the 2023 10-K. Though the revenue contribution is lower than a co-employment PEO customer generates, Incremental WSEs are accretive, as there is a platform service fee attached to each user and revenue for each service attached. Management stated that the revenue contribution from each incremental WSE is like that of revenue from HRIS users.

One of my KPIs for TriNet is HRIS user growth, which has yet to materialize. However, the addition of Incremental WSEs is just as good as growth in HRIS users. This type of customer was not an option for TriNet prior to Zenefits, and if my new sales funnel thesis plays out, these are the very customers who could become future PEO clients.

The company’s report and earnings call provide several important clues supporting the thesis that Zenefits may drive significant growth in the future. The positive outlook for PSR, retention, and discussions about efficient growth all indicate that this is progressing well.

Earnings call clues

TriNet is projecting PSR growth that exceeds total revenue growth, particularly in Q1. With an expected 5% PSR growth in Q1 and 3% for the full year 2024 (at the midpoint), and only 1.5% growth in total revenues for Q1 and FY 2024, management is indicating that it expects both WSE and HRIS users to increase in 2024. Much of this growth may come from HRIS and incremental WSEs. This became clearer after reading what CFO, Kelly Tuminelli had to say regarding WSE growth, during the Q4 earnings Q&A:

“So, we’re not really forecasting WSEs, but you can tell probably from our — both our professional service revenue growth forecast as well as our assumption around total GAAP revenue, roughly assuming how that comes in with a real low single-digit on the bottom end for CIE.”

What Tuminelli is saying is that despite low single-digit growth in its installed base of customers (referred to as CIE), TriNet is projecting full-year PSR to grow between 1% and 5%, which is faster than ISR. This growth is likely to come from HRIS users and incremental WSEs. Incremental WSEs and HRIS users are a result of Zenefits.

Could it be that we are in the early stages of the long-term market share gains that TriNet is attempting to capture with Zenefits?

The acquisition of Zenefits by TriNet has opened up a new market for the company, allowing it to grow more efficiently. With the addition of HRIS users and incremental WSEs, TriNet can now offer lower-touch services outside the traditional co-employment PEO construct. This means that the company can grow its revenue and user counts more efficiently, as it requires fewer staff for each additional customer, something that was discussed during the Q4 earnings call.

Company Updates

TriNet had two major pieces of news to report. It recently initiated a quarterly dividend of $0.25 and announced the retirement of CEO Burton Goldfield. Goldfield seemingly went out on top after guiding TriNet through its IPO and shepherding it through several key acquisitions that grew the company’s market size.

TriNet also reported solid Q4 and full-year 2023 results. The chart below summarizes the key metrics.

There were some positive indicators within the latest results that bolster my opinion that TriNet may continue to be a market-beating stock over the long run. FY Insurance Cost Ratio (ICR) remained strong at 84.3%, beating expectations but increasing year-over-year. If ICR remains in the mid-80s, it will support solid insurance services revenue. Even though total revenue only grew 0.8% for FY, it grew 1.5% in Q4. The general trend in the chart above is that Q4 looked better than the full-year results. Especially in Corporate Operating Cash Flows (COCF), which grew at 8.5% YoY for the full year and 151% in Q4. This is my proxy for Free Cash Flow, which will matter for valuation purposes.

With improved forward guidance, I anticipate that TriNet will see better growth in 2024 than in 2023.

Valuation

TriNet has seen a significant increase in valuation, with its EV/EBITDA multiple increasing from 6.2x in December 2022 to roughly 13.6x today. But considering its outlook, I do not believe the stock is overvalued.

Based on my expectations for normalized Free Cash Flow growth, I believe the stock is still undervalued. In December 2023, I outlined my methodology for normalizing FCF from COCF. With $539 million in COCF generated in 2023, TriNet’s normalized FCF would have been $517 million (96% of COCF). This is the foundation for my DCF model.

DCF Model assumptions

For my base case model, I am assuming the following:

Year 1: 3% normalized FCF growth.

Years 2-5: 10% normalized FCF growth.

Years 6-10: 8% normalized FCF growth.

Terminal Growth Rate: 2.0%.

Discount Rate: 12.0%.

I think this is a reasonable assumption, given the historical trends in COCF growth versus revenue growth. TriNet appears to be at the bottom of its current revenue growth cycle, and I believe that management will successfully meet or beat 2024 guidance and turn up from there.

After TriNet added significant debt to its balance sheet to partially fund its $1.1 billion buyback in 2023, it had a total of $1.085B of combined long-term debt and credit revolver borrowings on its balance sheet as of December 31st. This debt will need to be repaid, so I have reduced normalized FCF by $100 million each year for my model.

I believe my base case to be conservative, based on TriNet’s historical growth rates and operating leverage. If the company can grow revenue at a CAGR of 5% over ten years, an 8.3% CAGR in FCF should be attainable.

DCF Calculations

Despite trading near all-time highs, TriNet Group stock may still be undervalued.

Risks

With Burton Goldfield’s departure, Mike Simonds steps into the CEO role at TriNet. Simonds spent over 21 years at Unum, a 175-year-old health and benefits provider. During his last 11 years at Unum, Simonds filled the CEO and COO roles.

Another risk is that we enter a recession. Hiring is a critical component in TriNet’s success. The company is doing well in the areas it can control, but hiring in its installed base is beyond TriNet’s control. When this turns around, TriNet will benefit from its operating leverage.

Conclusion

TriNet has executed its growth strategy by accelerating new sales ACV and improved retention. The integration of Zenefits provides new opportunities for growth and an enhanced technology platform. TriNet has improved PSR guidance for 2024, and added new revenue sources from incremental WSEs, providing evidence of a turnaround. Despite facing challenges such as macroeconomic concerns and the retirement of its CEO, TriNet is well-positioned to deliver market-beating returns. It remains a buy, in my opinion, for patient investors looking for a relatively stable market-beating stock.