Beyond Payroll Market Sector enewsletter from Garry E. Meier Ephor Group Chairman

2014 Beyond Payroll Services to HRO eNewsletter

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Payroll Platform Market Sector Commentary The Evolving Landscape of the Payroll Platform The first half of 2014 saw continued strengthening as the "Bigs got Bigger." M&A activity deals were primarily tuck-in acquisitions as leaders gained market share from the private independents, and several of the deals announced highlight the depressed market valuations for small, subscale service bureaus. In addition to the Strategics growing at the expense of the smaller service bureaus, several financial buyer PE Groups have targeted consolidating the market. Outside of the traditional payroll platforms we have seen interest into the merging of HR benefits with workforce management vendors with service bureaus. Many of these firms are looking to broaden their service offerings and move up the value chain toward higher-end more comprehensive solutions.

Payroll Platform Market Landscape The marketplace for core payroll processing now extends fully into workforce management and often times related BPO including content, software, services, and outsourcing solutions. While there are thousands of service firms worldwide there are only a handful of meaningful platforms. The goal of HR software is to automate transactions, coordinate the human aspects of work, and measure and analyze it all. To satisfy today's workforce demands payroll providers must move beyond payroll services to offer HRMS technology as well as both HR services and FAO services (primarily time tracking and expense management). In summary, a shift has occurred from historically only managing “employee transactions” to greater ROI. While the payroll market for small businesses with less than 50 employees is highly price competitive; there are approximately 50 players with significant, meaningful revenues ($10M+ or greater in annual recurring non “pass-through / non-reseller revenues) with operations in the United States. For multinationals and global organizations half a dozen of these provide global payroll service providers. The middle market of small and medium organizations with 50 to 5,000 employees representing greater than a one million USA businesses is in transition as new technology platforms compete with the large public platforms as well as regional and industry specific payroll service providers. In addition to local accounting firms and banks, which are increasingly choosing to be referral sources and turn to private-label partners for payroll services, the landscape can be categorized into the following primary buckets of competitive players:

The big four “umbrella” brands – ADP and Paychex together control a significant share of the target market and continue to grow based on their sheer brand recognition and referral base. ADP primarily focuses on the mid-market and Paychex targets the lower end. Ceridian focuses up market and Intuit’s focus is with very small businesses. ADP and Paychex are the big targets and are showing vulnerabilities to the up and comers based on technology, service, and price.

Mid-Market Platforms



1. Middle Market Vendors for Enterprises: 1. Infinisource 2. Heartland Payment with OvationPayroll 3. SaaSHR from Kronos 4. Paylocity 5. Sentric for Payroll and HRMS 6. ExponentHR for HRM 7. Mangrove 8. AscentisHR 9. CompuPay 10. ZeroChaos 11. UnicronHRO 12. Optimum for Microsoft and and IBM Platform Users

2. Private Label for <100 employees:

1. SaaSHR from Kronos 2. Adaptasoft CyberPay 3. EmployeeMax 4. SynchSource Inc dba SyncHR 5. PeopleStrategy 6. SinglePoint 7. Apex

3. For PEOs (end user client is <100 employees): Darwin, PyramidHR,

Licensees (Millenium with 75 active bureaus, Evolution with 40+, Paychoice with 30+,

AdaptaSoft's Cyberpay with 10+, Mangrove, ePay and ExecuPay with 10+)– there are ~150 active service bureaus with greater than $1M+ to 5M in annual recurring revenues that are delivering their service based on licensed technology from a handful of software vendors in the market who in turn receive an average of 3 to 9% of the service bureaus’ revenue. These licensees are primarily small businesses that are operated on a lifestyle basis and were initially started based on local relationships.

There are hundreds of smaller payroll providers and a “handful” of larger players whom are operating older proprietary systems ("Home-grown" or legacy providers) that do traditional payroll processing but lack a differentiated technology strategy including WFM capabilities.

Software only providers – Intuit and Sage provide software only solutions for the very smallest of businesses (< 50 ees) with simple needs. These do-it-yourself solutions come with tax table updates for an annual fee, but do not guarantee compliance and keep the burden of processing payroll on the small business itself.

The future of workforce management technology leaders will consolidate into the following camps: BPO solution providers, system of record providers that include a suite of processes, and single application ("killer app") providers.

*Not included in the above: Benefits/Insurance, PEO providers, Fractional HR Consultants, HR Staffing



The old saying “Payroll is Payroll” has finally gone by the wayside and its associated legacy thinking that has inhibited us in the past.” said Meier. “This economy's labor markets and the increasing cost and governance burdens, coupled with the increasing workforce management complexities will continue to challenge us for quite some time.” The question is what can we do? Ephor Group Founder Garry E. Meier shares some of his findings, thoughts and conclusions to solving the many challenges facing us as executives. Here’s the recap.

The LATAM region has become a receptacle of some 120 new BPO facilities comprising approximately $350M in foreign investment in the past 2 years alone. Even with these impressive growth statistics in that region, Ephor Group has determined the total capacity utilization of BPOs in LATAM is in the lower 25% quartile, while the English speaking capacity utilization is even less. Of particular note, there exist a particular opportunity for the Healthcare Business Services BPO’s to expand and prosper in LATAM.

Payroll Services experienced less than 5% growth in sector demand in 2013 driven by an anemic job market & slow GDP growth; while Workforce Management (WFM) experienced greater than 25% Growth in sector demand driven by increased reporting, compliance & employment lifecycle requirements. This trend will continue for the near-term. Key Success Factor: COGS and Gross Profit Margin as a Percentage of Labor Costs, needs to be a real focus area. Don’t hire resumes first… create a more efficient and productive process… then the resumes. The Future: Meier said he expects margin pressure to get increasing more difficult especially in the North America labor markets due to “the administration’s” increase in compliance, reporting and cost burdens. Therefore consolidation of especially “sub-scale” assets to formulate scaled assets will be mandatory for survival and wealth creation. Ephor suggest that specialized and focused BPO’s, SaaS, and cloud computing services will be areas of opportunity in the near-term. Meier concludes: “In my 38 year career I have never seen an economic cycle or time where well managed and resourced service organizations have not been successful”


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Workforce Management Market Update As the overall services market is organically growing in the single digits, several niche segments and market leaders growing in double digits.

Demand for WFM is being driven by ROI value beyond labor arbitrage:

More employers are requiring integrated "beyond payroll" transaction services as well as enhanced analytics and reporting to minimize complexity, regulation, and compliance. All want to find simpler solutions to managing their workforce operations.

Factors limiting the growth of technology platforms: o The cost of upgrades and "keeping up with the Joneses" o An acute shortage of certified, credentialed mid skill

level workforce talent

Some leading HRO/BPO platforms can provide full customer lifecycle solutions including the modernization of the customer experience (using more advanced technology including cloud, social, mobile, big data analytics, and customer analytics. The vendors with advanced service delivery model competence are growing.

Increasingly, business process as a service (BPaaS) is extending the depth and scope of services.

Rapid advances in BPO procedures using new technologies and the application of technology on productivity efficiencies.

Continued outsourcing adoption by emerging and middle market corporations.

Because companies are looking for value beyond labor arbitrage, the conversations are increasingly centered around operating outcomes and buyers look to evaluate service providers more holistically. Service providers are therefore focused on creating value-added solutions that include social media channel, customer analytics, and skill development & training to drive better customer experience management.

Ephor Group, founded in 2002, is a strategic advisory firm exclusively focused on growth oriented Business

Process Outsourcing (BPO) corporations. Since its inception, the firm has provided outsourced corporate

development services and growth capital acquisition advisory services. This set of capabilities and expertise has

resulted in approximately 5,500 new jobs created over the past decade.

500 private payroll service providers greater than $1m in annual revenues (not including the dozen public companies nor subsidiaries).

7 private company acquisitions in 2013 (13 in 2012).

19 Platforms with multiple service bureaus greater than $1M in annual revenues.

Valuation multiples for scaled enterprises 2 to 4X revenue multiple and 8 to 12X EBITDA multiple.

FINDINGS



MARKET OBSERVATIONS HRO SECTOR SUMMARY TTM Demand for outsourced payroll services grew at a <5% rate due to the anemic job

market and slow economic growth within the US economy. However the demand for reporting requirements in the areas of compliance, healthcare services, retirement plan management, and other workforce management areas grow >25% in 2013, due to the Administration’s “big government needs to know it all” demeanor. It is clear that this influence and requirement is here to stay for the near-term.

In general, executives and leadership in the sector have not changed or facilitated change effectively in order to take full advantage of the changing HRO and WFM marketplace, the client requirements, and the resulting opportunities. This lack of change management leadership has resulted in an 18% increase in sector bankruptcies, “surrenders” or failures over the past 18 months.

The need for investment in human capital technology beyond

traditional payroll process has never been so prevalent in the sector; the lack of technology and its cost has driven a few of the sectors providers to “sell out” at sub-enterprise market valuations, thus enterprise valuations reflecting the “surrender” attributes have become quite prevalent.

The sector experienced an increasing requirement and desire

for data, beyond payroll data inclusive of human capital data, and bundled services such that more data is consolidated into information that can be “mined” for reporting and workforce management effectiveness.

Those few progressive providers that have focused on bundled HRO services, human capital data

and outcomes-oriented information applied as analytics have gained market share and have increased client retention. Therefore they will be the most attractive providers to partner with the best “‘Beyond Payroll Service Providers.” We are seeing a bifurcation in the market of those that are “getting it” and those that simply will not.

There is a bifurcation in the market between those companies that illustrate “Market Leadership

Qualities” who are “getting it” versus those who simply will not.



The need for “alliances” and the types of allies came running to the forefront in 2013. All participants in the “food chain” need core payroll data for use in their area of specialty more quickly and more seamlessly than currently exist. Therefore, selection of vendors, partners, and technology, along with distribution allies are critical to your success as a sector competitor. The question is: What is your strategy and plan for the future?

Size and Scale matters more so than ever! The customer marketplace and the strategic buyer

community prefer larger boutique organizations ($10-$50M revenue) that are “smart and skilled enough” to focus on a specialized vertical market or illustrate a specific sector focus; therefore they become the “comfort buy”. The successful participants will couple this focus with intimate and personalized customer service, versus “subscale providers” where risk of failure is more prevalent, or as compared to “branded” national providers and their “call/service center” one-size-fits-all business models.

Information & Data Security forever is a risk to be managed and must become a proactive part of every system, process and the culture. It is much more difficult to enhance security as an after- thought, add-on, or patch. Some vendors will “get it”, more vendors simply will not. Sector participates need to know the difference and demand that security be a key focus in the design of a solution, the resulting operating system, and the subsequent workflow processes and procedures.

ENTERPRISE VALUATIONS & NOTED M&A TRANSACTIONS

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In 2013 the lower middle market to subscale market experienced flat to somewhat lower enterprise valuations as M&A activity volume was likewise suppressed over 2012. Specifically in the HRO/WFM sector where the enterprise valuation metric is a multiple of EBITDA, the market presented itself at >7 times adjusted pro forma trailing twelve month (TTM) EBITDA. In the Payroll services sector where the enterprise valuation metric is a multiple of revenue the subscales commanded 1.7x -2.0x TMM Revenue. These purchase price multiples have been made possible due to the significant availability of liquidity to finance leveraged buyout (LBO) transactions. Total Debt / TTM EBITDA for middle-market LBO transactions have steadily increased since hitting a low in 2009, currently achieving 3.3x in 2013.

HRO >7x pro forma TTM EBITDA Payroll Services 1.7 – 2.0x TTM Revenue

*Significant ffinancing options for capital available for the “Best Business” models.

Valuations



WFM 2013 and 2014 M&A Private Company Deal Transactions

Buyer Seller Vertical Revenue Size $m

Deal Terms Deal Notes

CoAdvantage

OdysseyOneSource

HRO PEO ASO

<$25 NA Jan 2013

two of the top ten PEOs in the nation

Budco (Glencoe Capital)

South Shore Venture Enterprises

BPO CRM <$25 NA May 2013

expands our footprint in the healthcare and insurance vertical markets

Allied Global LLC

Marketlink Inc

Inbound & Outbound BPO

$75 NA Sept 2013

Together, the combined entity has 6,000 employees, 19 contact centers in 4 countries offering services in several languages.

24-7 Intouch Inc Innovative Contact Solutions (ICS)


NA NA Oct 2013

The facility currently houses 240 seats and is rapidly expanding its capacity to 600+ seats by the end of the year, bringing 24-7 Intouch’s global capacity to over 2,400 contact center workstations.

Enhanced Recovery Company, LLC

"ERC"

TMone Inbound & Outbound

NA NA Sept 2013

4 facilities acquired. The acquisition positions ERC to deliver next-generation Customer Experience Management (“CEM”), providing clients with access to best in class Customer Relationship Management (“CRM”) and ARM services

Etech Global Services

Global Contact Services’ (GCS)


NA NA May 2013

8 worldwide locations including one in Jamaica and 2 in India employing 2,5000 employees

FusionBPO Simply Outbound Ltd.

Inbound & Outbound

NA NA May 2013

Acquired for lead generation and database space in United Kingdom

*Public Company Deal Transactions: 1 2 3 4 5 6 7

1 In 2013 SYNNEX (NYSE: SNX) acquires IBM (NYSE: IBM) BPO Customer Care for $505 million, consisting of approximately $430 million in cash and $75 million in

stock. The acquisition will be branded and fully integrated with Concentrix, a wholly owned subsidiary of SYNNEX. 45,000 staff and 50 plus delivery centers focused on

12 industries across 6 continents.

2 In 2013 Innotrac Corp., a provider of outsourced e‐Commerce fulfillment, business intelligence and contact center services, was acquired by Sterling Partners, a

leading mid‐market PE firm Sterling Partners agreed to purchase the Company for an implied EV of ~$110m (12.1x LTM EBITDA)

3InMarch2014GlobalPaymentsCompletesAcquisitionofPayProsfor$420milliontoacquire58,000clients.



WFM Solutions are Changing the Landscape Workforce management solutions are changing who the decision maker is. In smaller

firms with less than 50 employees with simple to moderate needs, the decision maker remains the owner and/or the office manager. In larger companies, historically, the payroll group was a specialized section inside the Human Resources department and they made either the decision or were very strong advocates of the solution. HR, historically, managed the workforce from organization requirements, to job and skill definitions, to candidate search – interview/examine – hire – on-board – handbook, monitor and score performance, educate, retire or fire. Each of these functions had their own area specialists, data bases, and software.

The decision making dynamic is moving from separate specialized sections within the

Human Resources department to a single higher level executive or committee of executives. Therefore we must change who we market to and who we sell to. It is clear that the buyer community will be a “higher level, more perceptive and sophisticated professional” who enjoys a more holistic view of their organization and needs.

Payroll Service Providers Will Need New Organization Models to Provide a WFM-Centric Product Set

Employers in the future will be driven by more complexity and regulation/compliance as such will be driven to find knowledgeable holistic solutions to managing their workforce. It is clear that most will want to outsource their requirements to providers with deep domain subject matter expertise and the best technology.

The truth is most payroll providers lack the specific segment subject matter expertise in other employee lifecycle segments than payroll to provide this holistic single point of “intellectual capital”.

A select few payroll providers are in a position to re-organize themselves to expand

beyond payroll, provide funds transfer, settlement services, tax treasury services and compliance reporting, either as a lead or as a participant in an alliance, in bringing together a broader, more “bundled” list of services to satisfy the market’s holistic requirements. The legacy and failed thinking of the past of “just plug and play”, poor or no business practices, a lack of rules, accountability, and experience is a recipe for failure.

More Complexity

More Regulations/Compliance

A More Sophisticated Buyer

Deeper Domain Knowledge

Effective Change Management

Innovative Organization Structures

Effective Partnering & Alliances

Future Factors



KEYS TO STRATEGIC & MARKET SUCCESS IN THE HRO SECTOR

Payroll Service Providers Can Become Key Players in the WFM Arena Payroll service providers have several advantages as the workforce management arena

matures and evolves. Payroll is the source of key data that drives many of the services provided to employees. Payroll processing is complex, and is getting more complex and more regulated each day. Taxing issues, tax preparation and the flow of funds from tax, insurance, benefits administration services require controls, and many of core competencies that payroll service entities illustrate. HCM management and Payroll Services require that providers have working relationships and access to the national banking system to move customer funds throughout the financial system. Other HRO and WFM service providers generally do not have the same level of access to the system that payroll providers have, and they need that access. Exploit your “special skills.”

Technology is being developed, adopted and being utilized at lightning speed, and in many cases the technology is ahead of us, the providers, in terms of subject matter expertise, system of security and controls, and our employees are demanding convenience and immediate multi-platform access to their personal information. Business practices and user practices will need to be revised and in some cases invented. Our core technologies will need to be capable, compliant, controlled, and customer friendly, and provided in that order!



The sector participants that “dare to cross that chasm of change” and position themselves as sector leaders will be handsomely rewarded by enterprise valuations that should reflect a 25% to 40% premium above the valuations presented earlier in this report.

Please contact Ephor Group at 214.702.6427 or [email protected] for further information and discussion relating to:

2014 HRO market and 2015 market forecast Overview of Ephor Group’s services: “Solving the Value Equation” A discussion of your company’s strategy, growth and resource

requirements



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Beyond Payroll Market Sector enewsletter from Garry E. Meier Ephor Group Chairman

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Transcript of Beyond Payroll Market Sector enewsletter from Garry E. Meier Ephor Group Chairman