Acquisition Of Sterling And AI Investments Will Transform Employment Screening Industry

Key Takeaways

• The acquisition of Sterling significantly enhances First Advantage's scale, reduces costs, and lowers business risk through diversification.
  
• Investment in AI, machine learning, and next-gen technologies positions the company for growth and efficiency gains, improving net margins and revenue.
  
• The Sterling acquisition introduces integration and financial risks that could impact operational efficiencies, earnings projections, customer retention, and revenue stability.

Catalysts

Provides employment background screening, identity, and verification solutions worldwide.

• The $2.2 billion acquisition of Sterling is a major catalyst, as it effectively doubles First Advantage's size and is expected to realize $50 million to $70 million in synergies over two years, impacting future revenue and earnings through increased scale and cost efficiencies.
  
• Expanding international presence, with enhanced capabilities and resources from Sterling, provides significant growth opportunities in EMEA, APAC, LatAm, and India, positively impacting revenue by tapping into large and growing markets.
  
• Increased diversification and reduced customer concentration through the acquisition lower business risk and improve resilience against cyclical downturns, which can positively affect net margins and earnings stability.
  
• The strategic focus on AI and machine learning for innovation in service offerings is expected to boost efficiency and customer satisfaction, potentially increasing net margins due to cost reductions and enhanced service delivery.
  
• The combined company's capacity for greater investment in next-generation technologies could accelerate growth in high-margin areas, positively impacting both revenue and net earnings through innovative products and improved operational efficiencies.

First Advantage Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming First Advantage's revenue will grow by 32.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 0.6% today to 7.7% in 3 years time.
• Analysts expect earnings to reach $133.6 million (and earnings per share of $0.84) by about December 2027, up from $4.9 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 31.5x on those 2027 earnings, down from 680.3x today. This future PE is greater than the current PE for the US Professional Services industry at 25.0x.
• Analysts expect the number of shares outstanding to decline by 2.61% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.56%, as per the Simply Wall St company report.

First Advantage Future Earnings Per Share Growth

Risks

• The acquisition of Sterling, which expanded the company's size and capabilities, brings significant integration risks that may distract management and could temporarily impact operational efficiencies, potentially affecting net margins.
  
• Base growth for First Advantage remains a concern as it came in lower than anticipated, with the outlook for macro-driven base declines suggesting potential challenges in achieving revenue growth targets.
  
• The company's expected synergies from the Sterling acquisition face execution risks, and delays or challenges in achieving these could impact earnings projections and financial performance.
  
• The refinance of existing debt and new debt to fund the Sterling acquisition increases financial risk, with net leverage expected to be 4.4x, which could affect net margins and the cost of capital, especially if anticipated interest rate cuts do not materialize.
  
• The ongoing changes in management roles and responsibilities, along with integration of new technologies and products, present execution risks that could impact customer retention and satisfaction, ultimately affecting revenue stability.

Valuation

• The analysts have a consensus price target of $21.83 for First Advantage based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.7 billion, earnings will come to $133.6 million, and it would be trading on a PE ratio of 31.5x, assuming you use a discount rate of 6.6%.
• Given the current share price of $19.33, the analyst's price target of $21.83 is 11.5% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.