Sterling Integration Expected To Unlock Synergies And Improve Operational Efficiencies

Key Takeaways

• Strategic acquisitions and integration under the FA 5.0 strategy are set to enhance synergies, operating efficiencies, and profitability through margin expansion.
  
• Investments in technology and differentiated platforms are driving competitive advantages, improving customer retention, and supporting revenue growth through enhanced offerings.
  
• Macroeconomic uncertainties, seasonal revenue declines, and fixed cost challenges may hinder First Advantage's future growth and net margins amid integration risks with Sterling.

Catalysts

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

• The strategic acquisition of Sterling and subsequent integration under the FA 5.0 strategy is expected to unlock significant synergies, with an increased net cost synergy target range of $60 million to $70 million, which will contribute to expanded margins and increased profitability in the future.
  
• The adoption of a variable cost structure from Legacy First Advantage operations across Sterling's historically fixed cost model is anticipated to improve operating efficiencies, thereby positively impacting net margins and enhancing the bottom line.
  
• Strong pipeline momentum and recent large deal wins in verticals such as healthcare and retail, including two potential top 10 customers, indicate anticipated revenue growth acceleration in the second half of the year, impacting overall revenue positively.
  
• Continued investment in technology and automation, including leveraging AI capabilities and combined tech solutions from both First Advantage and Sterling, is expected to drive efficiency improvements and cost reductions, supporting margin expansion and stronger earnings.
  
• The combined entity's competitive advantage through differentiated technology platforms and expanded, industry-specific offerings is expected to enhance customer value propositions, increasing customer retention and facilitating revenue growth through upsells and cross-sells.

First Advantage Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming First Advantage's revenue will grow by 25.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from -12.8% today to 5.6% in 3 years time.
• Analysts expect earnings to reach $95.0 million (and earnings per share of $0.54) by about March 2028, up from $-110.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 53.5x on those 2028 earnings, up from -20.5x today. This future PE is greater than the current PE for the US Professional Services industry at 21.3x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.31%, as per the Simply Wall St company report.

First Advantage Future Earnings Per Share Growth

Risks

• The uncertain macroeconomic environment could negatively impact future revenues, affecting the company's ability to meet financial targets and projections.
  
• The results of Legacy First Advantage Americas saw a decline due to weaker seasonal hiring revenues, which could lead to lower future revenues if this trend continues.
  
• The historical fixed cost approach in Sterling’s operating methodology may impair net margins if not successfully shifted to a variable cost structure.
  
• The integration of Sterling poses execution risks, such as the successful realization of synergies and adjustments to operational models, potentially impacting net margins and earnings.
  
• Base revenue growth is expected to remain a headwind through mid-2025, suggesting potential negative impacts on revenue and earnings in the near term.

Valuation

• The analysts have a consensus price target of $18.857 for First Advantage based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $22.0, and the most bearish reporting a price target of just $13.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.7 billion, earnings will come to $95.0 million, and it would be trading on a PE ratio of 53.5x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of $13.05, the analyst price target of $18.86 is 30.8% 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.