Fitch Ratings has assigned TriNet Group, Inc. and its subsidiary, TriNet USA, Inc. (collectively, TriNet), a first-time Issuer Default Rating (IDR) of 'BB+'.
In addition, Fitch has rated TriNet's secured revolving credit facility (RCF) 'BBB-'/'RR1' and senior unsecured notes 'BB+'/'RR4'. The Rating Outlook is Stable.
The ratings reflect TriNet's strong market position, stable EBITDA and FCF generation. Subsequent to the company's increased shareholder-friendly actions, Fitch expects TriNet's leverage to be approximately 2.0x at FYE 2024 and remain between 2.0x and 2.4x through the rating horizon. The company's financial flexibility is strong, providing some cushion against insurance volatility and macroeconomic headwinds.
The ratings also reflect Fitch's concerns about the company's exposure to the small and midsize business (SMB) market, financial strategies, rising medical costs, uncertainties surrounding insurance costs, direct correlation with economic cyclicality, and limited revenue diversification. Despite these factors, Fitch believes TriNet remains well positioned in the professional employer organization (PEO) industry.
Key Rating Drivers
Stable Credit Profile: TriNet's rating reflects its stable EBITDA generation and strong competitive positioning in the highly fragmented human capital management (HCM) industry, placing it strongly among other Fitch-rated 'BB+' technology issuers. Historically, the company has operated with an EBITDA leverage profile below 1.0x, though its recently announced financial policy includes provisions to return approximately 75% of FCF to shareholders and to operate with leverage (as defined by TriNet) in the range of 1.5x-2.0x.
Leverage to Remain Low: Historically, TriNet operated with leverage under 1.0x and with the company's significant share repurchase plan, which was largely funded with debt, Fitch sees leverage much higher than historical levels. TriNet completed $1 billion in share repurchases in August 2023 and this was 60% funded through debt, and the remaining 40% was from cash flows from operations. Fitch expects EBITDA leverage will be approximately 2.0x at the end of 2024 and it is projected to be in the range of 2.0x-2.4x through the rating horizon, with capacity to delever supported by FCF generation.
Strong Financial Flexibility: TriNet's liquidity is strong with $245 million of unrestricted cash and short-term investments on its balance sheet at the end of September 2023. The company has recently amended its credit agreement to increase the capacity under the RCF from $500 million to $700 million, with $500 million remaining undrawn after the recent $1 billion share repurchase transaction. Fitch expects TriNet to generate a mid-single digit FCF margin to further support its liquidity and capital deployment strategy.
SMBs Negatively Affect Retention: TriNet has historically experienced client attrition rates of about 20%, which is high compared with enterprise software peers, although somewhat in line with other software companies with SMB end market exposure. The company maintained its average retention rate during the pandemic, with some improvements in the recent quarters. The loss of clients is attributed to M&A activity or multi-vendor, alongside few SMB's bankruptcy cases. Fitch believes that TriNet will maintain its retention rates through the rating period, considering the majority of its clients operate in predominantly white collar industries, and the average client life of five years.
Insurance Cost Volatility Risk: Fitch estimates TriNet's net insurance service revenues constitutes nearly half of total revenues. Trailing-12-month insurance cost ratio came in 1% higher due to increased insurance costs, driven by surging drug prices and increased health benefits utilization rates. Fitch expects insurance costs to be in the range of 88% to 89% of insurance revenues through the rating horizon. The number of medical claims, access to medical systems and services, and drug prices in any given period expose TriNet to volatility and uncertainty in the business.
To manage health insurance risk, TriNet has the ability to reprice its book on an annual basis and also utilizes different tools such as credit assessments, algorithms to assess claims risk, and manages a deductible layer with third-party carrier partners. While Fitch believes the unexpected likelihood of very high claims still presents some credit risk to the company's future insurance business, distribution of risks between TriNet and the carriers safeguards the company from higher claim amounts.
WSE Growth and Macroeconomic Headwinds: TriNet's revenues have a direct correlation with macroeconomic factors such as employment levels, GDP growth, wages, and government support for SMB's businesses. TriNet's higher number of average worksite employees (WSE) provides visibility to future revenue streams. Revenue declined by 2% in 3Q23 due to lower volume in WSE and lower health plan enrollment, which was partially offset by some service fee rate increases.
WSE growth has been negatively affected by the tech sector, which has a lower headcount than in recent quarters. Over the rating horizon, Fitch projects revenue growth to range from flat to mid-single digits, reflecting modestly rising unemployment rates and macroeconomic uncertainties in the near term, offset by price realization and some stabilization in WSE growth after mid-2024.
Cross-Sell Opportunities: Fitch believes TriNet benefits from cross-selling opportunities due to its broad portfolio and its ability to increase penetration of additional modules into the existing customer base, aided by recent acquisitions of Zenefits and Clarus R+D. TriNet's solutions support a wide range of HR functions including payroll, benefits, compliance, workers compensation, and risk mitigation, which the company is able to leverage by offering a centralized place to manage human capital.
Competitive Landscape: The HCM industry is highly competitive and fragmented with competitors of various scales. The company provides HR employers with software tools that automate processes, including payroll and taxation processing, employee hiring and engagement, compliance and many more, encircling employee lifecycle management. Fitch expects continued growth in demand for HCM software as companies migrate to cloud-based solutions to automate administrative functions to reduce costs and time spent, while focusing more on strategic investment decisions.
Derivation Summary
TriNet's 'BB+' Long-Term IDR reflects its strong market position as a PEO solution provider, historical growth profile and FCF generation. The company provides HCM solutions such as benefits, payroll, risk mitigation, and compliance, encircling employee lifecycle management. Fitch expects demand for HCM software to continue growing as companies migrate to cloud-based solutions to automate administrative functions to reduce costs and time spent, while focusing more on strategic investment decisions. Fitch projects the North American HCM software spend to grow at a low-teens CAGR for next five years.
The PEO service market is led primarily by four public companies: Automatic Data Processing (ADP: AA-), TriNet (BB+), Insperity (NR) and Paychex (Oasis; NR). TriNet has maintained its position in the market by driving strong sales execution, making consistent investments in its technology platform, and through its vertical-focused go-to-market strategy. Unlike many peers that are vertical agnostic, TriNet is focused on core verticals with white collar clients constituting approximately 80%. Fitch considers this as an important positive factor to credit, considering the company's exposure to the SMB space.
The company is small in scale when compared with large vendors such as Automatic Data Processing Inc. ADP is rated four notches higher since its revenues are four times larger than TriNet and its EBITDA margins are double. ADP's leverage is also well below 1.0x and it was 0.6x at the end of FY23 (fiscal year ends June 30) whereas TriNet is expected to have leverage of 2.0x-2.4x over the rating horizon.
TriNet's strong position in the SMB market should enable the company to maintain growth that is consistent with industry growth. TriNet's revenue scale is larger than other HCM providers such as Paychex Inc., Paylocity Holding Corp., Paycom Software Inc., Insperity Inc., and Ceridian HCM Holding Inc. TriNet's market position, average customer life and financial structure are strong when compared with 'BB+' Fitch-rated peers. Limitations to the rating include the company's narrow revenue diversification (HCM focus), and uncertainty surrounding insurance service segment. While TriNet's profitability in the low-double digit range compares unfavorably with the peers due to high insurance costs associated with the insurance service segment, Fitch believes TriNet is well positioned in the 'BB+' category relative to these peers and other SMB-focused technology issuers rated by Fitch.
Fitch rates the IDRs of the parent and subsidiary on a consolidated basis, using the weak parent/strong subsidiary approach and open access and control factors, based on the entities operating as a single enterprise with strong legal and operational ties.
Key Assumptions
Organic revenue growth rate in mid-single digits;
Insurance cost ratio approximately 88%-89% through the rating period;
EBITDA margins normalized circa 10%;
Capex intensity 1% of revenue;
75% return of FCF to shareholders annually via a combination of cash dividend and repurchases;
Fitch assumes aggregate debt-funded acquisitions of approximately $250 million through 2026.
Recovery Analysis
The 'BBB-'/'RR1' long-term rating for the senior secured revolver reflects the current debt structure that consists of a $700 million senior secured revolver and Fitch's view on superior recovery in a default scenario. This notching uses Fitch's U.S. Corporates criteria for companies in the 'BB-' to 'BB+' rating categories. Fitch assesses the above first lien revolver to be Category 1, which is reserved for U.S.-based borrowers, as TriNet does not feature any limitations in Category 2, such as being ranked junior to ABL facilities, excessive fully drawn secured gross leverage being greater by 50% of the midpoint of the 'BB' category for the sector (gross leverage is 1.6x for FYE 2023 versus an allowable 4.0x), or other factors that do not apply to the company.
The debt structure also consists of $900 million of senior unsecured notes. Per Fitch's U.S. Corporates criteria for companies in the 'BB- 'to 'BB+' rating categories, Fitch assigned a 'BB+'/'RR4' long-term issue rating to the above unsecured notes since these are junior to the senior secured revolving facility.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade is unlikely given the limited revenue diversification and SMB exposure of the company. However, the ratings could be upgraded with:
EBITDA leverage sustained below 2.0x;
Improved HCM market position, as evidenced by revenue growth approaching double digits on a sustained basis;
Evidence of increased revenue diversification into multiple end-markets.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Higher than expected incremental debt-financed acquisitions or share repurchases that materially weaken the company's credit profile, leading to EBITDA leverage above 3.0x on a sustained basis;
Unexpectedly higher number of health claims or health care utilization, significantly exceeding Fitch's expectation of insurance cost ratio on a consistent basis;
Significant market share erosion as evidenced by contract loss, increased client churn, and lower revenue growth.
Liquidity and Debt Structure
Sufficient Liquidity: TriNet's liquidity is strong with $245 million of unrestricted cash and short-term investments on its balance sheet at the end of September 2023. The company has recently amended its credit agreement to increase the capacity under the RCF from $500 million to $700 million, with $500 million remaining undrawn after the recent $1 billion share repurchase transaction. Fitch expects TriNet to generate mid-single digit FCF margins to further support its liquidity and capital deployment strategy.
Debt Structure: TriNet's debt consists of a first lien $700 million secured revolver due 2028, 3.5% unsecured notes due 2029, and 7.125% unsecured notes due 2031.
Issuer Profile
TriNet Group, Inc. (NASDAQ: TNET) is a leading PEO (professional employer organization) and human resources information system (HRIS) service provider for small to mid-sized companies, serving over 335k Worksite Employees (WSE) and more than 210k HRIS users, as of Sept. 30, 2023.
Date of Relevant Committee
06 December 2023
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
TRINET GROUP, INC. 
