Trust in the Operator

An M&A offer led me to think about The Outsiders and Richard Zeckhauser.

About a month ago, Richard Hermanns, HireQuest’s CEO, announced his intention to acquire another publicly traded staffing company: TrueBlue. Despite not yet having gone through and TrueBlue’s board being seemingly against such an action, it triggered several thoughts.

Numbers at a glance:

The Outsiders and Richard Zeckhauser

Reading Zeckhauser’s essay and Thorndike’s book was quite revealing, as I had formerly held the belief that jockeys didn’t matter as much as the horse. After coming across Hermann’s announcement, my mind went back to the book, for Richard reminds me of these operators. The Hermann’s case, however, remains before the fact and proof; that’s where risk lies. Absent the latter, ironically, no profit would there be to be made.

I wonder what I would’ve felt and done after hearing about Murphy’s acquisition of the ABC Network back in 1986. The deal went for $3.5 billion, while, in all likelihood, Capital Cities’ market cap was between $1.5-$2.5bn. “Will this acquisition turn out good?” Risk lives in the absence of determinant answers. My thinking propels me to twist the question slightly, “Is he capable of pulling out this operation?” And where does the answer come from if not from one’s judgment of the operator?

The Need for Analysis

I presume it would be very common to dive into the acquiree’s characteristics and economics to “assess” whether or not the acquisition will be profitable. It seems like a very sensible thing to do. Notwithstanding this, what if it is Tom Murphy, or Mark Leonard, or Buffett, who are at the helm? If you understand their true capacity, the only item that could stand in the way of you achieving exceptional results is yourself. For, let’s say you “reach the conclusion” that Murphy was wrong, then what? Would you have sold, assuming you had done a correct job at partnering with him, understood his superiority as an operator, and knew he had more information than you about both businesses?

The magnitude of the ABC acquisition could’ve driven many investors away given its size and the fact of it posing many new risks, not theretofore exhibited. This goes without saying. And the aim of this write-up is elsewhere.

Let Them Work

Long-enduring, exceptional returns, go hand in hand with identifying extraordinary operators and partnering with them. Both elements turn sound investing into an exquisitely laborious task. Despite not yet having come across much evidence in favor of the following, my suspicion is twofold: (i) that the first condition might be analyzed by the mind, but partnering relies on Trust, which resides in another department; (ii) human nature makes investors struggle with the second condition more than anything else, being one of the most return-destroying elements, even in presence of brilliance.

An investor’s job might be to understand the water and its currents just to validate the nature of its flow. But you are not the fish; swimming is delegated and you must learn to live with that. If one’s job is well done, the fish will not die by weather nor any factor inherent to the environment. If the job is greatly done, the fish will live for a long time, yielding offspring and spreading its genetic material throughout the ocean.

More Background on HireQuest

HireQuest went public in 2019 by acquiring a then-public company called Command Center. At the time, HireQuest had 98 locations, while Command owned 67. A successful integration followed and, thereafter, HireQuest reinvested most of its cash flow in acquiring staffing businesses, some of them being sizeable (i.e Snelling with 47 locations). In late 2022, Hermanns announced the acquisition of MRI Network, which offers permanent placements and had ~230 branches, almost the same size as HireQuest’s network. The success of MRI’s integration is undeterminable yet.

All of this was funded with cash generated by operations; the balance sheet remains extremely strong, with almost no financial debt, and shareholders have not been diluted in order to pursue any of these transactions.

Why Issue Equity?

My main concern when I heard Hermann’s announcement was his intention of paying in HQI shares for the transaction. It would’ve been more understandable in 2023, when management’s efforts to acquire TBI began. But they could’ve changed their mind, or even wait, but Hermanns hasn’t. This brings me back to an aforementioned point, aided by another factor.

Richard Hermanns is HireQuest’s largest shareholder (38.2%). If I’m right about his capacity as an operator, why would he be willing to dilute himself at a “less convenient valuation than 2023’s”?

Value is destroyed when one gives more than they receive. Therefore, being incentives so aligned between shareholders and Richard, I’m led to presume that, even by paying in HQI shares, Hermanns expects the acquisition to be highly accretive and this to be a great opportunity to consummate it.

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Notes

• When HireQuest acquires a company-owned location, they convert it into a franchise, selling it to its prospective franchisee. These branches have, in the past, been sold at a wide range of prices ($150k-$6.4M). Assuming $100,000-$500,000 per branch, HireQuest could receive $40M-$200M in total proceeds from the conversion of People Ready locations.

• Since HireQuest made public their intention to acquire TrueBlue’s shares at a price of $7.5 per share, on May 13, TrueBlue’s share price rose from ~$4 per share to $6.68 per share.

• “if TBI would prefer to remain an independent, publicly traded company, then HQI would be willing to acquire just the PeopleReady, Inc. subsidiary from TBI and would be willing to pay up to $150 million in cash subject to additional diligence”

Personal Remarks

I remain unconvinced that frequent posting will do any good at the moment, but writing this was real fun.