Private equity has always had a role in HRO, but KKR’s recent acquisition of NorthgateArinso offers the industry a vote of confidence.
What’s the best thing to arrive at your door? New furniture? A plasma big-screen? The plumber in the middle of the night? For my money, it would have to be a private equity guy with a checkbook.
That was the situation facing Chris Stone, the CEO of Northgate IS, whose HRO business recently became one of the biggest service providers in the world. Shortly after U.K.-based Northgate Information Solutions acquired Brussels-based ARINSO last year, fund giant KKR came calling with a $1.2 billion check for the publicly traded Northgate. Realizing that any offer that begins with a “B” is difficult to turn down, company shareholders obligingly cashed. The company continues to operate as Northgate IS, but the outsourcing business has been rebranded NorthgateArinso to reflect its heritage.
When the sale to KKR closed this past March, it fundamentally changed the company and sent repercussions throughout the HRO industry. For one, Stone no longer worried about meeting quarterly numbers; instead, he’s got an eye on growing the valuation of the business for the long term. Although he is still responsible for hitting growth targets—Stone noted that in his most recent meeting with KKR managers to discuss budgeting, they reached a consensus target that is within two percent of what the company was expected to report had it remained public—he is also mindful that the end game is the exit value.
Moreover, with the private equity firm’s vast financial strength behind it, NorthgateArinso can more easily capitalize acquisitions and expansion initiatives, giving it a bigger growth engine. That means as the business looks to aggressively tack on market share in the U.S., which company officials view as its most important growth region, it will have the cash to make decisive moves.
For the industry, the emergence of the new entity offers buyers a resource for their HR needs around the world. Aside from its European heritage and strong market presence there, its push into North America as well as a growing brand in Asia mean NorthgateArinso has indeed a global network paralleled by only a few competitors. And it was the marriage between ARINSO and Northgate that held the strongest appeal for KKR.
“Quite honestly, we felt the combination of Northgate and ARINSO is and should be a fundamental game changer,” said Todd Fisher, the new chairman of Northgate and a 15-year veteran of KKR. “We felt the merger, if you put the two together right, would be one plus one will equal more than two.”
Fisher explained that KKR during the past few years had invested in the tech and outsourcing industry in companies such as retail transaction provider First Data and software solution provider SunGard, and saw the potential in Northgate. In particular, he said, he felt the market had strong potential for future growth
especially in North America, where the company had limited presence despite ARINSO having established a beachhead here for several years. Northgate’s limited experience with the world’s largest HRO market meant there was potential even though it’s a brand not widely recognized in the U.S.
Strong market potential is one consideration; how well a company is managed is another. Fisher said as part of KKR’s research, it interviewed more than 100 stakeholders including clients to determine how Northgate was regarded in the industry. Those familiar with private equity know KKR has many significant, large investments around the world, but it is also extremely diligent about where it parks its money. In shopping Northgate, it spent six months examining the business and its markets.
But as enterprise HRO deals all but disappeared during the past two years, was this really a good investment for KKR? Fisher acknowledged that while he had experience with the tech sector, he was not a devotee to BPO prior to the acquisition. And even if NorthgateArinso is serious about making a big push in the U.S., are customers here ready to buy?
Both Stone and Fisher say they believe some key market conditions are favorable to their growth in the U.S. and elsewhere. As the world economy shrinks, employers may accelerate their cost-cutting efforts, turning to outsourcing as a possible solution, Fisher noted. “At the same time that there might be fewer workers on payroll, there is an emphasis on cutting costs, which might help with driving outsourcing,” he said.
Whether elasticity of demand for HRO services is actually inverse to economic growth remains to be seen, but Stone thinks there is another reason for getting excited about his company’s growth prospect: the multinational mid-market buyer. Underserved for some time, he contended, these companies might have 10,000 or 15,000 employees around the world, with a large but minority population of workers in the U.S. As they look to a global provider that can meet their needs everywhere, they’ll find only a few vendors have that capability, he said.
“The number of credible suppliers who can support that kind of organization is tiny. We, of course, are at the top of that list, and there are lots of opportunities in that space,” he added.
He noted that since having established its U.S. presence, the company has already started to leverage this capability. For instance, the Solvay chemical and pharmaceutical group has expanded its relationship with NorthgateArinso, which already provided HR services to the Belgian company throughout Europe. Just recently, NorthgateArinso also began servicing Solvay’s U.S. employees, who number a few thousand. “A lot of growth we’re getting is taking client work overseas,” Stone noted.
Indeed, the mid-market segment in the U.S. and overseas has long been regarded by analysts and providers as underserved. This is because until recently, large global providers have focused their efforts on enterprise engagements. Fewer vendors were attracted to the mid-market because of limited revenue potential, cost of entry, and what seemed to be a lack of interest on the part of buyers with 3,000 to 15,000 employees.
However, market trends have shifted during the past 18 months, and mid-market buyers are showing more signs of interest these days. Stone said he wants to reach not only companies that need global support, but also those looking to outsource highly transactional services. After all, the company’s SAP-based offering is aimed at providing customers with a foundation on which they can build out HR services. Stone said he is mindful of NorthgateArinso’s strengths and weaknesses and will look to pursue clients with specific needs.
“We have quite a clear focus on what bits of the market we want to be in. We see ourselves as starting with the implementation and management of the HRIS platform, and that platform will support all HR activities,” he said. “At that level, we are talking about managing the work. We’re not talking about getting aggressively into these high-touch, value-added processes. What we want to do is the repeatable core admin processes.”
That may be a clever strategy, considering a number of HRO deals have faced difficulties because many high-touch services were included in scope, only to have them later moved out of scope. But at the same time, value-added services help providers to generate higher margins, so it seems clear that Stone is cognizant of the risks of being stretched too thin.
He is also absolutely clear about not building benefits administration capabilities for NorthgateArinso. Stone conceded that as a European-based company, the outsourced benefits market simply doesn’t exist in the EU (retirement and healthcare are strictly government functions), and for the company to start from scratch in benefits may distract it from its core focus. He said the company would look to forge partnerships with best-of-breed providers to service clients that also need benefits administration services.
Most importantly, as CEO of a privately held company, Stone will be able to focus on long-term growth and not just next quarter’s results, a consideration that he said will allow him to home in on strategic growth. Fisher added that this would also improve KKR’s investment when it comes time to exit (the private equity said on average it holds on to companies for seven years).
“We now have an ability with a private company and knowledgeable shareholders to drive this long-term perspective over the next five to seven years as opposed to the next quarter,” Fisher said. “It means you can make some smaller and medium acquisitions, and it means making decisions that might not show up for three to four years. We have quite a bit of capital to help this company with.”
With strong financial backing, an established global footprint, and the CEO’s laser focus, NorthgateArinso seems well positioned to make a strong splash in markets here and abroad. That means its success will all hinge on execution, and if all goes well for the company and KKR, Fisher may be the one greeting the big check holder in a few years.