Northgate’s CEO is sure that global customers want all their outsourced HR services within arm’s reach anywhere in the world. He’s so certain that he has a €378 million bet riding on it.
Consolidation rumors have spread wildly throughout the HRO industry for several years now, but the number of actual mergers and acquisitions has been modest at best. That is until this year, when several large acquisitions have exploded onto the scene, including one expected to have a major impact on the European HRO community.
Most EU buyers of payroll services are probably familiar with Northgate Information Solutions, one of the largest providers in this sector. This summer, the company grew even bigger with a €378 million buyout of Brussels-based ARINSO, whose global presence includes Europe, North America, and Asia. The biggest buyout ever for Northgate—a software vendor that has grown quickly through acquisition—the ARINSO deal expands the company’s reach into every key HRO market—40 around the world.
The deal preceded an announcement by an investment group to acquire Ceridian, another big European payroll services provider, for $5.3 billion, a move that some speculate is the beginning of a roll-up that has been predicted for a few years now. With a number of other providers rumored to be targeted for sale, including U.S.-based Hewitt, is this indeed the beginning of the consolidation wave? And will buyers see a further decline in the number of choices they have in the marketplace? Also, what will be the benefits that employers may experience as a result of the rationalization?
To get the answers, HRO Today posed these and other questions to one of the pivotal players in the midst of the consolidation—Northgate CEO Chris Stone. At 44, Stone is one of the youngest CEOs among the global service providers, and he has been at the helm since 1999. But don’t let his relative youth fool you—during his tenure at Northgate, he has overseen rapid expansion and more than a dozen acquisitions, driving the company to a market capitalization of more than £460 million. Moreover, the company has transitioned itself from a technology-only company to provide HRO as a key portion of its business. And with the ARINSO buyout, it has established itself as one of the top HRO providers in the world.
But the HRO business is not for the faint of heart. So why would any company want to invest heavily to further its profile—and risk—to the tune of €378 million? For Stone, the answer was clear.
“Over the last six or seven years, Northgate has built market-leading positions in HR software and then HR BPO (business process outsourcing) predominantly in payroll, benefits administration, pension administration, and the whole range of administrative processing services. We make good margins, around 27 to 28 percent, with revenues of around £150 million, and we’re making about £38 million profit on that, which is great,” said Stone. “The problem is once you are a market leader, your growth rate comes down a bit, particularly since our software market is not growing as quickly. We have been thinking for two to three years now on our strategy.”
A former executive with outsourcing giants EDS and Accenture, Stone said Northgate’s HRO business had been growing at around seven to 10 percent a year—a respectable though hardly spectacular rate. Although the company in recent years set out to establish partnership agreements overseas in markets such as Australia and Hong Kong, Stone still viewed the U.S. as a critical foundation to Northgate’s growth strategy.
“We’ve always had one eye out for that opportunity,” he added. “We thought we could do a better job growing in some new markets.”
Tackling New Markets
Veterans of the HRO industry know that entering a new country is no small task, and doing so in a huge territory such as the U.S. requires adopting one of two approaches: spend tremendous time and energy, recruit pricey proven market leaders, and invest huge resources in building the infrastructure; or get out the checkbook. For Northgate, whose acquisition-focused approach has proven successful in the past, ARINSO was a logical target when its CEO Jos Sluys indicated the company was available.
“A lot of people were interested in the business, and the fact that you could get it was interesting,” Stone added. “What we saw in ARINSO was an opportunity to accelerate a strategy we had already set out and discussed with my board for the last couple of years. So when the opportunity came up, they were a little surprised by the scale of what I wanted to do.”
Indeed, the purchase was the largest ever for the company, and as of press time, Northgate was still acquiring outstanding shares in the market, after having secured the majority, controlling interest from Sluys. Stone said when he first considered the deal, he had to win both the support of Northgate’s board, as well as the bankers because of its size.
In reaching an agreement with Sluys, Northgate agreed to pay the CEO €18.75 and five shares of Northgate stock for each ARINSO share—around a 24-percent premium over its trading price on May 1, the day before the acquisition was announced. To Stone, the premium seemed like a good deal, given ARINSO’s 24-country, five-continent presence and a strong outlook.
“We paid a lower premium than the guys who paid for Ceridian, and we have better potential,” he contended, noting that ARINSO’s EBITA growth rate during the past six years was 16 percent. More recently, in the past year, that rose to 20 percent. “On a historic level, it looks like a lot of money, but given the past recent growth, it’s quite reasonable. We think we got a bargain compared with the sale of Ceridian.”
Stone said he is less focused on the premium than what ARINSO can do for Northgate. Because it had a physical presence in only a few more than a dozen countries, Northgate was limited in its reach and deal pursuits. While enterprise providers such as Convergys, Accenture, and IBM can serve clients anywhere around the world, Northgate needed the infrastructure to compete, and ARINSO offered this capability.
Aside from a global scale, Stone also said ARINSO demonstrated a talent for growing its customer base—a talent he acknowledged Northgate sometimes lacked. “ARINSO has always been really good on customer acquisition and retention, but we’ve not done that in the most efficient way. What we’re trying to do is bring a greater scale of efficiency to that,”he added.
According to Stone, ARINSO has a client base of around 1,000, with 350 to 400 active at any one time. Northgate has more than 2,500 software clients, 420 small and mid-sized HR BPO customers, and about 7,500 payroll buyers—some of whom have already expressed an interest in expanding their relationship with the company following the acquisition, he said.
He said that despite what appears to be a slowdown in enterprise HRO engagements in the U.S., there are many opportunities for the company to capture a greater share of the market. While Europe will account for the biggest portion of Northgate’s overall business for the foreseeable future, he sees potential for the mid-market and small enterprises.
“We are very pleased with the pipeline of opportunities in the U.S. I think we have fantastic opportunities in the 3,000- to 20,000-employee range,” he added.
Maybe so, but Northgate faces tough competition. Even though it is the payroll leader in the U.K., the No. 1 payroll provider in the world is U.S.-based ADP, which serves buyers of all sizes. In addition, other payroll providers such as Ceridian—as well as enterprise HRO providers such as Accenture, ExcellerateHRO, IBM, and others—will all be big competitors for Northgate. Stone, however, sees ADP as his biggest challenger, especially for international clients.
Even though Stone praises ADP as a world-class organization with which Northgate will most often compete, he said he is not concerned because the market still has ample room for growth. Besides, he added, opportunities today aren’t mired by competition in the market; instead, it’s the industry’s inability to convince buyers of the benefits from outsourcing that is the bigger bottleneck.
“The challenge is not whether we are doing what we say we are going to do. We are. The source of dissatisfaction comes from a perceived lack of innovation and the extra value—the X factor—that clients expect from a relationship. That’s something we have to get much better at. We have to deliver value to clients that they would otherwise struggle to deliver on their own,” he said.
That added value, Stone noted, includes innovations in service delivery, greater leveraging of scale, and even technology. Of particular importance is the ability to meet clients’ needs around the world, especially as they try to figure out their own global strategy and the best mix of domestic and international operations.
“This whole thing about onshore, near-shore, and offshore strategy—you better make sure you have one and be bloody sure that it works,” Stone added.
Also, as buyers grow their international presence, HRO service providers need to keep up, not only by providing local services but also by supplying compliance support from one jurisdiction to another. In fact, Stone added, there is great interest among buyers these days to make sure their payroll processes comply with critical regulations such as Sarbanes-Oxley and SAS 70.
And that’s why buyers outsource—or at least that’s one of the reasons: to gain the regulatory expertise, best-practice knowledge, and feet-on-the-ground presence. It’s also the reason why executives such as Stone are willing to pay hundreds of millions of euros to gain that knowledge and local expertise.
“I think we’re going to see a lot of players trying to position themselves with the scale and global reach and the competencies they need to offer differentiated, good-quality service to the client,” he added. “It is still a relatively young and lowly penetrated market. HR BPO in the U.K. is absolutely in its infancy.”