Barrett Business Services, Inc. (BBSI): A Tick-Tick-Ticking Time Bomb by Copperfield Research, Seeking Alpha
Today we shared our research and opinion on Barrett Business Services, Inc. (NASDAQ:BBSI). Highlights of our opinion/report are below, with our full opinion found here: www.scribd.com/doc/239934271/Barrett-Bus…
IMPORTANT – Please read this Disclaimer in its entirety before continuing to read our research opinion. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. We strive to present information accurately and cite the sources and analysis that help form our opinion. As of the date this opinion is posted, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not provide any advanced warning of future reports to others. Following publication of this report, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. However, such information is presented “as is,” without warranty of any kind – whether express or implied. The author of this report makes no representations, express or implied, as to the timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.
We believe Barrett Business Services, Inc. (NASDAQ:BBSI) operates with a precarious business model and substantial reserve deficiencies, which has created immense blow-up risk for public market investors. The combination of aggressive growth into the pernicious California workers’ compensation market and minimal transparency regarding a recently disclosed reserve study has created an un-investable stock. Our work suggests Barrett Business Services has systematically under reserved, which has resulted in materially overstated earnings and a high probability of a massive reserve charge. With only three covering sell-side analysts (none of whom appear to have any insurance domain expertise based on a collective coverage universe that includes movie theatres, executive staffing, water dispensers, and ecommerce solutions), the combustible issues at Barrett Business Services have largely escaped investor scrutiny. That should change with our report, which includes a compendium of forensic issues, as well as background on Barrett Business Services’s model and end markets.
Based on our analysis of 2013 incremental adverse development (applied to 2012 claims expense), we believe Barrett Business Services may have overstated earnings by 57%. Depending on the degree to which Barrett Business Services, Inc. (NASDAQ:BBSI)’s reserves may be inadequate, there are scenarios discussed herein which would completely wipe out BBSI’s previously reported profits. In addition to arguing our belief that Barrett Business Services has overstated past earnings, we outline why BBSI appears to be in blatant violation of U.S. GAAP accounting. Our accounting concerns are amplified by a 2014 lawsuit brought by a long tenured branch manager accusing BBSI C-Suite executives of “effectively cooking the books to create inflated profit margins to entice interest in Barrett Business Services stock in violation of SEC regulations.”[i] Unsurprisingly, we have been unable to find any disclosures in BBSI’s public filings about the existence of the lawsuit and associated incendiary charges. Barrett Business Services’s auditor is tiny Moss Adams, who does not even list insurance as an area of expertise on its website.
It is well understood that insurance companies can hide long-term economic liabilities for extended periods of time. However, a recently announced reserve study should act as the catalyst to publicly expose the magnitude of Barrett Business Services, Inc. (NASDAQ:BBSI)’s reserve hole. The dramatic shift in IBNR and case reserves are additional red flags, with the latter inexplicably increasing from $51 million to nearly $93 million in BBSI’s most recent quarter. Based on our analysis, if BBSI simply matched the reserve coverage of other PEOs and insurance companies, a charge between $69 million to $280 million would be required. For perspective, BBSI’s shareholder equity at 6/30/14 was just $74 million. A reserve charge representing just a fraction of our estimate would likely eliminate years of pretax earnings, while creating uncertainty over BBSI’s profitability and ongoing business model.
Adding even more asymmetry to Barrett Business Services’s stock is the new fronting agreement with ACE Limited (NYSE:ACE). Should the reserve study (or other issues discussed herein) cause ACE to non-renew its fronting agreement, Barrett Business Services’s corporate profile could be impaired with no replacement to renew its California business.
Under a rosy scenario analysis that assumes Barrett Business Services, Inc. (NASDAQ:BBSI) is somehow able to delay reserve charges, we still believe the stock will revalue significantly lower to account for balance sheet risk and incremental earnings pressure from regulatory changes occurring on January 1, 2015. Generously assuming benign outcomes for many of the issues identified in this report, we still believe fair value for Barrett Business Services’s stock is $29.00 per share, which is 50% below its recent price. The $29.00 per share scenario assumes the company is NOT required to take significant reserve charges to address its thin reserve position, has no negative changes in its ACE Limited (NYSE:ACE) fronting agreement, and no restatement of past results for inappropriate reserving practices occur. On the other hand, if we are correct about the considerable hole in Barrett Business Services’s reserve, we believe there are a plethora of long-tail scenarios that could cause the stock price to go much, much lower. We encourage all shareholders (and sell-side promoters) without insurance expertise to consult an insurance expert to independently verify our analysis and conclusions.
Our report contains several sections focused on relevant background information on Barrett Business Services, Inc. (NASDAQ:BBSI), workers’ comp, as well as the California PEO dynamics. Other sections are specific to the problems we have identified at Barrett Business Services, including detailed analysis examining Barrett Business Services’s reserving practices and business/financial models. For those with time constraints, we would encourage you to jump directly to sections 4, 6, 7, and 8, which provide the most specific analysis and discussion into the significant risks and “meat” of our Barrett Business Services opinion. If you can only read one section in its entirety, please see section 6 (“Severely Inadequate Reserves May Require a Significant Charge”). Sections 1-3 provide relevant, yet admittedly boring background. The following segments are covered in this report:
1) Investors Should View BBSI as an Insurance Company – Barrett Business Services is a PEO with a small staffing business. The PEO represents approximately 95% of gross revenues. BBSI competes in the challenging market of providing workers’ compensation insurance for blue collar employers. Further, most of its exposure growth has come in California, which now represents roughly 74% of net revenues. Over the past three