TriNet Enjoys Resilient Customer Retention Despite Employment Headwinds 

Equity Analyst

Emma Williams

We view TriNet as well placed to take share of the expansive, fragmented small and midsize business payroll and human capital management market, through industry consolidation and rising demand for comprehensive, outsourced solutions. Regional providers or do-it-yourself solutions such as Intuit’s QuickBooks or Microsoft Excel service most of the small-business market, creating meaningful scope for greater penetration by value-added providers like TriNet. 

We expect TriNet and fellow HCM providers to benefit from attractive industry tailwinds, including rising regulatory complexity, increasingly dispersed workforces, and fierce competition for talent. In the context of these industry tailwinds, the high-touch professional employer organization service model is increasingly attractive to SMBs looking to share employment risk liability via a co-employment model and leverage the PEO provider’s scale and expertise to access HR compliance support and competitive employee benefits. 

Relative to industry peers, TriNet is selective about the risk profile of co-employment clients given the firm operates an at-risk insurance model, and targets six core industry verticals deemed to have attractive employment growth and benefit attachment potential. Together, this strategy yields higher-value clients with lower insurance risk profiles at the expense of worksite employee growth relative to peers. Over the coming decade, we expect low-single-digit worksite employee growth, steady insurance attachment, and like-for-like price increases to drive mid-single-digit top-line growth. 

While TriNet is a PEO provider, the firm has diversified its offering via acquisition of self-service HCM software provider Zenefits and R&D tax credit solution Clarus R+D. The acquisitions expand TriNet’s addressable market and cater to clients that outgrow the PEO model, and as a pipeline for future PEO clients, minimizing client attrition and customer-acquisition costs. We view TriNet’s product expansion as strategically sound and complementary to existing offerings; however, we expect elevated investment to expand and market these acquired businesses to weigh on profitability over the medium term.

Business Strategy & Outlook

TriNet has garnered a narrow economic moat underpinned by high customer switching costs stemming from the mission-critical nature of the human resources function, and the deeply embedded and tailored PEO model. Despite competition from dominant HCM providers ADP and Paychex, Insperity, midsize providers and a slew of regional PEO providers, TriNet has achieved steady operating margin expansion while modestly expanding its base of worksite employees. The firm operates an asset light business model and generates impressive returns on invested capital. While we expect operating profitability to come under pressure over the coming decade as the firm invests in expanding, integrating, and marketing recently acquired businesses, we are comfortable TriNet can maintain economic profits for at least the next decade. 

TriNet derives most revenue from PEO solutions which are tailored to six target verticals: financial services, life sciences, Main Street, non-profit, professional services, and technology. This strategic industry vertical focus diverges from the overall U.S. PEO industry, where according to the National Association of Professional Employer Organizations, almost half of all PEO clients are in the professional, scientific, and technical services, manufacturing, and construction industries. 

The PEO model is a legal construct that allows an employer to share employment risk liability with the PEO provider via a co-employment arrangement and deploy a variable HR cost structure. A client can leverage the PEO provider’s scale to access competitive employee benefits typically inaccessible to individual SMBs, utilize the PEO provider’s expertise on complex and evolving HR and compliance matters, and access tailored HR consulting services. The PEO provider acts as the employer of record for administrative and regulatory purposes for the clients’ employees, known as worksite employees. Typically, a SMB will engage a PEO service provider when they become too large to handle human resource functions in house, but not large enough to justify hiring an in-house HR department. 

As with payroll and HCM peers, we believe TriNet benefits from high customer switching costs among its existing base, which is amplified by the high touch, deeply entrenched PEO model. Payroll and HCM solutions are mission critical and are typically deeply embedded in a business’ operations, making it a costly and time intensive process to switch providers. In our view, these switching costs are amplified for clients engaged in a co-employment model as services such as access and administration of employee benefits, and critical day to day HR functions such compliance and risk management, collecting and remitting payroll taxes and time intensive administrative tasks are outsourced or reliant on the PEO provider. In practice, a client looking to switch away from TriNet’s PEO offering would need to secure comparable and cost-effective employee benefits without the advantage of the PEO’s scale and would forgo the benefit of shared employment risk liability under the co-employment arrangement. Further, a client would likely need to bring HR and compliance functions in house and set up alternative processes for payroll and HR administration which elevates the risk of losing data, payroll errors and failures, compliance issues and employee dissatisfaction. TriNet does not disclose retention figures, but we view competitor ADP’s reported PEO client retention of about 85% which surpasses SMB software providers including Xero and Intuit at around 80%, as indicative of the stickiness of this model. Notably, while these retention figures lag enterprise software peers, we estimate about half of client attrition is due to small business’ collapsing or due to business combinations, rather than clients actively switching providers. 

We estimate TriNet is the third-largest PEO provider in the United States, following market leaders wide-moat ADP and wide-moat Paychex. As of 2023, TriNet services about 350,000 worksite employees, which represents an estimated 9% share of the United States’ PEO market. This compares with ADP and Paychex, which have an estimated market share of 17% and 15%, respectively, and Insperity with an estimated 8% market share, followed by midsize providers and a slew of regional providers. 

Nonetheless, amid rising regulatory complexity, greater adoption of hybrid work and persistently tight labor markets, we believe TriNet, and fellow value-added, outsourced HCM solutions are well placed to capture demand from the underpenetrated small business market. At present, we estimate most SMBs rely on either regional HCM providers or rudimentary do-it-yourself software-only solutions such as Intuit’s QuickBooks or Microsoft Excel, which lack the product functionality increasingly required by SMB customers such as talent management, access to competitive employee benefits, and regulatory compliance support. Assuming a PEO addressable market comprising SMB employers with 10-99 employees in the United States, we estimate the PEO model has about 12% penetration as of 2023. While we expect only a subset of SMB customers will require the high-touch full-service PEO offering, we expect these attractive industry tailwinds to support a modest uplift in PEO penetration and greater product attachment over the coming decade benefiting leading providers.

Narrow

Economic Moat

TriNet Group

TriNet Group, Inc. provides human resources solutions including industry solutions to small and mid sized businesses. Its services include payroll processing tax administration, employee benefits and a human resource technology platform with online and mobile tools and also employee onboarding and termination, compensation reporting, expense management, and benefits enrollment and administration. The company was founded by Martin Babinec in 1988 and is headquartered in Dublin, CA.

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TriNet reports strong Q2 earnings, faces challenges in professional services

TriNet's Q2 2023 earnings call showcased strong financial results, a commitment to enhancing shareholder value, and a focus on organic growth. While facing challenges in professional service revenues and forecasted Q3 revenues, the company remains optimistic about opportunities for growth and increased adjusted net income per diluted share guidance.

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TriNet Group, Inc. engages in the provision of comprehensive human resources solutions for small and medium-size businesses. The firm also offers access to human capital expertise, benefits, risk mitigation, compliance, payroll, and research and development tax credit services. The company was founded by Martin Babinec in 1988 and is headquartered in Dublin, CA.

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