First Advantage Corporation

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

A leading global provider of employment background screening and verification solutions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

First Advantage (FA) is a leading global provider of employment background screening and verification solutions, offering a range of services to businesses of all sizes to help with identity verification, employment and education history checks, and various other security and compliance related checks.

Business Overview

  • Revenues: FA operates in one core segment. The company generates its revenue primarily through providing pre-employment screening services.

  • Geographically, the company operates primarily in the United States, with some operations outside of the U.S. that are primarily in Latin America, Asia and Europe.

  • Customer base: First Advantage clients span a diverse range of industries, from large corporations to smaller organizations. It is worth noting that their client list is not dominated by any one particular sector, giving them some diversification in this aspect.

  • Industry Trends: The industry in which FA operates is undergoing changes due to new regulatory requirements and the rise of remote/hybrid work, especially after the COVID-19 pandemic. There has been increased demand for accurate and reliable background verification. The shift towards AI and automation in many industries, and thus greater use of technology in services that the company offers, also plays a role.

    • The increase in identity theft and deepfakes, could cause increase in the demand for the kinds of services provided by the company. However, the company needs to keep pace with the new and changing methods used for identity theft.
    • New regulation that is continually introduced, could significantly increase the demand for compliance and verification services, but at the same time also provide additional regulatory burden on operations.
    • The rise in remote/hybrid work is also a big factor. With new workforce trends and a more distributed workforce in different regions of the world, companies now more than ever have to employ background screening solutions to comply with regulations.

  • Competitive Landscape: In the background screening industry, a good portion of smaller companies and large fragmented market, even with some big players like Sterling, HireRight and Checkr. This means there is a medium level of competition in the industry. A good part of the business is obtained through contracts from large corporations, and smaller companies can not bid for them because of a lack of capacity, brand and reputation. This serves as a barrier to entry for the smaller players, giving more leverage to the bigger players.

    • The need for scale is an important factor, giving more advantage to the larger players and creating an entry barrier for smaller companies that do not have the needed resources.

  • What Makes FA Different: First Advantage tries to differentiate themselves in 3 main categories, technology, customer service and expertise. Although, many competitors seem to have similar aims in these areas. As of late, the company is pushing on international reach and global capabilities. They are also emphasizing their partnerships with clients and aiming to offer end-to-end HR services to them. This seems to be a key differentiator for the company. The company claims to have an ‘innovative’ business model which helps provide a seamless process.

  • Financials: The financials of the company show a steady growth in revenues year-over-year. The operating and net profit margins are quite small (around 5%) and that could be an issue of concern. In the latest report and financial results, the company’s operating results and net profit seem to be negatively affected by higher operational and interest expenses. The company’s free cash flow has also been quite volatile. The most striking point is the high amount of debt on the balance sheet that the company needs to improve to improve the performance of the stock, as well as the margins. The main goal for them should be to pay down their massive debt, which is a key risk for the company.

  • The company claims that the main source of their revenue is the screening of individuals for employment purposes, and this involves collection of information about various factors of the individuals, like criminal records and employment and education history. The company then sells this information to employers, so that they can make better decisions.

    • They are aiming for a higher market share, and in doing so, are entering into the mid-market and small business market segment. The company is also investing in AI technologies. This is good because these factors will help the company grow its revenue in the future.

  • Recent Controversies/Problems: The main issue with First Advantage has been its ability to grow and generate profit. The company has had a tough time improving its EBITDA margins, as a higher part of revenues has been attributed to expenses, and this is evident from the recent reports and financial calls. Also, the company faces strong competitive pressure that might impact growth in the coming years. The high amount of debt continues to be a hurdle, since it needs to prioritize debt payment rather than investing back into the business.

Moat Assessment: 2 / 5

  • Economic Moats: FA’s competitive advantage is weak, and this is highlighted by a moat rating of 2/5.

    • Switching Costs: There are minimal switching costs for companies changing their background screening solutions provider, so companies are ready to switch to a cheaper or more efficient alternative. The benefit of switching is also very easily understood for customers of such services.

  • Intangible assets: Although FA has been trying to create some brand and goodwill by working for big companies and institutions, the company still doesn’t seem to have substantial brand recognition to establish a moat. * Network effect: There are no signs of a network effect, and therefore the company doesn’t have an entry barrier in this respect. * Cost advantage: The company also doesn’t have any structural cost advantage. The barriers to entry in this industry are quite low, due to which smaller companies can easily compete with bigger companies. However, the bigger companies do enjoy some scale advantage, mainly due to being able to get large contracts with huge corporations. * Economic moats: Although they exist, FA’s economic moats are quite weak and they will continue to be under considerable pressure. The company also does not have any regulatory moat.

  • Moat Rating: 2/5. The company lacks major moats, and it could face difficulty in maintaining its margins and market share in the future. FA’s main competitive advantages are its size and experience within the market.

Risks & Business Resilience

  • Risks to Moat:
    • Intense competition: The background screening industry has many competitors which limits pricing power and can lead to market share losses.
    • Technological Disruption: New innovative solutions and AI-driven services can make the company and its systems outdated, if they are not adopted with agility.
    • Cyber security: Data breaches and hacks can cause loss of credibility for the company.
    • Changes in regulation: New laws and regulations can negatively affect the company’s profitability. This risk can be mostly mitigated by constantly adapting to new regulations.
    • Low switching costs: Due to little or no switching costs for companies to change from existing solutions to newer more innovative ones, the company risks losing existing clients

  • Business Resilience:

    • As a part of risk management, the company has a diversified customer base, which provides some resilience. Also, a growing market and increasing demand of background check services will help protect against huge losses and revenue drops.
    • The company also has a good amount of revenue from recurring clients, which can provide consistent revenues. The company is also focusing on technology investments that can help improve its services, and make it more efficient.

Understandability: 2/5

  • Business Complexity: The company has a straightforward business model. They sell background verification services.
  • Industry Complexity: But, given the constant changes happening in the HR and technology sector, the company has to adapt and make constant changes to its business. The different type of risks also adds to the complexity. This make it difficult to understand if the company is on the right track. Also, the constant need for changes in operations and management practices to remain in compliance with regulations, is also difficult to keep up with.

Balance Sheet Health: 4 / 5

  • Balance Sheet Strength: The company does show relatively good overall health, and this is driven by increasing revenue and a positive current ratio. But, the company has a very high amount of debt, which could severely limit it in any economic downturns. The amount of goodwill is also significant, but has not changed substantially. So, while the company is performing well, it could make big changes to improve its performance more.

    • The company has a decent current ratio for the most recent filings, indicating it has current assets to cover its current liabilities. The total debt is around 1.6 billion dollars while its current assets are slightly less than $400 million.

    • The debt equity ratio is at 1.6.

    *The company’s financial statements, while slightly complicated, have been improved in recent quarterly reports and filings, offering transparency to the investors.