I am becoming increasingly worried about the pressures that the...

I am becoming increasingly worried about the pressures that the regulatory environment will have on APM’s earnings, particularly as it relates to the changing disability / unemployment services framework in Australia.

My key concerns relate to:

- The cessation of the Aus Govt’s Disability Employment Services program (in June 2025), which was originally due to cease in June 2023, as is a material part of APM’s business

- The transition from Jobactive to Workforce Australia, which means the more disabled / unemployable individuals are the ones accessing APM’s employment services, and only once they have been referred to APM via the relevant government department

- The Government ‘offboarding’ regular jobseekers from the likes of APM, trying to reduce the cost of service providers after some very expensive years in 2020-2023, by getting jobseekers to go online to their Workforce Australia online portal rather than using service providers, which directly impacts APM’s revenue and pool of potential customers

- Margins being compressed because their remaining customer pool are far higher-involvement from APM in order to get them into employment, given it is less employable people – the more employable individuals are getting pushed online to find their own jobs

- Debt burden is increasing, which is crimping cashflow and potential investment / dividend potential

- Margins overseas are structurally low – interest service is all in Australia, and combined with the regulatory headwinds, makes for a tricky outlook

This note focuses on the Australian business, which is the most material component of APM’s performance and in FY23 made up 43% of APM’s revenue and 48% of underlying NPAT(A).

The foreign business are recently-acquired, predominantly funded by debt, and materially lower-margin than the Australian business, so I won’t address them here.

APM’s Australian model overview

APM makes its Australian revenue from two key Government programs – Disability Employment Services (DES) and Workforce Australia – a new program which replaced Jobactive.

The Australian Government recently introduced Workforce Australia (hereafter WFA) – it came into effect on 1 July 2022, meaning APM’s most recent accounts reflect the first full-year impact of Workforce Australia.

WFA was brought in to replace JobActive, which was the previous unemployment services program. This is the program by which people who are on unemployment welfare payments (such as JobSeeker) receive those payments. It effectively requires an unemployed individual to demonstrating that they are taking the necessary steps to get back into the workforce.

Much of that work, under JobActive, was facilitated by services providers such as APM, which included providing education services, interview training and coaching, and facilitating employment opportunities for Australia’s unemployed. They would then charge the Australian Government a fee for the services they provided, and a large commission payment when that individual became employed.

APM did extremely well from Jobactive, including from the provision of training services – whereby APM could develop a training program, find an unemployed individual, and ‘sell’ them that training course, which would be paid for by the Government. It was particularly fruitful for APM in 2020-2022, when a lot of COVID stimulus measures were flowing and there was disruption to employment markets, meaning demand for APM’s services where high.

JobActive / DES Review and transition to Workforce Australia

DES review: In late-2020, the Morrison Govt commissionedBoston Consulting Group to undertake a review of the Disability EmploymentServices (DES) due to a blowout in total cost and number of participants – seebelow extract:

• “Since these [2018] reforms were introduced, the number of participantsin the program has grown significantly. Service provider caseloads have risenby 46 per cent in under two years, yet the number of employment outcomesachieved for participants has risen by only 8 per cent. Government expenditureon the program has increased over the same period by approximately 48 per cent,to a forecast $1.25 billion in 2019-20. With no changes to program design,expenditure is projected to reach $1.6 billion by 2022-23, taking into accountthe COVID-19-induced economic recession (Chapter 2).

"In light of these results, the Department brought forward the scheduled Mid-term Review of the DES program to assess its efficacy and efficiency, and to evaluate the impact of the 2018 reforms. The Review aims to identify opportunities to improve employment outcomes for program participants, and maintain financial sustainability.”

The key findings of the BCG review, pertinent to APM, include:

- “misaligned provider incentive structures(e.g. over-emphasis on education outcomes)"
"Poor alignment with adjacent programs.Inconsistencies in incentive structures of DES and the aligned jobactiveprogram have contributed to the growth in DES program participant numbers. Poorintegration with the NDIS also causes confusion for participants and employers”

- “Growth in cost-per-outcome. The average spendfor each 26-week employment outcome achieved has risen to almost $40,000 inrecent quarters, from an average of $28,000 pre-reforms”

“It is proposed that a broad-ranging redesign of DES be undertaken prior to the expiry of the current Grant Agreement on 30 June 2023, allowing implementation of a new DES model to comprehensively address current pain points”

The result of the above was that DES was intended to be completely shut down and overhauled by June 2023 – and the Government had started to give DES participants the opportunity to roll over on to ‘mainstream digital employment services instead of DES’ – eg WFA – but more on that below (WFA section).

The shutdown of DES was cancelled in October 2022, when it was announced that DES would be extended for two years through to June 2025 – however this means that APM effectively have another 18 months of DES, before a new system is brought in. Based on the BCG review, I suspect that there could be a world where DES is later merged with WFA, particularly given the wording around on the DES website (see below) around disabled jobseekers using WFA Online too, eligible immediately.

WFA replacement of jobactive: This is a key one for APM, as I thinkit materially impacts margins and growth.

On 1 July 2022, WFA formally replaced jobactive, as a way of theGovernment cutting the amount of people using Service Providers like APM, toreduce the cost of the program. The key difference between the old jobactiveand the new WFA is that it shifts the responsibility for getting a job to theunemployed individual via an online portal for jobseekers, rather than thoseindividuals being able to approach the services provider (such as APM) to dothe hard work for them.

In effect they are cutting out the middleman (APM):

- The Government created a portal, WorkforceAustralia, whereby people can log on and view the available job opportunities,to which they have to accrue ‘points’ via job applications, interviews etc inorder to be eligible for their welfare payments

- In the Government’s words, this change‘empowers jobseekers who are ableto manage their own search for employment to have greater control over theservices they access’ – in other words, you aren’t able to use a servicesprovider like APM unless you are approved by the Government to do so

- This has materially reduced the amount ofjobseekers using the services of services providers such as APM – in effect,only disabled jobseekers are able to use a Service Provider, everyone else hasto go online. See the text below from the Department of Social Services‘Disability Employment Services’ page

“Job seekers with disability who choose digital services willremain eligible for DES and can request a referral to a DES Provider atany time while receiving digital services. Job seekers who have not started ajob within 12 months will be referred to a DES Provider.”

Financial impact

I haven’t been able to find a split of the amount of revenue received by APM between jobactive / WFA and DES, however their disclosed WFA contract is A$335m (per the Australian Government Tenders website) – which compares to their FY23 revenue in Australia of A$817m – suggesting there is a material amount to be made up by DES to maintain earning at the FY23 level. It is interesting because their other contract, announced at the same time as the WFA implementation, was A$67m for Employability Skills Training for the period 2022-27 – if the A$335m is for the same period it would equate to ~A$65m a year, a material step-down from FY23.

It was also noted in the FY23 annual report that APM won ‘13% of all Workforce Australia contracts’ – which, if you consider that WFA only makes available A$1bn per annum on a go-forward basis, would equate to A$130m if you conservatively assume that each contract is roughly the same value. Now this could be wrong, but it is still materially lower than the A$817m they got in FY23.

See below a forecast, provided by the Australian Treasury department, of total expenditure on employment services – you can see a noticeable drop-off from 2022 to 2023, driven by a) the push to getting customers onto WFA Online (eg not going through a Service Provider like APM):

Important to note in the above table, it is only the WFA Services provider available to APM, whereas previously the whole amount was available – so you can see a drop-off from A$1.3bn to A$800m in 2023, being a 40% drop in available revenue.

In all, I think there will be a material impact on profit margins. In APM’s own words, on the initiation of WFA:

- On 22 February 2023, when they announced the first half-year of WFA, for the Australia / NZ bUsiness: “Revenue was up 22% to $389.4 million, while underlying NPATA was down 21% to $43.8 million as the Company mobilised the new Workforce Australia contract that scaled during the half.”

- I think this drop in margin is because APM are having to fight harder for their revenue, because:

• The whole purpose for the cessation of DES and switch to WFA is to lessen the cost of these services to the Government
• A huge amount of people have been taken out of APM’s addressable client market because they are being pushed to online WFA portal to get their own jobs / training
• Those people who still want to use APM need to be approved, then referred to APM or another services provider by the Govt – APM and the individual can’t just find eachother unilaterally
• Those people who are being referred to APM are more severely disabled (or unemployable, for whatever reason, and thus APM need to work materially harder to get them into gainful employment than an ‘able-bodied’ individual, who is now online

This means more physio / speech therapy / OT, more interview training, more time and effort, which obvious is at APM’s cost and thus crimps margins

The barriers to selling APM’s higher-margin training services are much higher now – as noted in the BCG report, there was a ‘misalignment of incentives’ previously whereby service providers such as APM could sell education services and make a good margin, rather than trying to get the people into employment straight away (whereby the income is less, as the person has a job, and doesn't require APM's ancillary services like training and education)

I am not going to go into the argument that many detractors of the employment services sector go into, around ‘churning’ – the practice of getting people new jobs once a Service Provider has clipped their fee, thus making money off the same people over and over – because I don't think it is nearly as prevalent as some people try to represent - but it wouldn’t surprise me if the new WFA program is going some way to restrict that practice too.

Further, in the FY23 results, APM had the below disclosure re Australian NPAT margins and WFA:

You can see that pre-interest, NPAT was flat at A$120m vs a A$130m increase in revenue (driven by ‘Health and Wellbeing’ eg not employment services) – this corresponds to a fall in margins from 17.6% to 14.7%.

There was not a lot of discussion or disclosure on this in the FY23 results – it was noted that margins were tight due to lower ‘flow’, which means less people seeking APM’s services, and due to tightness in the market for Allied Health professionals (physios, OTs, speech) which APM uses for their training programs for disabled people to get jobs. The bullets on WFA and margins said:

- “Mobilised Workforce Australia contractduring the period with lower client flow across employment services offset by performance”

“Margin lower due to the continued investment in Allied Health and NDIS businesses and initial year of Workforce Australia”

It's also important to note that most of APM’s competitors in the space are not-for-profit. Without getting into the moral issues with APM being a for-profit provider, ASX-listed so all the world (including the Govt) can see how much profit APM are making, it also results in a bit of pressure as to how contracts are being awarded – as evidenced by the below, where Australian Government Minister for Employment requested an Audit into the process for awarding contracts to Employment Services providers:

Growth driven by Govt COVID welfare and unsustainable: In light of the above, I think the last two years’ financials have been significantly inflated by the expanded budgets allocated by the Government to welfare payments (via Jobseeker) and the inflated unemployment conditions resulting from COVID-19 and the Government’s response to same – this has directly driven APM’s growth. This can be observed below – you can see the cost per person, to the Government, was substantially higher, thus contributing to APM’s growth over that period.

Getting this growth in expenditure under control is likely the Government's target of thenew WFA system.

Note that table includes both WFA / jobactive and DES. You can see the spike of A$1bn from pre-COVID to post-COVID – this is exactly what the Government is likely trying to wind-back.

International acquisitions do not plug the gap

International acquisitions have clearly diversified the business away from Australia and inorganically grown the business, but let’s have a look at the revenue and margin performance of each business, and their contribution to APM in FY23.

As you can see, margins are being crunched –with the exception of the USA, where all the growth was via M&A (in theacquisition of Equus, which the APM FY23 annual report notes ‘has a lowermargin profile’ – and Australia is by far the most important division,particularly given it is where all the margins are.

Debt

All of this is before we get to APM’s obvious balance sheet issue – they are burning cash in order to fund the expensive interest payments on all their acquisition debt. See the below from the FY23 report:

The current terms of the debt are:

- Closing balance at 30 June 2023 of A$866m

- Cost of 226 basis points above BBSY (currently ~4.2%), so total debt cost would be 6.5% per annum

- That would mean FY24 interest, excluding any increases in BBSY (driven by the RBA cash rate, currently 4.1%), would be a minimum of A$56m

- This compares to A$42.5m in FY23, and A$33m, driven by increased debt to fund acquisitions (namely Equus) and increasing BBSY (driven by increasing interest rates

This compares to cash balance of A$107m resulting in net debt of A$760m, or 2.1x net debt / EBITDA based on FY23 underlying EBITDA of A$365m

This feels like quite high gearing for a company with NPAT margins as skinny as APM’s are currently.

Moreover, cash fell A$70m last year, whilst dividends of A$90m and interest service of A$42m were paid – meaning there is littleheadroom to keep up both dividend and interest in FY24 without a material improvement in cash generation.


Conclusion

In all, I am very happy to be wrong on any of the above, as I think APM is a great home-grown Australian company with a really strong ESG-related thematic, and if you believe the story, then it looks to be trading on pretty undemanding valuation multiples on a P/E and EV / EBITDA basis - so if anyone has views contrary to the above, or wants to educate me, please feel free to respond.