We came across a bullish thesis on First Advantage (FA) on ValueInvestorsClub by felton2. In this article we will summarize the bulls’ thesis on FA. First Advantage shares were trading at $17.17 when this thesis was published, vs. closing price of $19.1 as of Sept 10.

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First Advantage (FA), a leader in employment background screening and identity verification, recently announced a $2.2 billion acquisition of Sterling Check (STER). This strategic move is seen as a highly favorable opportunity for FA, led by an experienced management team that has acquired a competitor during a cyclical downturn, positioning the company for substantial upside in an eventual market recovery. Despite some investor concerns over the elevated leverage at the deal’s closing, FA is expected to remain cash-generative, and potential synergies may exceed initial estimates. We forecast mid-teens free cash flow (FCF) growth per share over the next several years, with further upside potential.

FA’s comprehensive service offerings include criminal background checks, drug and health screenings, biometrics, and employment verifications. In 2023, FA conducted about 100 million screens for 30,000 customers, with a strong focus on enterprise clients, particularly in blue-collar industries. The company’s proprietary database, Verified!, provides a competitive advantage over other firms. Post-IPO, FA achieved approximately 11% compound annual growth in revenue between 2021 and 2023, driven by consistent execution of its growth strategies.

The acquisition of STER, which is expected to close by the end of 2024, will create the largest entity in the background screening industry, diversifying FA’s market exposure and nearly doubling its size. The lack of overlap among the top 20 customers of each company is expected to enhance cross-selling opportunities. FA is also positioned to enhance STER’s margin profile before accounting for traditional deal synergies, given the margin differential and operational efficiencies to be gained from FA’s disciplined management.

Synergies from the acquisition, initially estimated at $50 million, may prove conservative given the combined revenue and operating expense bases. The combined entity will benefit from an increased R&D budget and technology investments, further strengthening FA’s competitive position. Although leverage will initially rise to about 4.5x, FA aims to return to its target range of 2-3x by 2026-27.

FA’s acquisition of STER represents a strategic use of capital at a potential cyclical low, creating a more diversified and compelling business model with significant synergy benefits. However, risks remain, including antitrust concerns from the DOJ, potential macroeconomic downturns, and customer churn post-merger, although FA is well-positioned to manage these challenges effectively. Overall, the combined entity presents a unique investment opportunity with multiple drivers for future growth.