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Can This Upstart Compete With the Benefits Giants? – Wageworks Inc (WAGE), Automatic Data Processing (ADP), Aon PLC (AON)

Companies both large and small continue to struggle with rising health care and compliance costs, which was only exacerbated by the passage of federal health care reform in 2010. In response, they have increasingly outsourced the design and administration of benefits packages to third parties, while encouraging their employees to use tax-advantaged spending accounts. The shift has benefited companies like

Automatic Data Processing (NASDAQ:ADP)

Inc (NYSE:WAGE), a leading provider of consumer-directed benefit (CDB) accounts that are mainly used for health care and commuter expenses. After a steep gain in 2012, is this company still worth a look?

Founded in 2000, WageWorks started out by providing commuter benefit plans to employers that wanted to assist their employees with transit expenses. Since then, the company has branched into the flexible spending account (FSA) and health savings account segments. According to the Kaiser Family Foundation, average health care premiums have risen 102% over the past 10 years, leading many companies to offer spending accounts as a supplement to traditional health care plans.

In FY2012, Wageworks Inc (NYSE:WAGE) reported strong financial results, with increases in revenues and operating income of 30.7% and 39.6%, respectively, versus the prior year. The company benefited from the continued adoption of plans by commercial and municipal organizations, as well as the acquisition of competitors’ account portfolios that included Aetna Inc. (NYSE:AET)’s CDB plan unit. In addition, WageWorks’ operating margin hit a five-year high in 2012, as it was able to leverage its internet-based technology and marketing expenditures across a larger customer base.

WageWorks has succeeded by capitalizing on the growing popularity of tax-advantaged spending accounts and the company’s intuitive web interface that eliminates the need for customers to buy software or train their personnel. In addition, Wageworks Inc (NYSE:WAGE) provides online information resources that detail the costs and benefits of the various types of spending accounts, which have been proven to increase the adoption rate by employees. However, success breeds competition and a number of industry giants have moved into the CDB plan space, including Aon PLC (NYSE:AON) and Automatic Data Processing (NASDAQ:ADP).

Aon is one of the world’s leading providers of risk management products and services through a global network of insurance brokerage offices that operate in 120 countries. In addition, the company moved headlong into the human resources administration segment with its blockbuster purchase of leading provider Hewitt Associates in 2010. Aon PLC (NYSE:AON) hoped to reduce its exposure to the cyclical insurance business through the purchase, while also enhancing its sales opportunities.

In FY2012, Aon struggled against a self-described “soft” industry environment, with marginal growth in its core insurance operations. For the period, the company reported increases in overall revenues and adjusted operating income of 2.0% and 0.2%, respectively, compared to the prior year. Its operating margin fell slightly as Aon continued to integrate the Hewitt operations and deliver on its promise of over $300 million in cost savings for the combined company. However, the company did generate a 4% increase in its human resources outsourcing business, which is a focus for Aon PLC (NYSE:AON) as it tries to leverage its global business network.

Meanwhile, ADP has reported relatively better growth in its business units, although its overall revenue has been limited by the low interest rates that it receives on the large fund balances that it holds for customers. In the first six months of FY2013, the company reported increases in revenues and adjusted operating income of 6.0% and 3.0%, respectively, versus the prior-year period. ADP, like Aon PLC (NYSE:AON), has seen profit pressures due to the rising costs of delivering its labor-intensive administrative services.

However, ADP continues to increase its overall market opportunity by organically expanding its new segments, including ventures involved in health care IT management, equipment dealer services, and professional employer organization (PEO) services. In 2012, the company achieved its highest growth in the PEO segment, where ADP and its employees partner with clients and become their de-facto human resources department. This relationship also positions ADP for future sales opportunities, including retirement administration and flexible spending plans.

WageWorks’ business is currently strong, but it is somewhat susceptible to the implementation of the federal government’s health care legislation starting in 2014. In addition, the company needs to continue diversifying its product mix, as its competitors try to position themselves as gatekeepers to companies’ benefit programs. Investors should put Wageworks Inc (NYSE:WAGE) on the watchlist, though, and wait for a pullback to buy.

The article Can This Upstart Compete With the Benefits Giants? originally appeared on Fool.com and is written by Robert Hanley.

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