Expect Improved Profit Margins, Higher Growth, Continued Dividend Aristocrat Status after Spinoff of Dealer Services
Automatic Data Processing, Inc. (ADP) is a Roseland, New Jersey, based provider of Human Capital Management (HCM) solutions – for payroll, time and labor management, HR record-keeping, recruiting, employee training, performance assessment, compensation and succession planning – to employers worldwide, and is a member of the coveted S&P Dividend Aristocrats index with 39 consecutive years of dividend growth.
On October 1, 2014, ADP’s Dealer Services division was spun-off as an independent publicly-traded entity and renamed CDK Global, Inc. (Nasdaq: CDK). The surviving ADP entity retains the ADP name and plans to focus on growing its HCM solutions with renewed focus. Wall Street analysts applauded the spinoff because it increases shareholder value and improves profit margins while retaining dividends and annual dividend growth as before. Management has delivered double-digit returns and earnings growth, with consistent dividend growth, and the spinoff should further enhance management’s ability to deliver outstanding shareholder value. Moreover, its core Employer Services division generates the bulk of ADP’s revenues and is well-positioned to gain market share while its PEO Services division should also see gains as customers continue to outsource HR functions.
Spinoff Rationale – Greater Strategic Focus on Growing Each Business, Improved Shareholder Value
ADP’s Dealer Services division has about $2 billion in annual revenues, most of which are recurring, with good profit margins and strong cash flow. It is the world’s largest provider of integrated dealership management, business intelligence, business process outsourcing, deal management, digital marketing, mobile, phone systems and networking, retail and technology solutions to automotive manufacturers, retailers and stakeholders with a total market opportunity of $17.5 billion.
This division serves over 26,000 retail dealerships across 100 countries and virtually all automotive manufacturers. The company has solutions for each stage of the sales cycle from pre-sale advertising, targeted online marketing and digital lead generation to financing, sales, insurance, repair, maintenance and parts supply.
Dealer Services’ includes Dealer Management Systems (DMS) with a dash board to run all aspects of an auto dealership, Front End solutions that provide integrated vehicle marketing and sales functionality, Fixed Ops for parts and service management, Dealership-Wide process improvement solutions and Technology Solutions for secure and reliable networking and phone operations.
In April 2014, ADP announced plans to spinoff its Dealer Services division as a separate publicly-traded business because it was inherently different from ADP’s core HCM business of payroll, benefits, retirement administration and other Human Resources’ functions. The rationale for the spinoff was to allow each business to focus on its own strategy and growth, unburdened by the other, and to unlock shareholder value. The spinoff is expected to bring more value to shareholders by streamlining business operations and improving margins across the board. The spinoff was approved in 2014 because the automotive market had recovered substantially after the 2008 crisis and Dealer Services faced strong growth prospects and could easily survive as an independent company.
After the spinoff, Dealer Services will be called CDK Global, Inc. and trade under ticker symbol CDK. After the close of trading on 9/30/2014, CDK Global was added to the S&P MidCap 400, replacing Bill Barrett Corp. (BBG). Dealer Services’ division president, Steve Anenen, and chief financial officer, Al Nietzel, will become CEO and CFO, respectively, of CDK Global.
The spinoff was structured to be tax-free, with $700 million in proceeds which ADP plans to use to buy back ADP shares after the spinoff. After market close on September 29, 2014, ADP shareholders (on record 9/24/2014) received one share of CDK Global for every three ADP shares held. ADP shareholders in the U.S. will not be subject to taxes on CDK shares received but may have to report cash received in lieu of fractional shares.
Bank of America (BAC) reiterated its Buy rating for ADP shares and increased its 12-month share price target from $90 to $95 per share, viewing the spinoff as favorable to unlocking shareholder value and citing robust demand for ADP’s human capital management services.
Standard & Poor downgraded ADP’s
credit rating from AAA to AA because of ADP’s plan to buy back $825 million of shares. In August 2014, ADP increased its buyback authorization by 30 million to 45 million shares.
Moody’s Investor Service (MCO) downgraded ADP’s credit from Aaa to Aa1 citing reduced diversity in ADP’s product portfolio as a result of the spinoff.
Dividend Aristocrat ADP to Continue 39-y Track Record of Annual Dividend Increases
Post-spinoff, ADP will maintain its quarterly cash dividends and expects to return to a dividend payout ratio of 55% to 60%. ADP has raised dividends every year for the past 39 years and is on the S&P 500 Dividend Aristocrats list which features companies that have raised dividends for each of the past 25 years.
On August 5, 2014, ADP announced a regular quarterly dividend of $0.48 per share payable October 1, 2014 to shareholders on record September 12, 2014. At $1.92, annualized dividends per share are up 7.3% relative to 2013. ADP has paid quarterly dividends and raised annual dividend amounts every year since January 15, 1974.
At $1.92 per share annualized and with shares at $74.85 (as of 10/3/2014), ADP offers a dividend yield of 2.25%. Shares trade at 23.3x trailing twelve-month earnings and 23x cash flow per share, with a market capitalization of $36.1 billion. Valuation multiples reflect ADP’s strong 21% EBITDA margin but the P/E ratio is roughly double TTM earnings growth of 11.6%. ADP’s share price valuation reflects future growth potential of ADP’s standalone business. In addition, shareholders have benefited significantly from the spinoff of the Dealer Services business.
Post-Spinoff, ADP Leads $90 billion HCM Market
Before its spinoff, ADP had three business segments: Employer Services, Professional Employer Organization Services (PEO) and Dealer Services. After the spinoff of Dealer Services, the surviving ADP entity will focus on HCM solutions through its Employer Services and Professional Employer Organization Services segments, with a solutions suite that’s capable of serving over 95% of all multinational employees.
ADP has been in business for over 65 years and has approximately 637,000 clients across 125 countries. The company is an industry leader in the $90 billion HCM solutions market and serves clients in several different industries, with solutions for every segment of the HCM market.
ADP’s HCM solutions serve over 400 of the Fortune 500 companies and 90 of the Fortune 100 companies, for 24 million workers domestically (1 in 6 U.S. workers) and 10 million workers abroad.
ADP is currently #1 provider of HR outsourcing services in Europe with over 30,000 clients with over 10 million employees.
Well Positioned to Capitalize on Affordable Care Act (ACA) Compliance
ADP has proactively developed a platform solution that allows U.S. companies to track compliance with all key aspects of the Affordable Care Act (Obamacare). This proactive move should further help with account and new client growth.
Tremendous HCM Growth Potential
ADP’s comprehensive cloud-based HCM solutions have helped the company dominate its industry. The company has doubled its mobile HCM user-base to over 2.5 million users of its Mobile Solutions application. Cloud-based clients increased 45% to over 430,000 clients of which 380,000 use ADP Run (payroll and tax solutions) and 50,000 use ADP Workforce Now (comprehensive HCM solution).
Robust Strategic Plan for Continued HCM Success
Post spinoff, ADP management has a robust strategic plan for financial success, continued growth in HCM client base, market-beating shareholder returns through capital appreciation and dividend growth and employee engagement for higher productivity and retention.
ADP plans to leverage its global brand, broad HCM solution suite, global sales and service coverage and strong balance sheet to expand its HCM solutions and scale market share in the U.S. and abroad.
The company plans to grow its solution base organically and through acquisitions and, in 2015, expects Employer Services
revenue growth of 6%-7% and Professional Employer Organization Services (PEO) revenue growth of 13%-15%. The company currently has an all-time high client revenue retention rate of 91.4%.
Award-Winning HCM Modules Ensure Brand Leadership
ADP’s modules for different aspects of HCM continue to outperform the competition and set new standards. In June 2014, ADP’s SmartCompliance Tax Credits successfully passed a Service Organization Controls 2 Type-1 audit. The completion of this audit is an industry first, led by ADP, and reassures customers that the module meets standards set by the American Institute of Certified Public Accountants on functionality, accuracy, security, reliability and integrity.
In July 2014, ADP received the 2014 North America Product Line Strategy Leadership Award for Human Capital Management from industry analyst firm Frost & Sullivan. The award is based on size of product line, size of potential customer base, customer value, market value and markets served.
In August 2014, ADP was named the leader for payroll business process outsourcing by information technology analysts at Gartner, for the third consecutive year. Gartner based its ranking on 13 payroll service capabilities and noted that ADP had led payroll processing outsourcing for over six decades.
In September 2014, ADP’s AdvancedMD healthcare management solution was certified by the Drummond Group’s Electronic Health Records ONC-ACB program for meeting all criteria set out by the U.S. Department of Health and Human Services. AdvancedMD provides cloud services for electronic health records, practice management, medical scheduling and medical billing. ADP is one of only a few companies that offer enterprise-level medical office software solutions.
Customer Partnerships Help Drive Revenue Growth
In the last two weeks of September 2014, ADP signed laundry and linen service provider COMTEX Laundry and IT storage hardware solutions provider EMC Corporation (EMC) as customers. COMTEX came to ADP after a competitor promised lower prices but was unable to meet the company’s demands. COMTEX will use ADP’s services for payroll, human resources and timekeeping. EMC has been an ADP customer for over 20 years and recently extended its partnership to include EMC offices in an additional 28 countries bringing the total to EMC offices in 47 countries. For EMC, ADP provides payroll, health and wellness, and time and labor management services for 65,000 employees. The partnership allows EMC to easily consolidate its reports and analytics from country to country on a single platform and greatly simplifies workflow and reporting for EMC.
The New ADP Experience Continues Innovation Track Record
By the end of 2014, ADP plans to roll out a re-designed user interface for its entire product portfolio to deliver a streamlined and personalized experience. The re-designed interface is the first release from the ADP Innovation Lab in New York City and will reduce the burden of transaction support, drive employee engagement and free human resources departments to concentrate on strategic business priorities. Key features of the new experience include interactive payroll to show how benefits and taxes affect take-home pay, easy share options for pay check stubs and tax statements, a cost calculator to compare benefit plans, instant work schedules and integration between desktop and mobile devices.
Veteran ADP Management Will Continue to Lead the Company
Carlos Rodriguez has served as President and CEO of ADP since May 2011 and has been with the company since 1999. Rodriguez has been President of ADP TotalSource and ADP Retirement, where he helped rapidly grow those businesses. He holds a B.A. in Government and an MBA from Harvard College.
Jan Siegmund has served as ADP’s CFO since 2012 and previously held positions as Chief Strategy Officer, President – Added Value Services and Vice President – Corporate Strategy. Siegmund’s business and corporate development experience has been integral to ADP’s growth strategy. He holds an M.S. in Industrial Engineering and a Ph.D. in Economics.
Mike Capone is ADP’s Corporate VP – Product Development and CIO, and is a 25-year veteran with the company. Capone previously worked as Senior VP and General Manager of ADP GlobalView. He holds a B.S. in Computer Science and an MBA.
Collectively, ADP’s leadership team has been instrumental in growing the company’s technology platform and solutions base to serve clients across the globe as a preferred provider, and has risen to lead the HCM and Dealer Services markets. Management has delivered double-digit returns and earnings growth, with consistent dividend growth, and the spinoff should further enhance management’s ability to deliver outstanding shareholder value.
Management has also maintained balance sheet strength with a Current Assets / Current Liabilities ratio of 1.08x (any number above 1 indicates enough resources to pay liabilities over the next 12 months), and highly manageable debt at 33% of equity and 7% of total assets.
Increased FY2015 Guidance after Spinoff
For its fiscal year ending June 30, 2015, ADP expects revenue growth of 7%- 8% and diluted earnings per share growth of 12%-14% (increased from earlier guidance of 11% – 13% growth) over FY2014. Earnings growth includes a $0.02 benefit from $825 million in share repurchases by the end of fiscal 2015 from dividend proceeds associated with the spinoff of CDK Global.
Management will announce Q1 2015 results on October 29, 2014.
Robust Growth Across all Business Segments in FY2014
For the year ended June 30, 2014, ADP (pre-spinoff) reported total revenues of $12.2 billion (up 8%), earnings from continuing operations before income taxes of $2.3 billion (up 10%), net earnings from continuing operations of $1.5 billion (up 11%) and diluted earnings per share from continuing operations of $3.11 per share (up 12%).
Total revenue growth came from a revenue increase of 8% in Employer Services, 15% in PEO Services and 7% in Dealer Services.
The table below presents ADP’s income statement over the past five years with consistent revenue growth and earnings growth.
As of June 30, 2014, ADP had $4.0 billion in cash and cash equivalents, $11.5 million in long-term debt and $6.7 billion in total stockholders’ equity. The company had $1.82 billion in operating cash flow for FY 2014.
ADP’s spinoff of its Dealer Services business is expected to boost growth for both companies over the long-run with better focus on core operations and growth. As the global leader in HCM solutions, the surviving ADP entity has a large addressable market and dominates its industry. Management’s strategic growth plan addresses should deliver significant revenue growth for its Employer Services and PEO Services segment in fiscal 2015. In addition, ADP plans to continue yearly dividend growth and shareholders should see additional upside on their CDK Global shares amidst a red-hot automobile sales environment. At $74.85 (as of 10/3/2014), ADP shares trade at a significant discount to Wall Street’s 12-month targets.