By Ryan Barnes. Edited By Douglas A. McIntyre
Automatic Data Processing (ADP)
ADP – the 500lb gorilla of the HR services world – has seen its valuation get slowly eroded in the past few years as top-line growth has slowed down from the double-digit levels they were putting up like clockwork in the past. The company is clearly focused on increasing shareholder value, as seen by the pending spin-off of the Brokerage Services group, which will happen sometime in 2007. This will be a 100% spin-off to existing shareholders, and takes out one of the two segments that show lower operating margins than the flagship Employer Services (i.e., payroll services) group. The other segment that lags behind Employer Services is the Dealer Services group, which is a mature enough business to stand alone as a publicly-traded company should the company decide to go that route.
ADP’s biggest asset is the fact that they are used by just about every large company in America for something, whether it be for just payrolls or, for financial firms, more high-touch services like proxy filing and securities clearing. ADP will often gobble up small companies that have new & interesting service offerings and then offer them to their world-class client list. It’s a potential hit-or-miss strategy, but a few winners a decade is all ADP needs to generate above-market returns for shareholders. Then as a fledgling operating segment becomes more mature and larger in size, it can be considered for divesting or spinning off, such as with the brokerage group.
It makes sense for ADP to eventually spin off the Dealer Services group, as the lower margins are compressing the company valuation to some degree. ADP still won’t get the multiple of Paychex, but it could certainly get closer (currently ADP trades at 17x earnings to PAYX’s 30x).
To take a stab at the breakup value we first need to determine how big the brokerage spinoff will be; based on industry multiples for brokerage-related services, current growth rates and operating margins, the new stock should trade at about 20x earnings, which would garner just over $3b.
The Dealer Services group has very similar margins and growth rates to the brokerage group. Based on the same multiple, this division would be worth $2.7b.
After all this spinning around, the core of ADP, human resources and outsource planning, would be back to 20% plus operating margins across the board, and should allow for some multiple expansion. Given the fact that – 1) ADP is held in just about every institutional manager’s portfolios because of the unique area of the economy that they operate in, and 2) the company is a proven operator and innovator with a great distribution system – the company still deserves a premium – we’ll give it a P/E of 25, which translates to a PEG of 1.67 and a total breakup value for ADP of $44. ADP is a company based on people and information capital, and these companies will usually trade at levels above breakup value, as the key assets have less tangible value.
Ryan Barnes
Ryan Barnes has over 10 years’ experience in portfolio management and investment research, covering equities, fixed income, and derivative products. Ryan spent the past 5 years working as an institutional trader & manager for high-net worth investors, working with Merrill Lynch, Charles Schwab, Morgan Stanley, and many others. Ryan is currently working as a writer and financial modeling consultant on hedging and capital appreciation strategies, and does not own securities in the companies being covered.
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