Recently, I summarized activist investor Bill Ackman's proposed changes for Automatic Data Processing (NASDAQ: ADP), the largest company in payroll services. Ackman, who announced an 8.3% stake in the company, believes ADP is in need of transformational change that the current management is incapable of delivering.
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Both management and the board rejected Ackman's conclusions, as well as his three proposed directors for nomination.
In the interest of fairness, I went through ADP's responses, which fall into two categories: challenging Ackman's understanding of the numbers and challenging Ackman's tactics.
ADP objected to the way Ackman went about his fight in the following ways:
- On Aug. 1, Ackman requested a 30-day extension to the Aug. 10 deadline to nominate directors. This was very close to the deadline.
- Ackman turned down a meeting with company CEO Carlos Rodriguez and Chairman John Jones, insisting on speaking with the entire board, and then demanding an extension because he was going on vacation and didn't have the presentation ready.
- Ackman wanted to fire CEO Carlos Rodriguez without talking to him or the board first. (However, it's clear Rodriguez did not agree with his ideas, once presented.)
- When the board said it would not extend the deadline but would discuss his ideas, Ackman said he would wage a proxy fight. On top of that, Ackman threatened to use his clout in the media against the company.
- Since Rodriguez became CEO, ADP is up 200% versus the S&P's 80% return and Pershing Square's 22% (gross) and only 7% (net).
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This makes for good melodrama, but it mostly has to do with denigrating Ackman, rather than his arguments.
On fundamentals and strategy, here are ADP's responses to Ackman's critiques (my paraphrase), and my take:
Strategy and numbers
- Ackman's complaint, management is insular. Ackman claimed he spoke with 85 former senior executives. If management is so insular, how is there so much turnover? It's also possible many of these executives were disgruntled. ADP leadership rose through the ranks just like any other large company. It doesn't mean they're closed off. My take: I think this has merit, as ex-employees could be unreliable; however, 85 is a pretty large sample size.
- The company depends on tenured engineers to parse legacy code. 20% of ADP's tech engineers are less than a year with the company, and 50% are less than five years. My take: That may be true, though we'd have to know what skills these hires possess and what project they were assigned.
- Enterprise client count has dropped since 2009. ADP's CEO Rodriguez says the client count has slightly increased since then. Ackman was getting 2009 numbers given by the previous CEO who counted core employer services differently than today. My take: I have no reason to doubt management, but if there is a difference, it should be made clear to shareholders (which apparently it is not).
- Headcount grew faster than revenues. The company has a 10% revenue average growth rate but only 5% employee growth since 2011. My take: There are shades of gray here. CEO Rodriguez does not seem to be stripping out the PEO revenue, which Ackman does. Ackman also claims sales headcount grew 8%, not 5%, and his adjusted "true revenue" growth outside PEO was only 5.1%, not 10%. It should be noted that all of Ackman's information had to be extrapolated from past documents and conference calls, with lengthy footnotes describing how his team came up with adjusted numbers. It's possible they got it wrong. It would be nice if the two could sit in a room and go through the numbers together and parse the differences. Regardless, core employer services revenue in the past two years has slowed to only about 3.5%, according to the company's annual report, so growth could use a boost.
- ADP's margin is much lower than those of its peers. ADP claims to be fundamentally different from its peers as it is so much bigger, more diverse, nd generates high-returns because they have low capital intensity. My take: This is the core difference. CEO Carlos Rodriguez appears to disagree with the need for a large upfront capital investment in technology. In an interview on CNBC, Rodriguez pointed out that ADP has raised its dividend 42 years in a row, so maybe he wants to invest incrementally and protect shareholder returns (this is, of course, Ackman's main objection). Rodriguez also said the company has been modernizing, pointing to the SMB business, which is now cloud-based; however, he did admit that business is only "almost" as high-margin as SMB rival Paychex. To determine who's right, one would have to project the returns on Ackman's projected investment, and what risks such an investment might pose.
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