Earlier this month, I wrote about activist investor Bill Ackman's proxy fight against Automatic Data Processing (NASDAQ: ADP). In August, Ackman's hedge fund, Pershing Square, proposed three executives for nomination to the ADP board, including himself, but ADP quickly rejected them, instead putting its incumbent 10 directors up for renomination. The election is taking place now, and if you're a shareholder, you can cast your vote before Nov. 7.
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"Adding Mr. Ackman's nominees would not be an improvement," ADP Chairman John Jones stated. "Unlike Mr. Ackman's nominees, ADP's directors have a deep understanding and appreciation of the current state of ADP's business and its clients."
That's a very polite and highly corporatized version of trash talking.
However, Pershing Square scored a big win last week, when two top proxy advisors endorsed Ackman's hypothesis and nominees.
Glass Lewis and Eagan Jones vote Ackman
Glass Lewis, formed in 2003, is a leading provider of global corporate-governance services. Part of what Glass Lewis does is give independent opinions on proxy fights such as these, and in this case, it definitively took Pershing Square's side:
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[W]e believe investors have an opportunity to convey their discontent with the board's continuation of a potentially sub-optimal business plan, and to encourage fresh perspectives, analysis, and discussion in the boardroom. ... [T]he board's response, or lack thereof, to the substance of Pershing Square's argument leaves much to be desired by shareholders. ... Similarly, the board's stated operational and financial plan strikes us as being inadequate and underwhelming given the substantial opportunity thoroughly detailed by Pershing Square.
Eaton Jones, a second proxy-recommendation service, also threw its weight behind Pershing's nominees:
[I]n our view, ADP's complacency resulted in the board and management's failure to acknowledge the company's underperformance in the recent years. ... Pershing Square's presentation of the indicators of operational inefficiency is a credible ground why change is warranted in the board room.
ADP, of course, did not take too kindly to the recommendations, responding:
We strongly disagree with Glass Lewis' recommendation, which does not take into account the significant business risk inherent in Pershing Square's margin expansion target, nor the negative impact it would have on client retention and ADP's overall business.
A definitive win?
While it may seem that these firms are saying Ackman is right and ADP is wrong, that's not exactly true. Ackman is seeking three of 10 seats, so the firms are merely saying Ackman's nominees should become part of the conversation. These proxy firms were formed with the impetus of providing good corporate governance, so I think they probably lean more toward owners and board diversity more often than not. For instance, Glass Lewis also endorsed Nelson Peltz in his fight against Procter & Gamble, but Peltz wound up narrowly losing.
Of course, good management should think like owners. Warren Buffett instructs his managers to run their businesses as if they were 100% owners, the business was their only asset, and they couldn't sell for 100 years.
Ackman agrees and made the important point that he is the company's largest shareholder with an 8.3% stake (though most of that is in options), while the board and CEO own less than 0.1% of ADP's shares outstanding.
The main issue
Ackman made a four-hour, 168-slide presentation highlighting his argument against ADP's current regime, but most of his arguments center on a single plan to transform ADP's technology infrastructure to the cloud, improve the customer experience, and increase margin through efficiency -- which would almost certainly involve headcount reduction. To that end, Pershing built a website on which it posed a series of questions surrounding ADP's margins, disclosures, and management's current plans to improve.
ADP claims it's already implementing a plan and points to several existing board members with tech backgrounds, such as PayPal Holdings COO William Ready. Moreover, the company says it has improved margin in the past and has a plan to increase margin by 500 basis points by 2020 -- though that's far less than Ackman's proposal of 1,200 points. Ackman challenged ADP on that point, saying that ADP's 2020 guidance implies only 100 to 200 basis points of margin improvement, not 500.
Is an overhaul risky?
It's quite possible that Pershing Square's plan may jeopardize ADP's existing operations, and like most hedge funds, Pershing Square definitely has an incentive to swing for the fences. That being said, service providers such as Amazon.com and Microsoft are making it easier than ever to migrate data and business-critical applications to the cloud, and both ADP's competitors and spinoffs have been able to make similar transformations, so it's certainly a question worth exploring. And if that's the case -- that there may be merits to both arguments -- then both sides should have representation on the board to hash out the best way forward, as long as both sides enter discussions with an open mind.
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