We are maintaining our fair value estimate amid the bid by Pershing Square to add directors to the ADP board.
By Brett Horn, CFA | 08-04-17 | 10:00 AM | Email Article

On Aug. 4,  Automatic Data Processing  announced in a press release that Bill Ackman’s Pershing Square is seeking to nominate five directors to ADP’s 10-person board through an 8% ownership that’s “mostly in derivatives.” In effect, Bill Ackman is attempting to take control of ADP. However, 8% in derivatives isn’t the same commitment as an 8% share position. Given that we expect Pershing Square to experience outflows, this may be the only way for the firm to establish a large, initial investment. Though we haven’t seen any specific plan from Pershing, we know the general playbook: find a management team that appears vulnerable and force the company to make changes that seem to favor short-term results over long-term value creation. However, ADP trades at more than 28 times earnings. It would be hard to argue there is much value in ADP that the market hasn’t already recognized. We’ll be maintaining our fair value estimate of $86 per share, a more than 30% discount to the current share price. Our lower fair value estimate largely results from our anticipation for higher incremental investment needed by ADP.

Brett Horn, CFA, is a senior equity analyst for Morningstar.

Pershing Square will frequently make the claim that a company’s margins should be higher. With ADP, we’d make the opposite claim. Though the market has largely ignored this, ADP is facing increasing competition from Paycom, whose customer service and technology offering is superior. To counteract this, ADP has increased investment to improve its IT infrastructure and customer service. The company should have been doing this sooner. In addition, investing in technology and personnel shouldn’t be a one-time expenditure, but an ongoing commitment. We don’t believe the company suffers from overinvestment, but rather from previous underinvestment.

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