Ackman's ADP Argument Is Illogical

Colin Plunkett: Wide-moat-rated ADP is in an interesting situation right now. The stock is trading at 30 times our 2018 earnings estimate, which is about a 38% premium to our fair value estimate of $80 per share. More recently, the company has been the target of an activist campaign by Bill Ackman of Pershing Square. He has made some hyperbolic claims that ADP can improve margins by 1,200 basis points if only the company would invest in technology and cut costs.

While there is some truth in Bill Ackman's criticism, we believe his thesis is illogical. For now, ADP's management is winning the debate as Bill Ackman failed in a proxy contest earlier in November. We don't doubt ADP has some room for improvement, the company certainly uses antiquated technology and has an irrational real estate footprint that could be consolidated. However, a 1,200 basis-point improvement is an incredible claim. We're aware of only a few historic examples where a company in a similar position to ADP has drastically improved margins in such a short time without impairing the business.

Based on this history, we believe it's more likely ADP would damage its underlying business by adopting such a proposal. In addition, we're confused by the activist's arguments; the activist is so negative that at times, we would guess that Pershing Square is suggesting a short position.

Furthermore, it's really hard to argue that at 30 times earnings, ADP doesn't already reflect all the positives of their business. Thus, we think ADP's future stock performance will lag its recent history.