“We can say without reservation that, in investing, spinoffs are the closest thing you can find to a sure thing. It all comes down to the incentives when companies spin off a subsidiary or division and hand out shares to their shareholders. Study after study has shown that after an initial adjustment period of a few months, spinoffs tend to outperform groups of comparable stocks for several years….” Pat McKeough shows how spinoffs and other “special situations” can create windfalls for informed investors.
Automatic Data Processing (ADP) spun off its brokerage-services business in April 2007 as Broadridge Financial (New York symbol BR). The new stock went sideways for a few years, but has now more than tripled since the spinoff.
On September 30, 2014, ADP completed another spinoff: its car-dealer software business (CDK Global). Investors received one CDK share for every three of their ADP shares.
That spinoff has also worked out well: While ADP is up nearly 90%, CDK has jumped over 150%. We like the prospects for both companies and believe each stock is poised for further gains. Activist attention also highlights their potential.
AUTOMATIC DATA PROCESSING INC. $138(Nasdaq symbol ADP; Manufacturing & Industry sector; Shares outstanding: 440.5 million; Market cap: $60.8 billion; Dividend yield: 2.0%; Takeover Target Rating: Medium; www.adp.com) is one of the world’s largest outsourcing human resources firms. It has over 700,000 clients in 110 countries. The U.S. accounts for 85% of its revenue.
ADP began operating in 1949 as Automatic Payrolls Inc.
First sold shares to the public in 1961
Began offering computerized inventory and accounting services to auto dealers in 1972
Spun off car dealer business as CDK in 2014
The company has two core businesses. Employer Services (70% of revenue) handles payroll, benefits, taxes and other human resources activities. The Professional Employer Organization business (30%) sells similar services, mainly to small and medium-sized businesses. It relies on onsite employees that work for both the client and ADP.
Overall revenue rose 7.9%, from $11.3 billion in 2013 to $12.2 billion in 2014 (fiscal years end June 30). Following the CDK spinoff, revenue declined to $10.9 billion in 2015. However, it then rebounded 6.7% to $11.7 billion in 2016 before rising another 6.1% to $12.4 billion in 2017.
ADP earnings improved 10.2%, from $1.4 billion in 2013 to $1.5 billion in 2014. Due to fewer shares outstanding, per-share earnings rose at a faster rate of 11.1%, from $2.80 to $3.11. Earnings then fell to $2.89 a share (or $1.4 billion) in 2015, before recovering to $3.25 a share (or $1.5 billion ) in 2016 and to $3.58 a share (or $1.6 billion) in 2017.
As of March 31, 2018, the company held cash of $2.3 billion, and its long term debt was just $2.0 billion.
Activist investor Bill Ackman controls about 7% of ADP’s shares. He wants the company to cut costs and boost its profit margins. However, shareholders rejected his proposed slate of directors at the latest annual meeting.
Meantime, ADP is already cutting its costs, and now expects its earnings for all of fiscal 2018 to increase between 16% and 17% to around $4.17 a share. The stock trades at 32.1 times the 2018 estimate. That may seem high, but is reasonable given the growing number of companies now turning to outsourcing services to navigate more and more complex tax codes and benefit plans.
The company also recently increased its quarterly dividend by 9.5%, to $0.69 from $0.63. The new annual rate of $2.76 yields 2.0%. ADP has now raised its dividend each year for the past 43 years.
ADP is a spinoff buy.
CDK GLOBAL INC. $67(Nasdaq symbol CDK; Manufacturing & Industry sector; Shares outstanding: 134.6 million; Market cap: $9.0 billion; Dividend yield: 0.9%; Takeover Target Rating: High; www.cdkglobal.com) sells analytical software and services that helps car dealers, automotive parts makers and related firms manage their vehicle purchasing, inventories, and repair activities.
The company operates three businesses: Retail Solutions North America (72% of total revenue) serves car dealers and other automotive companies; Advertising North America (14%) helps dealers create and manages their websites and online marketing; and CDK International (14%) serves dealers in over 100 countries outside of North America.
The company’s revenue rose 20.7%, from $1.84 billion in 2013 to $2.22 billion in 2017 (fiscal years end June 30).
CDK’s earnings rose 14.5%, from $1.24 a share (or a total of $199.4 million) in 2013 to $1.42 a share (or $227.9 million) in 2014.
In 2015, the company launched a new plan to streamline its product lines and cut operating costs. Altogether, the initiative should expand CDK’s annual gross earnings by $300 million for fiscal 2018.
Due to costs related to the plan, the company’s earnings fell to $1.10 a share (or $178.4 million) in 2015, but recovered to $1.51 a share (or $239.3 million) in 2016, and rose again to $1.99 a share (or $295.6 million) in 2017. CDK spends around 7% of its revenue on developing new software.
The company’s long-term debt was $2.1 billion as of March 31, 2018. That’s a manageable 24% of its market cap. CDK also held cash of $461.4 million.
The company’s prospects are strong, particularly as its products help car dealers cut their costs and boost sales. As well, activist investment firm Elliot Management is CDK’s largest shareholder with a 10.3% stake. It has a long history of successfully pressuring companies to boost returns.
The stock now trades at 26.8 times the $2.50 a share that the company should earn for fiscal 2018. The $0.60 dividend yields 0.9%.
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