On Thursday morning, Bill Ackman will apprise investors of the "enormous opportunity" to improve the business of payroll and outsourcing services company Automatic Data Processing Inc. (ADP) - Get Report .
Anticipation has been mounting since Aug. 4, when ADP said it had rebuffed a request by Ackman's Pershing Square Capital Management LP to extend the deadline to nominate directors to its board. Ackman has since said it will nominate directors for ADP's board and plans to outline his plan during a Thursday-morning investor call and an analyst lunch later in the day.
An unflattering comparison of ADP to Paychex Inc. (PAYX) - Get Report is likely at the top of the presentation. Paychex's Ebit margins are about 20%, or 2,000 basis points, higher than ADP's, Wedbush Securities Moshe Katri observes.
Katri estimates that every 100 basis points that ADP expands its margins is worth 30 cents in earnings per share. Efforts to extract more value from ADP could have a negative impact on the business, the analyst cautioned.
CEO Carlos Rodriguez acknowledged the margin gap with Paychex in an Aug. 10 interview on CNBC, but said Ackman has "a lack of understanding" about ADP's business.
"They're a great competitor—they're just a different company than us," Rodriguez said of Paychex.
"They're about a third of our size or a quarter of our size. They operate mostly in the small business segment," he said. "We're a global company, so we have international operations, we have operations also in the national account segment for very, very large clients."
Katri expects Ackman to look at ADP's Professional Employer Organization services, which includes outsourced human resources, employee benefits, regulatory compliance, and other functions.
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Wedbush's Katri estimates that about 500 basis points of ADP's margin gap comes from PEO services, which comes to $1.50 per share in EPS.
ADP's international business and non-payroll, ancillary services such as HR management, employee time and attendance management, insurance and others to attract attention from Ackman.
"You can safely assume that the PEO business is dilutive," Katri said. "You can safely assume that the ancillary piece is dilutive. The international base is also not making enough money."
While these businesses account for the margin gap between Paychex and ADP, they have also contribute to the resilience and "stickiness" of the business.
"Management has done a really good job building this buffer to the traditional business to protect the company from economic changes or drastic economic change, which worked out really well in 2000 and 2007 and 2008," he said.
While PEO eats at margins, it has been one of ADP's fastest growing businesses. "If you disconnect that business that will help get you that margin relief, but on the flipside that will impact your top line growth," Katri said.
Wall Street will be eager to hear whether Ackman can disprove Rodriguez's claims about his understanding of ADP.
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