Deals

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Automatic Data Processing Inc.'s rejection of Bill Ackman's board candidates will leave the decision in shareholders' hands. That's not great news for the activist.

Ackman articulated some valid criticisms of the provider of outsourced human resources services in his three-and-a-half hour, 167-page presentation on the company last week. But I'm doubtful it went far enough to turn investors against the current management team at ADP. There's a reason why companies that have handily outperformed benchmark indexes don't tend to make ideal activist targets. It's never been clear what Ackman and his two other board nominees could do that the current directors couldn't. 

What Else You Got?
ADP initially spiked on news of Ackman's investment, but has since fallen back as investors cast doubt on his ability to implement "transformational change"
Source: Bloomberg

The crux of Ackman's argument was that ADP could meaningfully increase its margins by improving its technology and simplifying its bloated corporate and service-team structure. These are not new issues at ADP; Evercore ISI's David Togut pointed out the company's market share losses in June. Management could move more aggressively, but structural disadvantages and the risk of disruption for clients made analysts skeptical of Ackman's targeted 1200 basis points of overall EBIT margin expansion by fiscal 2022.

Work to Do
Ackman's Pershing Square argues that ADP overstates the margin for its employer services business, masking the opportunities for improvement. It thinks ADP can get to margins of 35 percent to 40 percent for that unit by FY 2022.
Source: Pershing Square
Note: Pershing Square's actual margin is derived by excluding ADP's float income as a separate line item and charging employer services for corporate overhead.

Either way, it seems like investors will give the current management team an opportunity to correct the problem. They've earned that much. Few companies in general, let alone activist targets, command the level of respect and loyalty that equity analysts and prominent one-time shareholder and board member Leon Cooperman have shown to ADP amid this proxy fight.

Who Asked You Anyway?
It's not a perfect comparison, but ADP has far outpaced the returns of Pershing Square
Source: ADP
NOTE: ADP measures its own shareholder returns based on CEO Rodriguez's November 2011 start date and intraday market data on July 27 before news of Ackman's investment. The company assumes shareholders have held shares of its CDK Global business since it was spun off. ADP measure the S&P 500 return based on a July 26 close. Pershing Square returns are from Jan. 1, 2012 to Dec. 31, 2016.

And that raises an interesting quandary for Ackman. It's entirely possible that he could win at ADP on any stock gains as the company takes steps to address some of his criticisms, but still suffer a loss from a publicity standpoint on his activist goals. By most accounts, his battle at ADP isn't looking like the glorious post-Valeant Pharmaceuticals International Inc. and Chipotle Mexican Grill Inc. comeback he might have hoped it would be. (Add to that, his well-documented bet against Herbalife Ltd. took a blow on Monday as the company announced an aggressive buyback plan.) Ackman says he didn't want his ADP campaign to turn into a proxy fight, but he has largely himself to blame for this souring of relations.

ADP CEO Carlos Rodriguez got reprimanded by Egan Jones for calling Ackman a "spoiled brat," with the proxy-advisory firm noting such a comment highlights the lack of shareholder input on running the company. But Rodriguez also wasn't wrong. Ackman started this process by demanding special treatment: He wanted the company to agree to extend the nomination window for board candidates, but wasn't very upfront about the details of his plan for "transformational change." Cooperman was also irritated by Ackman's approach, calling it "destructive."

Cooperman likely won't be the only one. Big asset managers such as BlackRock Inc. have been pushing back against settlements with activist investors that limit their opportunity to make their own voice heard. Ackman has a long horizon (in activist terms) for his ADP plan; it's not too late to rethink his approach.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net