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Noam Kagedan

Sean Hinton

Automatic Data Processing (ADP) processes payroll for 585,000 companies,^[1] is responsible for paying 1-in-6 non-farm employees in the U.S.,^[2] and produced 54 million W-2 tax forms in 2007.^[3] Beyond basic payroll processing, ADP sells companies other outsourced human resources services, such as payroll tax administration, retirement plan administration, health benefit administration, and workers' compensation insurance services. Additionally, ADP earns interest on funds that are temporarily held for its clients (e.g. between the time the money is transferred to ADP and the time the checks are sent to and cashed by employees). In fiscal 2007, this net interest income totaled $653.6 million, or 8.3% of total net revenue.^[4]

Aside from ADP's payroll and HR segments, which it collectively refers to as Employer Services, the firm has two other segments: Professional Employer Organization (PEO) Services, in which ADP handles nearly all of its clients' employment tasks, and Dealer Services, which provides inventory management, accounting, and related business services to automobile and other vehicle dealers in over 50 countries.^[5]

As of fiscal year 2007, sluggish economic conditions in the U.S. had not caused ADP to take overall losses; ADP's revenue and net income grew by 14% and 21%, respectively.^[6] However, economic downturns do put a damper on ADP's earnings because higher unemployment decreases demand for payroll services and falling interest rates decrease the revenue earned from interest in funds held for clients. The U.S. unemployment rate hit 5.5% in May 2008,^[7] and the Fed cut rates to 2% in 2008 from 5.25% in 2007.

Business Overview

ADP's 2005-2007 Revenue and Net Income, in millions USD^[8]

As shown in the table and chart, ADP's revenues have grown by double-digit percentages in the last 3 years and its net income has grown solidly as well, hitting double-digit percentages in 2 of the last 3 years.

^[10]

ADP's business model for its Employer Services segment is profitable because many of the services it offers reuse data that ADP is already collecting and processing as part of its basic payroll services; for instance, if ADP is producing an employee's paychecks, it already has all of the information necessary to calculate payroll taxes and send them to the government.

The divisional breakdown chart to the right shows that Employer Services account for the majority of ADP's business, with Dealer Services coming in second and PEO services, ADP's smallest segment, coming in third.

Trends/Forces

ADP spun off or sold three business segments between January and July of 2007 in order to better focus on its divisions that have stronger barriers to entry.

Between January and July of 2007, ADP spun off or sold three of its segments: Sandy Corporation, a dealer services business;^[11] the ADP Brokerage Services group, which became Broadridge Financial Solutions, LLC (BR); and the ADP Travel Clearing segment.^[12] In addition to being slow-growing, these segments weren't in ADP's specialty areas of payroll and HR services.

The payroll and HR services markets have high barriers to entry; it's not easy for new companies to compete in these markets because it requires developing infrastructure with government agencies, insurance companies, and financial institutions. ADP specializes in this market and is the largest firm in terms of revenue, net income, and clients served, giving it scale advantages. It has long-standing relationships with banks, retirement planners, and insurance companies that make it easy for ADP to gain and set up new clients and add new services. By spinning off its non-core businesses, ADP has focused on growing its already strong presence in the payroll processing and HR services industries.

U.S. unemployment rate hit 5.5% in May 2008

In May 2008, the U.S. unemployment rate rose to 5.5% from 5% in the previous month, the largest one-month increase in 20 years.^[13] ADP's revenue depends on the fees that businesses pay to have ADP operate their payroll. When an economic downturn or recession occurs and unemployment rises, firms don't need as many paychecks, which translates to lower demand for ADP's payroll processing services.

Fed slashed interest rates from 5.25% to 2% in 2007-2008

Between September 2007 and April 2008, the U.S. Federal Reserve cut interest rates by 3.25% to just 2%. This impacts ADP because it made 8.4% of its 2007 total revenue from the interest earned on clients' money.^[14] Some payroll services require that clients give ADP money directly, which ADP then pays out to the employees or other recipients. To avoid complications, customers often give ADP the money before it's actually needed. In the time between receiving money from clients and sending it out to recipients, ADP puts it in an interest-bearing account, earning a return in between major transactions. Unlike banks, however, ADP doesn't pay out interest to others, so it unambiguously benefits from higher rates. The rate cuts of 2007 and 2008 will take a bite out of ADP's interest income for FY2008.

Competition/Market Share

ADP is the largest firm in the payroll outsourcing market in terms of both revenue and net income. In second is Paychex (PAYX), a firm that specializes in small to medium-sized businesses, those with under 100 employees. Finally, in third place in the market is Ceridian (CEN). The following table compares the 3 firms:
Note 1: Ceridian went private in 2007 when it was acquired by Fidelity National Financial (FNF) and Thomas H. Lee Partners ^[15], so net income and revenue for 2007 are not available.
Note 2: Market share percentages are based on a figure of 5,885,784^[16] as the total number of U.S. firms with employees: a number accurate as of 2004, the last year with available data.

While Paychex (PAYX) closely rivals ADP in terms of the number of companies each one serves, ADP had approximately twice the amount of 2007 net income that PAYX did. This is because ADP serves many large companies, while only about 2% of PAYX's clients have over 100 employees.^[25] This discrepancy is reflected in the table - PAYX only produced 11 million forms W-2 in 2007, compared to ADP's 54 million. The difference in the numbers of actual employees processed also shows that Paychex operates more efficiently - ADP produced almost 5 times as many W-2's as PAYX, but had only 2 times PAYX's net income.

References

1. ↑ ADP 2007 10-K, page 7
2. ↑ ADP National Employment Report Homepage
3. ↑ ADP 2007 10-K, page 3
4. ↑ ADP 2007 10-K, page 17
5. ↑ ADP 2007 10-K, page 5
6. ↑ ADP 2007 10-K, page 13
7. ↑ Unemployment benefits pass House, but future uncertain - CNN.com, June 12, 2008
8. ↑ ADP 2007 10-K, page 13
9. ↑ ADP 2007 10-K, page 13
10. ↑ ADP 2007 10-K, page 25
11. ↑ ADP May Become a Powerhouse Through Acquisitions - Seekingalpha.com, November 8, 2007
12. ↑ ADP 2007 10-K, pages 5-6
13. ↑ Unemployment benefits pass House, but future uncertain - CNN.com, June 12, 2008
14. ↑ ADP 2007 10-K, pages 13, 26-27
15. ↑ Ceridian to Be Taken Private in $5.3 Billion Deal, The New York Times, May 31, 2007
16. ↑ Statistics about Business from the Census Bureau
17. ↑ ADP 2007 10-K, page 13
18. ↑ ADP 2007 10-K, page 3
19. ↑ ADP 2007 10-K, page 7
20. ↑ PAYX 2007 10-K, page 13
21. ↑ Paychex F3Q07 (Qtr End 2/28/07) Earnings Call Transcript, Page 2
22. ↑ PAYX 2007 10-K, page 1
23. ↑ CEN 2006 10-K, page 31
24. ↑ Ceridian - About Us
25. ↑ PAYX 2007 10-K, pages 2-3