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Shares of Automatic Data Processing (ADP - Analyst Report) declined almost 2.0% ($1.49) to close at $73.73 on Apr 11, after the company announced its plans to spin-off the Dealer Services business into an independent publicly traded company. ADP expects the spin-off to be completed in the early part of the fourth quarter of 2014.  

The 100% tax-free spin-off will help ADP to focus more on its core Human Capital Management (HCM) business, going forward. Per management, the strong long-term growth prospect of automotive market will provide significant growth opportunities to the Dealer Services business.

The transaction is expected to provide ADP at least $700.0 million, which it plans to use in buying back shares. ADP expects to keep the current quarterly cash dividend of 48 cents per share constant for the time being. Post the spin-off, the company expects to eventually raise its dividend payout ratio to 55.0–66.0%.

Although the plan sounds shareholder-friendly, it did not go down well with credit rating agencies. The Standard & Poor’s lowered ADP’s credit rating from AAA to AA, primarily due to the company’s plan of using the proceeds to buy back shares. Moody’s (MCO - Analyst Report) Investor service decreased its rating to Aa1, citing lower scale and variety of ADP’s product portfolio.

The Dealer Services business segment provides marketing solutions to over 26,000 auto retailers, distributors and manufacturers. In the first six months of fiscal 2014, Dealer Services reported revenues of $957.0 million, which increased 7.2% on a year-over-year basis. On the other hand, Employer Services and PEO Services increased 8.5% and 13.0% to $4.06 billion and $1.04 billion, respectively, during the same period.

For fiscal 2014, Employer Services revenues are expected to grow approximately 7%, while PEO Services revenues are expected to improve 12.0% to 13.0%. Dealer Services revenues are forecasted to increase 8.0% on a year-over-year basis. Improving payroll market remains a major positive for ADP, going forward.

We believe ADP’s strong market position in the HCM will further improve due to the spin-off, despite intensifying competition from the likes of Paychex Inc. (PAYX - Snapshot Report) and Equifax Inc. (EFX - Analyst Report). Moreover, aggressive share buyback will boost profitability, going forward. However, the reduced scale of operations will hurt results in the near term.   

Currently, ADP has a Zacks Rank #3 (Hold).

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