Ceridian CEN
December 22, 2006 - 3:59pm EST by
2006 2007
Price: 27.85 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,935 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Summary: I am recommending Ceridian (CEN) as a long.  The company’s payroll processing business, HRS (“Human Resource Solutions”), has been poorly managed over time, and as a result the stock is relatively ignored.  The sell side has 12 neutrals and only 3 buys. The stock is trading significantly below break up value and private market value.  The company generates significant fcf, is not capital intensive, and has spent $270m on stock repurchases the last two quarters.  The balance sheet is entirely unlevered, although this business could support leverage of >5x.  I believe the current stock price discounts little recovery in the company’s HRS business, and undervalues the very profitable, well-managed, fast growing Comdata business.   There are literally zero synergies between HRS and Comdata, and I believe that within a year there will either be a spin off of Comdata, or perhaps a sale of all or part of the company to a strategic or private equity acquirer.  I think conservative downside is limited to $24.00 (6.5x HRS 07 ebitda and 18x Comdata 07 EPS, plus cash), and the upside conservatively in a year is $34 (9x HRS 08 ebitda and 20x Comdata 08 EPS, plus cash).  Clearly Pershing Square has stolen some of my thunder here; their involvement is a great ongoing catalyst which I think also limits downside to the stock.
Price:                $27.85                                                            
Shares              141.3m                                                           
Mkt cap:          $3.9B                                                                          
Cash                210m                                                              
Debt                 89m                                                                                        
Ent value          3.8B
Share volume    864k
$volume           $24m
Short interest    3.3m shares
Business description:          
Human Resource Services (“HRS”).  Ceridian is the third-largest payroll processor in the US, providing payroll, tax filing, and other human resource services to corporations in the US, Canada and UK.  Payroll processing primarily consists of preparing and furnishing employee payroll checks, direct deposits, supporting journals and summaries, and transmitting customer payroll funds to employees.  The Company also files social security, Medicare and federal, state and local income tax reports, remits funds to the appropriate authorities, and handles regulatory correspondence.
Summary P&L    
F'04 F'05 F'06e F'07e F'08e
HRS Services Core Revenue 893 944 965 1,023 1,084
Float income 72 106 139 149 159
Total HRS Revenue 964 1,050 1,104 1,172 1,243
HRS Services EBIT -4 51 95 129 162
HRS services EBIT Margin -0.4% 4.8% 8.6% 11.0% 13.0%
HRS EBIT ex-Float -76 -56 -45 -20 3
HRS EBIT Margin ex float -8.5% -5.9% -4.6% -2.0% 0.3%
HRS Incremental ebit margin 64.2% 81.3% 50.3% 46.3%
HRS Incremental ebit margin ex float 40.0% 52.0% 41.9% 37.9%
Comdata.  Comdata provides transaction processing, financial services and regulatory compliance to the transportation and retail industries.  Comdata’s transportation segment is 66% of revenue, while the retail segment is 34% of revenue.  Through the transportation segment, Comdata provides cards used by national trucking fleets to purchase fuel, pay drivers, monitor driver spend and prevent fraud.  In the retail segment, Comdata markets and processes loyalty cards to major retailers.
Summary P&L
F'04 F'05 F'06e F'07e F'08e
Comdata reported revenue 356 409 462 515 572
Comdata ex fuel 351 398 454 515 572
Comdata revenue growth 14.9% 13.1% 11.5% 11.0%
Comdata EBIT 117 136 161 170 189
Comdata EBIT Margin 32.9% 33.3% 34.9% 33.0% 33.0%
Comdata EBIT Growth 16.4% 18.4% 5.5% 11.0%
Investment Positives:
·        Large value gap, good risk/reward.  I think that the current valuation implies both parts of CEN are too cheap.  Comdata as a stand-alone entity should trade at the high end of the payment processor universe, implying at least a 20x P/E on 2007 earnings, owing to its high margins, scalability, double digit topline growth, and strong competitive position.  Comparable payments companies are FDC, GPN, HPY, MA, ADS and WXS, which trade at an average of 21x ’07 EPS.  At 20x 2008 EPS of $0.88, Comdata is worth $17.6/share.  The HRS business two closest comps are ADP and PAYX, which trade at 10.7x and 15.8x EBITDA.  Assuming CEN’s HRS business trades at 9x ‘08 EBITDA (a steep multiple discount on a low ebitda number), implies HRS is valued at $15 in a year (only 16.8x fcf).  Adding $0.85 in net cash, CEN should be valued at $34.00 in a year. 
·        Comdata transportation business.  Comdata is a dominant, growing, high fcf generative, 95%+ retention, high barrier to entry business with high switching costs.  Comdata essentially owns its available “Over the road” long haul diesel truck market, with 50%+ market share.  Comdata’s card and brand are a critical element of the trucking industry, enabling truck drivers to get paid, obtain fuel at a discount (the Company purchases 20% of diesel fuel in the US), and monitor spending patterns to prevent fraud.  Comdata benefits from the same “network effects” as does Mastercard and Visa; Comdata has almost ubiquitous acceptance at diesel fueling stations in the US and Canada, and has ubiquitous acceptance among truck fleets.  For a company to recreate Comdata’s network, that company would have to convince all the diesel stops to accept their card and simultaneously convince truckers to use their card.  (Comdata currently has 900,000 cards in use at over 20,000 fleets and 8,500 truck stops).  As a result of these barriers, Comdata has high retention and pricing power.  The marginal costs of a new transaction is low, so Comdata’s model is very scaleable and high margin (34% ebitda margins in 2007).  Additional growth drivers for Comdata going forward are entering the local fleet market and increasing wallet share of its truckers (such as capturing food, lodging and maintenance spend), which the company thinks could double the size of the current business.  Importantly, Comdata’s customers (the truck fleets) generate < 20% of revenues as most revenue is generated in the form of a merchant discount at the point of sale (obviously this dynamic facilitates adoption).  Comdata extends minimal credit to its fleets as most receivables are collected in < 5 days.  Finally, only 10% of Comdata revenue is directly tied to the price of fuel (this is not a fuel story in my view).
·        Comdata retail business.  Comdata and FDC are the two leaders in the rapidly growing prepaid gift card industry.  Retail generates 34% of Comdata revenue, grows revenue in the mid teens, and has mid 20s operating margins.  Gift cards are a “hot” area in payments as customers such as GAP, Lowe's, Barnes, Applebee’s and Target are looking to create loyalty and customer retention. Gift card SSS growth in the penetrated national retail markets is 8%, while middle market, QSRs and international is significantly less penetrated and growing faster.  FDC and Comdata have a lock on the national retail market, with customers under 2-3 year contracts.
·        HRS business is improving.  Ceridian has made long strides to improve margins in its HRS business.  Margins have improved progressed from 0%, 4.8% and 8.6% from 2004 to 2006.  The company has laid out a plan to get 20% EBIT margins by 2010.  There’s multiple reasons why HRS should be able to continue to improve margins:
o       Key competitors ADP and PAYX currently have 23% and 39% margins respectively.
o       There are four businesses within HRS which are losing money or are breakeven, i.e. if management were to shut them down, it would be immediately accretive.  These businesses are Human Resource Outsourcing (“HRO”), Small business, UK and Benefits, which together account for ~ $330M of revenue (30% of HRS) and generated an EBIT loss of ~30m.  Although management believes these are strategic and will not shut these down (although an acquirer certainly could), ex these losses HRS does 16% margins.
o       All four of the above business segments have new senior managers within the past year.   
o       The 380 bps HRS’ margin improvement this year is particularly encouraging given the Company had two “one-time” accounting items which negatively impacted the income statement this year.  An accounting change increased deferred revenue by $12m relative to last year, while stock compensation expense was $11m incremental, i.e. ex these two items margins would have been 200 bps higher.  Expanding margins in 2006 by 380 bps (despite a 200 bps headwind) and the fact that CEN does not have to grow over deferred revenue and stock comp in ’07, gives me added confidence they can continue to expand margins going forward.
o       Even excluding float income, incremental margins are 40-50%+ for the HRS business (was 52% in 06 including stock comp and deferred revs grow over).
o       The company spends $200m (20% of revenue on IT), i.e. way out of line.
·        M&A potential.   I think CEN in whole or part has a reasonable probability of being acquired at a significantly higher level.  ADP bought a HRS business called Probusiness in June of 2003 for 2.7x trailing revenue, even though ProBusiness generated negative ebitda.  Assuming Comdata is worth $17.60 (20x 08 EPS), CEN’s HRS business is trading at 1.1x ’07 revenue and only 6.7x ‘07 EBITDA.  Secondly, CEN’s main payroll competitor in the UK, a company called Northgate Information Solutions (Ticker: NIS LN), was recently rumored to be in play.  Several private equity firms including GA, Blackstone, and Carlyle were rumored as bidders.  The reported valuation of 1 pound/share was ~ 10x forward ebitda, although a deal ultimately fell through.  There are many strategic acquirors for HRS, including EDS, ACS, ACN, IBM and FDC.  I think ultimately the value to a PE buyer of HRS (from managing the business better) or to a strategic buyer (with large synergies from overlapping significant fixed costs) is significantly higher than the implied value of 1.1x revs and 6.7x EBITDA.
·        New CEO.  CEN hired Kathy Marinello in mid October ’07 to replace outgoing CEO Ron Turner.  This is a positive for the stock in my view as Turner has been in place since 1993 and a leadership change should further push CEN away from the status quo of HRS underperformance.  Marinello spent the last 10 years at GE fleet services and previously was with FDC.  That said, she has no specific HR experience and spoke of “acquisitions” during the Q3 conf call.  The biggest risk to the stock in my view is that she “clears the deck” when she takes full command or starts spending money frivolously.  Mitigant: The company has been improving HRS margins, and given the inherent scalability, I’d be hard pressed to see how she could steer the business in a worse direction.  The management team has said they are opposed to dilutive acquisitions. She has gotten good reviews in reference checks as a cost conscious and strategic thinker.
·        Board is hesitant to spin off Comdata.  Management has argued that spinning off Comdata is problematic for two reasons.  For one, HRS’s credit rating will be reduced to “junk” which would place them at a competitive disadvantage relative to ADP.  Secondly, there’s an outstanding SEC case related to accounting restatements which needs to be decided before they can split the company.  Mitigant: Management is arguably making excuses because they are afraid of having to run HRS in a more optimal manner.  The credit rating should be a non-issue because the company has no debt and management could simply opt to not have a credit rating.  Secondly, as it relates to the SEC investigation, management should be able to resolve this for $50m, not a meaningful amount. (Bisys just settled a similar investigation for $60m).  Third, I believe management thinks if they get HRS to 10% margins (an ‘07 event), they could spin Comdata.  Finally, structurally there are literally zero synergies between Comdata and HRS, i.e. there’s no business reason for them to coexist.  Ultimately, I’d expect some visibility into a Comdata spin by mid to late 2007.
·        Fuel and interest rate headwinds.  Rising interest rates have helped grow revenue at HRS, and the increase in float income has boosted revenue by 3% each of the last two years (all at 100% margin).  Half of the current ~ $3b HRS float is invested at Fed funds and the other half in 3-4 year duration money funds.  If the Fed cuts rates by 100 bps, HRS revenue would decline by $15m (1.5%) and EPS would be cut by 6c (4%).  Similarly, on the Comdata side, rising fuel prices increase ticket amounts and therefore Comdata revenue.  Mitigant: HRS has hedged interest rates in the past and will lock short term rates here at 5.25% and forgo upside above 6%.  If HRS hedged half of its short term portfolio at current rates, a 100 bps FED reduction (an unlikely ’07 event anyway) would reduce EPS only 3c.  Similarly, a 10c decline in diesel fuel impacts Comdata revenue by only 1.8m annually, so if diesel contracts 22% (a large move) in ’07 that’s a $10m revenue and ebitda hit (only a 4c hit to EPS).  So in total, I’m not that concerned about the financial impact of rates and fuel.
Fully diluted shares 141.3
Stock price $27.85
Market cap 3,935
Adjusted share price $27.85
Cash at 9/30 210
Debt at 9/30 89
Ent value 3,815
Net Cash/share $0.85
Dividend yield 0.00%
CEN   2005A 2006E 2007E 2008E
HRS Services 1,050 1,104 1,172 1,243
Comdata 409 462 515 572
TOTAL 1,459 1,566 1,687 1,815
HRS Services 51 86 129 162
Comdata 136 161 170 189
Corporate 0 0 0 0
TOTAL 187 247 299 350
Net Interest income 2 7 3 5
Tax 72 96 115 135
Net income 117 157 187 220
Shares 141 141 137 132
EPS          $0.83        $1.11      $1.36      $1.66
EBITDA 272 330 387 442
D&A 85 83 88 92
Capex (64) (65) (68) (70)
EBIT Margin %
HRS Services 5% 8% 11% 13%
Comdata 33% 35% 33% 33%
Total Margin 12.8% 15.8% 17.7% 19.3%
Rev Growth %
HRS Services 5% 6% 6%
Comdata 13% 12% 11%
Total Growth 7.4% 7.7% 7.6%
Comdata D&A assumption 20% 20% 20% 20%
HRS EBITDA   119 152 199 235
COMDATA EBITDA 153 178 188 207
Total Company 2006E 2007E 2008E
EV/Revenue 3.5x 3.3x 3.1x
EV/EBITDA 11.6x 9.9x 8.6x
P/E 25.0x 20.4x 16.7x
P/FCF 22.5x 18.5x 15.2x
2008 TARGET PRICE        
2008 HRS Multiples, Comdata at $18
Stock EV/ EV/ GAAP Cash  
price Revenue EBITDA P/E P/FCF Return
$24.35 0.6x 3.3x 7.2x 6.1x -13%
$24.85 0.7x 3.6x 7.8x 6.7x -11%
$25.85 0.8x 4.2x 9.1x 7.8x -7%
$26.85 0.9x 4.8x 10.4x 8.9x -4%
$27.85 1.0x 5.4x 11.7x 10.0x 0%
$28.85 1.1x 6.0x 13.0x 11.1x 4%
$29.85 1.3x 6.6x 14.3x 12.2x 7%
$30.85 1.4x 7.2x 15.6x 13.3x 11%
$31.85 1.5x 7.8x 16.9x 14.4x 14%
$32.85 1.6x 8.4x 18.2x 15.5x 18%
$33.85 1.7x 9.0x 19.6x 16.6x 22%
$34.85 1.8x 9.6x 20.9x 17.7x 25%
$35.85 1.9x 10.2x 22.2x 18.8x 29%
$36.85 2.0x 10.8x 23.5x 20.0x 32%
$37.85 2.2x 11.4x 24.8x 21.1x 36%
$38.85 2.3x 12.0x 26.1x 22.2x 39%
$39.85 2.4x 12.6x 27.4x 23.3x 43%
2008 SCENARIO ANALYSIS                            
COMDATA price/share at COMDATA EBITDA Multiples HRS Stock Price at HRS EBITDA Multiples
$192 $197 $202 $207 $212 $217 $222 $220 $225 $230 $235 $240 $245 $250
$0.85 $0.87 $0.89 $0.92 $0.94 $0.96 $0.99 $0.82 $0.84 $0.87 $0.89 $0.91 $0.94 $0.96
10.0x $13.60 $13.96 $14.31 $14.67 $15.02 $15.37 $15.73 7.0x $10.91 $11.15 $11.40 $11.65 $11.90 $12.15 $12.39
2008 10.5x $14.28 $14.66 $15.03 $15.40 $15.77 $16.14 $16.51 7.5x $11.69 $11.95 $12.22 $12.48 $12.75 $13.01 $13.28
EBITDA 11.0x $14.96 $15.35 $15.74 $16.13 $16.52 $16.91 $17.30 8.0x $12.47 $12.75 $13.03 $13.31 $13.60 $13.88 $14.16
Multiple 11.5x $15.64 $16.05 $16.46 $16.86 $17.27 $17.68 $18.09 8.5x $13.24 $13.55 $13.85 $14.15 $14.45 $14.75 $15.05
12.0x $16.32 $16.75 $17.17 $17.60 $18.02 $18.45 $18.87 9.0x $14.02 $14.34 $14.66 $14.98 $15.30 $15.62 $15.93
12.5x $17.00 $17.45 $17.89 $18.33 $18.77 $19.22 $19.66 9.5x $14.80 $15.14 $15.47 $15.81 $16.15 $16.48 $16.82
Implied P/E Multiples Implied P/E Multiples
$192 $197 $202 $207 $212 $217 $222 $220 $225 $230 $235 $240 $245 $250
$0.81 $0.84 $0.86 $0.88 $0.91 $0.93 $0.95 $0.69 $0.71 $0.73 $0.76 $0.78 $0.80 $0.83
10.0x 16.7x 16.7x 16.6x 16.6x 16.5x 16.5x 16.5x 7.0x 15.9x 15.7x 15.5x 15.4x 15.2x 15.1x 15.0x
2008 10.5x 17.5x 17.5x 17.5x 17.4x 17.4x 17.3x 17.3x 7.5x 17.0x 16.8x 16.7x 16.5x 16.3x 16.2x 16.1x
EBITDA 11.0x 18.4x 18.3x 18.3x 18.2x 18.2x 18.2x 18.1x 8.0x 18.2x 18.0x 17.8x 17.6x 17.4x 17.3x 17.1x
Multiple 11.5x 19.2x 19.2x 19.1x 19.1x 19.0x 19.0x 18.9x 8.5x 19.3x 19.1x 18.9x 18.7x 18.5x 18.4x 18.2x
12.0x 20.0x 20.0x 19.9x 19.9x 19.9x 19.8x 19.8x 9.0x 20.4x 20.2x 20.0x 19.8x 19.6x 19.4x 19.3x
12.5x 20.9x 20.8x 20.8x 20.7x 20.7x 20.6x 20.6x 9.5x 21.6x 21.3x 21.1x 20.9x 20.7x 20.5x 20.3x
Implied FCF Multiples Implied FCF Multiples
$192 $197 $202 $207 $212 $217 $222 $220 $225 $230 $235 $240 $245 $250
$0.85 $0.87 $0.89 $0.92 $0.94 $0.96 $0.99 $0.82 $0.84 $0.87 $0.89 $0.91 $0.94 $0.96
10.0x 16.1x 16.0x 16.0x 16.0x 16.0x 15.9x 15.9x 7.0x 13.3x 13.2x 13.2x 13.1x 13.0x 13.0x 12.9x
2008 10.5x 16.9x 16.8x 16.8x 16.8x 16.8x 16.7x 16.7x 7.5x 14.3x 14.2x 14.1x 14.0x 14.0x 13.9x 13.8x
EBITDA 11.0x 17.7x 17.6x 17.6x 17.6x 17.6x 17.5x 17.5x 8.0x 15.2x 15.1x 15.0x 15.0x 14.9x 14.8x 14.8x
Multiple 11.5x 18.5x 18.4x 18.4x 18.4x 18.4x 18.3x 18.3x 8.5x 16.2x 16.1x 16.0x 15.9x 15.8x 15.7x 15.7x
12.0x 19.3x 19.2x 19.2x 19.2x 19.1x 19.1x 19.1x 9.0x 17.1x 17.0x 16.9x 16.8x 16.8x 16.7x 16.6x
12.5x 20.1x 20.0x 20.0x 20.0x 19.9x 19.9x 19.9x 9.5x 18.1x 18.0x 17.9x 17.8x 17.7x 17.6x 17.5x


- Shareholder agitation
- A spin off of Comdata
- A sale of the entire company
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