Lays Out Opportunity for CDK to Optimize
Operations, Capital Structure
Introduces Value-Maximizing Plan Yielding ~$81
Per Share
Elliott Management Corporation (“Elliott”), which manages funds
that collectively own 8.6% of the common stock and equivalents of
CDK Global, Inc. (NASDAQ:CDK) (the “Company or “CDK”) today sent a
letter to the Board and Management of CDK outlining the opportunity
for compelling value-creation that exists at the Company. The
letter introduced a Value-Maximizing Plan, showing how optimization
of both CDK’s operations and its capital structure could generate
an increase in the Company’s stock price of more than 70% within 14
months. The letter can be viewed at
http://elliott-graphics.com/CDKletter.pdf.
Full text of the letter follows:
May 4, 2016
The Board of DirectorsCDK Global, Inc.1950 Hassell RoadHoffman
Estates, IL 60169Attn: Chairman Leslie BrunAttn: CEO Brian
MacDonald
Dear Les, Brian and Members of the Board:
I am writing to you on behalf of Elliott Associates, L.P. and
Elliott International, L.P. (together, “Elliott” or “we”),
which collectively own 8.6% of the common stock and equivalents of
CDK Global, Inc. (NASDAQ:CDK) (the “Company” or “CDK”),
making us one of the Company’s largest shareholders.
Over the past year, we have participated in an ongoing private
dialogue with the Company, particularly with Chairman Les Brun and
CFO Al Nietzel. We have also had the chance to spend time with
Brian MacDonald since his appointment as CDK’s new CEO in March. We
have enjoyed this dialogue, and we look forward to continuing it.
We have enormous respect for Les, Brian and Al, and we think their
combination of skills and experience could be critical to realizing
the significant opportunity in front of CDK.
The purpose of today’s letter is to share our thoughts on this
compelling opportunity and to lay out a plan for CDK to optimize
its business operations and drive a meaningful improvement in
shareholder value. As the leader in the Dealer Management System
(“DMS”) market, CDK possesses a uniquely attractive business,
selling mission-critical software on a subscription basis to sticky
auto dealership customers with long-term contracts. However, our
extensive public diligence has confirmed that CDK’s operations
remain vastly under-optimized, which is affecting both business
performance as well as valuation.
In fact, CDK has the opportunity to enhance its EBITDA margin
profile to 42% in FY2018 from its current 24% margin and to
re-orient its capital structure to one more appropriate for its
durable, subscription-based business. For
shareholders and employee shareholders, such optimization, if
executed correctly, should yield a stock price of ~$81 within 14
months, a 72% increase to the current price.
For Brian and his new management team, we view this moment as a
unique opportunity to embark upon a new era of outperformance at
CDK under their leadership. The letter is organized as follows:
- We begin by introducing the situation
briefly. CDK has a uniquely attractive
business, despite being spun out of ADP with an
operational framework and capital structure that are not optimized
for a market-leading vertical software business.
- Next, we focus on the progress to date.
Despite the clearly identifiable opportunity, CDK has not yet taken any meaningful steps to pursue
an optimization of its business operations and capital
structure.
- We then discuss the value-maximizing
path forward. CDK can and absolutely
should take steps to realize the margin-improvement and
capital-return opportunities at hand. With CDK’s main
competitor running its North America business at EBITDA margins of
~55% (versus CDK’s ARNA segment at just 30%, with corporate
overhead fully allocated in both figures) and exhibiting healthy
growth recently, there is significant opportunity for CDK
management to improve its target margin profile.
- Finally, we address the road ahead. We
believe that given the time lost since CDK’s spin-off, progress cannot be delayed any longer.
Expedient implementation of the Value-Maximizing Plan laid out in
this letter would upgrade the organization, streamline the
operations, optimize the capital structure and position CDK for
growth. Unless the Board plans to run a
process to fully explore the existing strategic and private-equity
interest in acquiring CDK, it should commit to the Value-Maximizing
Plan without reservation.
As active investors in the technology industry, we have
considerable experience investing in software companies, and we
have put a tremendous amount of resources and time into researching
these recommendations. We thank the entire Board and management
team for its consideration of our thoughts and welcome any
questions.
About Elliott
Elliott is an investment firm founded in 1977 that today manages
approximately $28 billion of capital for both institutional and
individual investors. We are a multi-strategy firm, and investing
in the technology sector is one of our most active efforts and one
in which we have built a long track record. Elliott’s current and
prior investments in software companies include Citrix, Qlik,
Mitchell International, Informatica, Novell/Attachmate, BMC
Software, MSC Software, Compuware, E2Open, EMC/VMware and many
others. Through years of experience operating, investing and
sitting on the boards of software companies, we have developed
significant in-house expertise not only in understanding the
business models, growth prospects and competitive dynamics of
horizontal and vertical enterprise software companies, but also in
achieving operational excellence across sales and marketing,
product development, support and implementation functions. Over
time, we also have formed strong relationships with senior
executives and expert consultants and advisors across the space,
which have informed our viewpoints.
Our approach to CDK is consistent with our approach to many of
our current and previous technology investments. We have conducted
extensive public research to better understand the Company’s
operations and strategy, including working with respected
technology and management consultants to examine the broader DMS
and Digital Marketing markets and CDK’s position within those
markets. We have also worked with industry experts and IT buyers at
dealership groups to examine and assess the capabilities and
competitive positioning of CDK’s products and technologies across
all of its offerings. Our efforts included a survey of over 450 IT
buyers at various dealerships, enabling us to better understand the
DMS landscape from a buyer’s perspective and to identify what
factors are most important in driving purchasing behavior. We have
also retained experienced and proven C-level executives with
technical and operational capabilities in the software and broader
technology marketplaces to advise us on higher-level corporate
considerations. Finally, we have retained several
performance-improvement consulting firms, which have conducted
public research to evaluate CDK’s operational efficiency and have
developed specific recommendations across all functional areas.
We believe this time- and resource-intensive exercise has given
us a strong understanding of the markets in which CDK participates
and has resulted in well-researched recommendations for creating
value. We believe these recommendations will significantly improve
CDK’s business and drive substantial shareholder value-creation
over time.
CDK: A Unique Opportunity
As we have written to the Board previously, CDK has an extremely
compelling business model. It leads the DMS market in North America
with over 40% market share, generates a highly attractive annuity
stream through its subscription-based suite of software
applications and enjoys a sticky, diverse
customer base with an average DMS client tenure of 20 years.
This customer stickiness is driven by the mission-critical nature
of its DMS offering, the quality of its products and CDK’s
long-term customer contracts – all of which make CDK’s subscription
revenue stream grow nicely during good times while remaining
incredibly resilient during economic downturns. Indeed, from the
perspectives of both business-model quality and the magnitude of
its value-creation opportunity, CDK is one of the most attractive
software businesses we have invested in to date.
However, it is not surprising how and why
the current state of affairs exists at the Company. Based
outside of Chicago, CDK was a division of ADP, a large
payroll-services company headquartered in New Jersey, for 42 years.
ADP senior management took a hands-off approach to managing the
division as long as it achieved its single-digit revenue-growth
goals and demonstrated a small amount of margin expansion annually.
The division was never optimized as a vertical software business,
primarily because its management team did not hail from the
software industry and did not have strong incentives to
meaningfully improve the division’s operational effectiveness and
productivity. Furthermore, when the business was spun off in
October 2014, the CEO chosen to lead the new public company was a
39-year veteran of ADP and the same executive who had been running
the division for the past decade.
CDK was thus separated from ADP with what we believe to be two
unique and substantial opportunities to create value: highly
inefficient operations and a suboptimal capital structure. In
addressing these two issues, CDK has the opportunity not just to become more efficient, but to become a
better business.
With the spin-off of CDK having been announced in early April
2014, CDK has had over two years to develop an appropriate business
plan as a standalone company and execute swiftly against it.
Unfortunately, over this long time period, little has been done to
capture this opportunity.
Progress To Date Has Been Limited
In the two years since CDK’s spin-off was announced and in the
19 months since the Company has been public, very little progress
has been made in improving its operations or capital structure.
Despite significant encouragement from shareholders and the
announcement of moderate operational changes in June of last year,
little has been done, with CDK achieving only $15 million of cost
savings to date under its margin improvement plan and initiating a
small buyback of $250 million, only 3% of the Company’s market cap
at the time.
(Follow this link for a graphic illustration of the limited
progress made to date:
http://elliott-graphics.com/exhibit1.html)
This lack of progress has created a credibility gap with
investors and also has real business implications, including
employee uncertainty as they are forced to head to work each day
aware that there is a “restructuring” going on without any end in
sight. In contrast, successful large restructurings in the software
sector are executed swiftly, with such
prompt cost actions considered a “best practice” by nearly all cost
consultants. Such action is best for employees, for customers and
for the business itself, allowing for a return to business as usual
rather than being mired in a multi-year restructuring.
(Follow this link for a graphic illustration of the reasons that
prompt cost action is best for the Company:
http://elliott-graphics.com/exhibit2.html)
Employee feedback submitted on Glassdoor indicates the
importance of acting swiftly and decisively during this
restructuring in order to limit uncertainty and prevent CDK from
falling into a perpetual state of flux:
“Direction and focus on work is in flux...
lack of clear leadership in upper management. New, key senior
leadership roles will either make it great ... or not. Only time
will tell.”
– Current Full-time Employee, Feb.
2016
“Constantly changing company. Job security is
nonexistent as the changes they make may or may not put you out of
the job. Make up your minds. Pick a business plan and stick with
it. Give your employees time to adjust.”
– Current Full-time Employee, Jan. 2016
“The whole RIF environment has everyone on
edge, even if no one talks about it.”
– Current Full-time Employee, Oct.
2015
For their part, investors have been deprived of the valuation
potential of CDK and the cash flow the Company could have yielded
to invest in growth. Below are quotes from current CDK shareholders
that reached out to us to convey their frustration with the
Company’s current state of affairs:
“…even after 18 months since the spin,
CDK’s margins are less than half of Reynolds’ and the company has
only cut $15 million under the plan they put out last
June.”
“CDK should be levering up and doing a $1.5 billion buyback immediately given
where the stock is.”
“We know that CDK can double its margins if it executes, but
everyone we speak to is skeptical that
management is actually focused on taking out cost due to the total
lack of progress so far.”
“CDK’s buyback is much smaller than we had expected.
This company can support a ton of leverage
and should be buying back stock aggressively at these
prices.”
“We hope that they can focus on margins – they should outperform their 35% EBITDA margin target
if they execute successfully.”
“We have been holders since right after the spin-off and were
happy to see such an active shareholder base take shape as we think
this will help keep management
laser-focused on the big opportunity ahead of them.”
“The DMS business has a lot of recurring revenue and generates a
lot of cash – we wish management would
announce something more aggressive on the buyback
front.”
Shareholders are understandably disappointed and concerned by
the lack of progress to date and believe the optimal value-creative
actions are long overdue. They feel strongly that CDK’s Board and
management must take more significant steps with regard to
enhancing operational effectiveness and capital return, providing
greater clarity around the path to an optimal margin profile and
demonstrating an overall commitment to long-term
value-creation.
While CDK’s legacy management team squandered a substantial
amount of time by failing to take action, we believe with the recent appointment of Brian as CEO and what we
hope is a new mandate for change, CDK can now make up for this lost
time. There is a tremendous opportunity for real leadership
at CDK, and we believe Brian, Al and the rest of their team, with
support from the Board, can present a plan to maximize value at
CDK.
CDK Can and Should Be More Efficient
Though CDK possesses a uniquely attractive business model with
loyal customers, sticky contracts and a strong competitive
position, the extensive public diligence we performed has clearly
confirmed that CDK is profoundly
under-managed. For example, in FY2015 ended June, CDK’s
adjusted EBITDA margin was 23% and EPS
(excluding stock-based compensation) was $1.50. With proper
management, CDK can achieve an EBITDA margin
and EPS of at least 42% and $4.06, respectively, by FY2018.
We believe this significant improvement in CDK’s financial
performance can be achieved in a timely fashion if the right steps
to improve the Company’s operations and capital structure are
taken.
CDK has clear operational benchmarks to look to in the form of
DMS peer Reynolds & Reynolds (“R&R”) and digital marketing
competitor Dealer.com. The North America and International DMS
businesses of R&R, the second largest DMS vendor, are nearly
perfect comparables for CDK’s ARNA and ARI segments, respectively.
Though smaller in scale than CDK in the DMS market (with R&R
generating approximately 40% less revenue than CDK in North America
DMS), R&R is able to compete effectively in the DMS market with
a vastly superior approach to managing operations, manifested in a
substantially more efficient margin profile. R&R achieves this
level of operational effectiveness by limiting the management
layers that sit between senior and junior members of the company;
running highly efficient and productive teams in software
development, customer support and implementation; and operating out
of low-cost locations.
As a result, R&R is able to grow its revenue while
maintaining a consolidated EBITDA margin
profile of more than 50% and an EBITDA margin for its core North
America DMS segment at approximately 55%. Similarly,
Dealer.com, prior to its acquisition in 2014, achieved meaningfully
higher margins than CDK’s Digital Marketing segment currently
generates. The margin differential between CDK and R&R is in
part due to R&R’s more productive workforce (higher revenue per
head), more cost-effective labor base (lower cost per head) and
smaller facility footprint (8 R&R facilities globally versus 80
for CDK). Our public diligence shows that CDK can close this gap
and has a significant opportunity to drive increased employee
productivity across functional areas; reduce cost per head; move
operations to lower-cost geographies; restructure its software
development, customer support and implementation organizations;
optimize management spans of control; leverage inside sales; and
rationalize facility footprint. The charts below illustrate the
significant differences in operational effectiveness and
productivity between CDK and its closest peers.
(Follow this link for a graphic illustration comparing CDK’s
margins to those of its closest segment peers:
http://elliott-graphics.com/exhibit3.html)
(Follow this link for a graphic illustration comparing CDK and
Reynolds & Reynolds on productivity measures:
http://elliott-graphics.com/exhibit4.html)
If the gap is closed between CDK and its direct peers, then CDK
will generate a consolidated adjusted EBITDA margin of at least
42%, as shown below. It is important to note
that in each of its segments, CDK is larger than its relevant peer
comparable below, which suggests there is potential upside for CDK
beyond the figures below due to scale advantages.
(Follow this link for a graphic illustration of CDK’s Target
EBITDA Margin Profile:
http://elliott-graphics.com/exhibit5.html)
In addition to taking prompt operational action to achieve an
optimal margin profile, CDK should capitalize on its current
inexpensive valuation by immediately looking to improve its
suboptimal capital structure and capital return program. Given the
significant opportunity to improve margins by almost 20 points over
the medium term, we believe the Company should repurchase a
substantial amount of stock promptly. As CDK executes against an
appropriate margin-expansion plan, its stock price should increase
meaningfully, by which point CDK will have missed out on an
attractive opportunity to invest in its own stock at lower prices.
Thus, it is highly advantageous for CDK to commence a large buyback
now to maximize its earnings-per-share accretion and the
return-on-investment on the buyback.
Both a large one-time share buyback and ongoing repurchases can
be funded with new debt given CDK’s attractive credit profile,
characterized by substantial recurring revenue, long-term contracts
with sticky customers, a strong competitive position, demonstrated
resilience through economic downturns and a compelling
margin-expansion story. Despite this attractive credit profile, CDK
is currently only levered at 1.8x net debt / LTM EBITDA. Based on
our analysis with our investment banking and credit rating
advisors, we believe a net leverage target of 3.0x is prudent as a
public company of CDK’s quality. With net leverage of 3.0x and an
improved margin plan, CDK would still produce over $400-$500
million of annual free cash flow while retaining significant
balance-sheet capacity and financial flexibility. Also, given the
nature of CDK’s business and its low customer concentration, we
believe there is no business purpose for maintaining an
investment-grade rating. Rather, CDK should look to lower its
overall cost of capital and commence debt-funded share repurchases
at these very attractive stock price levels and ahead of several
years of meaningful earnings growth. There are a number of relevant
public technology companies with attractive durable businesses that
maintain net leverage significantly above 3.0x including Solera
Holdings (prior to its recent take-private), SS&C Technologies,
Sabre Corp, and Zebra Technologies.
We have also performed extensive diligence on CDK’s ability to
repurchase a meaningful amount of stock during the two years since
the spin-off on October 1, 2014. Our legal advisors and tax experts
have concluded that CDK has complete flexibility to repurchase 20%
of the initial shares outstanding at the time of the spin-off
through September of this year, after which point CDK’s ability to
repurchase stock is completely unconstrained. Given the Company’s
low level of repurchases to date, this allows for over $1.2 billion
of stock repurchases through September, which depending on expected
trading volume, could take the form of a tender offer, accelerated
share repurchase or normal course open-market buyback.
The Value-Maximizing Plan
We strongly believe in the opportunity for CDK to put in place
the following two-pronged Value-Maximizing Plan:
- Improved
Operations: CDK should announce that it is increasing
its FY2018 EBITDA margin target from 35% to 42% and is committed to
improving operating performance quickly and decisively. CDK will
provide shareholders regular updates on progress against the
plan.
- Enhanced
Capital Return: CDK should accelerate its capital return
plan by committing to repurchase $1.0 billion of stock through the
end of calendar year 2016 funded with new debt and balance-sheet
cash as well as announce a new long-term capital return plan
comprised of ongoing buybacks funded by both cash proceeds
generated by maintaining a 3.0x net leverage target and returning
65% of annual free cash flow.
In our view, this plan will drive significant shareholder value,
and with more productive operations and an
appropriate capital return program, CDK’s share price should be
~$81 within 14 months, an increase of 72% to the current share
price.
This sizable quantum of upside reflects the magnitude of the
opportunity. Further, this situation – an exceptional business run
for years as a segment within a much larger organization and
therefore never optimized as a standalone public company, coupled
with clearly observable peers and data points that lay out the
roadmap to vastly superior profitability – is rare. This
combination of factors drives the size of the opportunity.
Below we illustrate the value-creation opportunity using what we
believe are conservative assumptions, below our internal base case.
We use Street consensus revenue figures that we believe will prove
conservative over time. Internally at Elliott, we believe CDK will
perform closer to a 7% revenue CAGR for FY2015-19E, which is the
forecast developed by our advisors, including a leading management
consulting firm that we commissioned to perform a months-long study
on CDK and the DMS and Digital Marketing markets. Regarding margins
and capital structure, we are comfortable with our assumptions for
all the reasons highlighted above with a margin improvement plan
that our advisors and consultants have developed and validated
through their public research and a prudent and realistic capital
return approach that was constructed by our investment banking and
credit ratings advisors.
Under this framework, we derive a price target of ~$81 in the
next 14 months, which we believe to be conservative. We are
assuming 20x FY2018E EPS (excluding stock-based compensation) as
the mid-case NTM P/E multiple based on the below analysis of
Vertical Software peers. We compared i) the companies’ growth rates
and ii) overall business quality, which we define as stickiness and
durability. As CDK has exhibited a uniquely durable business model
with an average customer tenure of 20 years, established clear
leadership in its market and demonstrated unusual resilience
through economic downturns, we believe CDK has extremely high
business quality.
(Follow this link for a graphic illustration of the NTM P/E
multiples for CDK and its vertical software peers:
http://elliott-graphics.com/exhibit6.html)
Given this level of business quality, we believe our 20x forward
P/E mid-case assumption has upside. CDK currently trades at 23x NTM
P/E (excluding stock-based compensation), and we see potential for
the business to more reasonably trade at 24x over time. Finally,
the mid-case of our analysis implies an NTM EBITDA multiple of
~13x, which we also believe is conservative. We sensitize our
valuation multiple assumption below to capture other scenarios as
well. We would also note that peer DealerTrack, which has a large
auto finance network business that grows faster than CDK but which
is transactions-based and reliant upon auto sales (versus CDK’s
highly durable and stable subscription-based business), was
acquired by Cox Automotive in 2015 for ~40x forward P/E.
(Follow this link for a graphic illustration of the framework
for the Value-Maximizing Plan:
http://elliott-graphics.com/exhibit7.html)
This plan is entirely achievable over the medium-term and would
result in not only a higher stock price but a better, more productive business.
An attractive feature of the Value-Maximizing Plan is that it
requires no counterparty, and thus it is completely within the
control of CDK’s Board and management to implement. That said, we
are aware of significant private equity interest in acquiring CDK
and believe that strategic buyers may be interested in the Company
as well. These are certainly options that the Board should
thoroughly explore if the Company prefers to engage in the
recommended business optimization outside of the public eye or as
part of a larger organization. There are absolutely merits to receiving certain, premium value
in the form of a sale for cash, which requires no
ongoing exposure to business risk or the capital markets.
However, if CDK chooses to remain a
standalone public company, we believe the Value-Maximizing Plan
should be implemented immediately.
Next Steps
We are excited about the opportunity to drive significant value
at CDK and are firmly committed to our investment as active
shareholders. We strongly believe it is time to take urgent action
to address the opportunities that have existed since CDK’s
separation from ADP. Despite being public for 19 months, CDK’s
previous management made very limited progress executing on the two
clear and fundamental points of value-creation: margin improvement
and capital allocation.
We believe that the delay has hurt CDK and that much more needs
to be done. Signs of Board commitment to this pathway appear to us
to be urgently needed, as shareholders are looking for leadership
from both the Board as a whole and Brian as the new CEO. For our
part as large and engaged shareholders, we are committed to seeing
this change through. We respect and have confidence in the new
leadership team at CDK and believe this moment represents the
fortuitous combination of a talented team with a historic
opportunity. We believe all shareholders will be well-rewarded by
the improved operations and significant value-creation that
result.
We look forward to maintaining a collaborative dialogue, and we
are excited about the path ahead. Thank you very much for your time
and consideration.
Best regards,
Jesse CohnSenior Portfolio Manager
Cautionary Statement Regarding Forward-Looking
Statements
The information herein contains “forward-looking statements.”
Specific forward-looking statements can be identified by the fact
that they do not relate strictly to historical or current facts and
include, without limitation, words such as “may,” “will,”
“expects,” “believes,” “anticipates,” “plans,” “estimates,”
“projects,” “targets,” “forecasts,” “seeks,” “could,” “should” or
the negative of such terms or other variations on such terms or
comparable terminology. Similarly, statements that describe our
objectives, plans or goals are forward-looking. Our forward-looking
statements are based on our current intent, belief, expectations,
estimates and projections regarding the Company and projections
regarding the industry in which it operates. These statements are
not guarantees of future performance and involve risks,
uncertainties, assumptions and other factors that are difficult to
predict and that could cause actual results to differ materially.
Accordingly, you should not rely upon forward-looking statements as
a prediction of actual results and actual results may vary
materially from what is expressed in or indicated by the
forward-looking statements.
About Elliott
Elliott Management Corporation manages two multi-strategy hedge
funds which combined have approximately $28 billion of assets under
management. Its flagship fund, Elliott Associates, L.P., was
founded in 1977, making it one of the oldest hedge funds under
continuous management. The Elliott funds’ investors include pension
plans, sovereign wealth funds, endowments, foundations,
funds-of-funds, high net worth individuals and families, and
employees of the firm.
View source
version on businesswire.com: http://www.businesswire.com/news/home/20160504005997/en/
Media:Elliott Management CorporationStephen Spruiell,
212-478-2017sspruiell@elliottmgmt.com
CDK Global (NASDAQ:CDK)
Historical Stock Chart
From Jun 2024 to Jul 2024
CDK Global (NASDAQ:CDK)
Historical Stock Chart
From Jul 2023 to Jul 2024