Trade idea: Paychex vs ADP

Both businesses provide payroll/HR outsourcing services, with PAYX targeting smaller businesses (17 employees on avg) vs ADP's 96. Historically growth rates have been similar at 10-12% revenue, and multiples have been ~20-22x P/E. Now however PAYX is trading much more expensively at 22x P/E while ADP is around 16.5, even cheaper counting in the cash. I think the multiple gap should converge to ~2.5x => PAYX should fall ~15%.

ADP segments include Employer Services, within it basic payroll offering (delivering the checks, tax filing, w2 forms, direct deposit), and beyond payroll (retirement benefits management, insurance services like workers comp, other benefits admin). This segment is ~80% of income and 72% of revs. PEO segment - fully outsourced HR for SMB, not very profitable (5% of PBT, 12% of revs). Dealer services is a back-office solution for 25K auto dealers. ADP has ~600K clients, average retention is 90%.

Historically PAYX has traded at 25% premium to ADP, however believe this might be skewed as ADP used to own Brokerage Services and Travel Clearing business that it divested in 2007 - businesses and growth rates should be more comparable now.

Market dynamic: three top guys (ADP, PAYX, Ceridian) are around 60% of the market. Pricing typically works per employee: say $1 charge per each of 25 pay cycles on the low end, $6 per cycle for smaller firms.