Cliff Banks - The Banks Report

CDK — A company in Transition

July 2, 2015 — Its stock price has more than doubled since October, yet CDK is transforming its company. Executives recently announced a series of moves that will have a long term effect on the company’s future. The moves include an ambitious financial plan to return value to shareholders; a new board member who could end up running CDK; and a new data security initiative.

CDK Global, under pressure from investors to increase margins, laid out two weeks ago to analysts how it plans to return value to its shareholders. The aggressiveness of the plan’s goals surprised analysts who, along with investors, responded favorably.

But the company was vague about how it actually will meet those objectives. It likely will include significant — yet targeted — layoffs, some of which have already begun.

Despite the challenges, CEO and President Steve Anenen and his team, appear to be making the right moves.

To see previous analysis of CDK Global click: CDK Global Analysis.

Ambitious Targets

Anenen told analysts to expect the following results over the next three years (taken from a press release from CDK):

  • Revenues will grow 4% to 5% annually on average for the next three fiscal years, and 5% to 7% thereafter;
  • Additional EBITDA of $250 to $275 million will be generated over the next three fiscal years resulting in significant margin expansion of approximately 1,300 basis points during that time, and approximately 150 basis points annually thereafter;
  • Target adjusted EBITDA margin for fiscal 2018 is 35% for total CDK;
  • Target segment adjusted pretax margins for fiscal 2018 – 45% for Automotive Retail North America, 20% for Digital Marketing, and 25% for Automotive Retail International;
  • Adjusted pre-tax earnings will grow more than 25% annually on average for the next three fiscal years;
  • Increased earnings will drive free cash flow generation of approximately $1 billion over the next three fiscal years of which 70% to 80% will be returned to shareholders through dividends and share repurchases or other appropriate vehicles that are available.

Multiple analysts in Hoffman Estates for the presentation relayed to The Banks Report that they were surprised at how aggressive the targets are. The message clearly is what investors and analysts were looking for as the stock jumped nearly 10% to almost $56 following the presentation.

Background

Last September ADP spun off its Dealer Services Group into a separate and public company called CDK Global. Within a month of the IPO investor Scott Ferguson of Sachem Head announced an activist position in the company. He was soon followed by Jeffrey Tannenbaum of Fir Tree Capital (Fir Tree in May reduced its position in CDK by more than 12% to 7.8%).

The investors clearly saw a company whose financial performance could be significantly improved.

Analysts speculated that Anenen was fighting for his job — and he may still be as the company announced in mid-June the addition of Brian MacDonald to its board. MacDonald recently served as interim CEO of the Hertz Corporation. He also led a significant restructuring as the Chairman, CEO and President of Sunoco.

If Anenen were to be forced out by the investors, MacDonald is the logical choice to step into his role.

At the moment, though, it may be hard to make the case for Anenen’s ouster as the company’s stock price has more than doubled from a low of $25 in October to more than $53 today.

Tough to complain about doubling one’s investment…not to mention CDK is one of the top three companies in automotive retail generating nearly $2 billion in revenue with a market cap of more than $8 billion (for comparison, Dealertrack, with just over a $1 billion in revenue and a market cap of $2.4 billion, is in the process of being acquired by Cox Automotive for $4 billion).

Companies in automotive retail haven’t had to deal with activist investors (unless you’re Autobytel) but there is a playbook to follow for executives in such situations, and Anenen seems to be following it perfectly. It’s always tough to know exactly what’s going on inside the walls of any company, but outside those walls, Anenen and his team are saying the right things and the plan they introduced is what investors have been looking for.

For now, Anenen and his management team seem to be providing a great example for future business school textbooks and other CEOs on how to work with activist investors.

Analysis

The challenge is going to be executing in a way to hit the ambitious targets CDK has set.

Executives understand they’ll need to maintain a level of pricing discipline without sacrificing market share. It’s a fine line to walk for a public company. When UCS acquired Reynolds and Reynolds and took it private in 2006, the company was able to walk away from numerous unprofitable contracts — a key reason it has been able to drive extraordinary margins the last several years.

CDK has no such luxury. Because it’s a public company, it has to continue growing market share and that means taking on or maintaining some contracts that generate little to no profit.

It’s likely much of its increase in margins is going to come from significant layoffs or employee attrition — some of which has already begun according to company insiders. (The same was true of Reynolds and Reynolds in 2006).

Another challenge is the lack of a viable CRM product. Neither its CRM solution or the service solution, ServiceEdge, have performed well in the market. The problem is, both products need to be fixed — and probably rewritten from the ground up. Great concepts — but CDK needs to get the products right.

But that may take too long so an acquisition is likely the way to go. The company CDK needs to target is ELeads — which likely isn’t for sale.

That acquisition — though it would be pricey — would solve several of CDK’s challenges. A viable CRM product with significant market share (including among the top dealer groups) with the latest service-related solution to compete directly with Cox’s Xtime — and it would likely help CDK drive margin growth.

Dealersocket might also be in the picture but would be stretch — mainly because Vista Equity Partners made a significant investment in Dealersocket last year. It is the leader in the CRM space and CDK needs a solution, so don’t rule Dealersocket out — although, highly unlikely.

Security First Initiative

The same week CDK announced its financial plan, it also introduced a new data security initiative — Security First. The announcement was short on details — actually, it had no details other than the name and the fact that it was being launched.

This is a tough one — for the last year or so, vendors have expressed concern that CDK appeared to be setting the stage to adopt stringent integration rules — similar to or tougher than what Reynolds and Reynolds has.

There is no doubt, data and platform security is going to be a driving issue the next several years. We wrote about it extensively earlier this year — Dealerships are Key in Cyber Attack Wars

CDK and Reynolds executives know this. So the focus on security is well-founded. The issue is that CDK (nor Reynolds) is not just a DMS vendor — it has numerous solutions that surround and integrate with the DMS.

And those solutions compete with other solutions in the market that have to integrate with its DMS in order to be effective.

There’s no way CDK will admit this publicly but why would it make it inexpensive and easy for competitors to integrate into its system? Other vendors like to talk about the principled approach that it’s the dealer’s data and that CDK and Reynolds are preventing the dealer from effectively using that data.

But if they were on the other side, they would take CDK’s approach — which is to make integration much more difficult than it has in the past. The challenge is that several of CDK’s dealer clients use competitive solutions and don’t want to see that integration go away.

It’s likely the investors believe there is an opportunity and are pushing CDK’s management to take a much tougher approach. It will be interesting to watch CDK navigate these waters over the next several months — it has to be able to work with certain competitors to keep key dealer customers happy.

CDK’s strategy will continue to evolve over the next year.

Other Ventures

An intriguing announcement last week revealed CDK participated in a $24 million Series B investment led by USAA in Automatic, a connected car platform.

First, it’s likely we’ll see more of these types of investments from CDK. It’s a similar model to that of Cox Automotive, which has invested in ventures such as CarMD, Get Around Auto and Vinli.

Second, it indicates that CDK is looking at potential telematics solutions for its dealers. Automatic uses an adapter that plugs into the vehicle’s OBD-II port to collect data which then is shared via Bluetooth with the driver’s smartphone.

Automatic recently launched a software development kit for app developers which should provide significantly more usability for drivers.

The investment positions CDK to be a leader in what should be an exploding sector the next several years.

Final Note

Within the next year, CDK will be a much leaner company. It’s already underway. But it has to make those changes in a way that doesn’t negatively affect client support levels (and that’s always a danger with activist investors or private equity money — the changes are great for the bottom line but not always what’s best for the customer).

Meanwhile, it will continue to be one of the power vendors, along with Reynolds and Reynolds and Cox Automotive, essentially controlling much of what happens in the automotive retail space.

 

 

 

 

 

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