Paychex Faces Threat From Intuit; ADP Continues SaaS Roll-up

Payroll giant ADP (NASDAQ:ADP) started off the year with a SaaS acquisition, DO2. This is its second SaaS acquisition within three months, the previous one being HRinterax. Its rival Paychex (NASDAQ:PAYX), on the other hand, has yet to make any acquisition. In fact, Paychex announced the sale of Stromberg to Kronos in October.

Paychex had acquired Stromberg and its product Time in a Box in 2003 to accelerate its entry in the time and labor management space. Paychex says Time in a Box will continue to be a part of its portfolio while Stromberg will be paired with Kronos, a leader in workforce management solutions that shares Stromberg’s focus on larger clients.

Paychex targets the small businesses with fewer than 100 employees, which are about 7.9 million in number, and has about 600,000 clients. SaaS is a good business model for small businesses, but Paychex has yet to make an acquisition while Intuit and ADP are marching ahead with SaaS acquisitions. Intuit has emerged as a strong threat to Paychex with its recent acquisition of PayCycle. PayCycle targets small businesses with fewer than 20 employees and has about 80,000 clients. I fully expect PayCycle, using Intuit’s brand and channel in the under-20-employee business segment, to grow rapidly in the next 24 months and pose a serious threat to Paychex. PayCycle is much cheaper than Paychex, almost one- third the cost of Paychex or ADP.  That would pigeonhole Paychex’s sweet spot to the 20- to 100-employee segment.

In December, Paychex reported Q2 revenue of $496.6 million, down 5% y-o-y. Net income was down 10% to $125.8 million or $0.35 per share. The company has a strong financial position with cash and total corporate investments of $605 million and no debt. Taleo is one SaaS talent management company that Paychex might consider. It has a partnership with Taleo, which has market cap of about $629 million and annual revenue of $168 million. Taleo, however, is an enterprise solution, and an acquisition would give Paychex a good offering in the higher end of the market.

In the SMB segment, an attractive acquisition prospect would be Intaact, which provides on-demand financial management applications to over 2,500 small and medium-sized businesses. Intaact is doing well as a replacement for people who are outgrowing Quickbooks. In 2007, Intaact was recognized by Inc. Magazine as the “Best for Replacing Quickbooks”. Acquiring Intaact would be a smart move on the part of Paychex to counter Intuit and embrace SaaS.

Paychex’s Payroll Services revenue decreased 7% to $350.8 million as checks per client declined 3.7% in the quarter, versus 5% in Q110 and 1.2% in Q109. Human Resource Services revenue increased 3% to $132.2 million.

The company reiterated that it expects revenue in 2010 to decline 2% to 5% to a range of $1.98 billion to $2.04 billion and earnings to decline 10% to 12%. The stock is currently trading around $29 with market cap of about $10.5 billion. It hit a 52-week high of $32.88 on December 4.

On the other hand, ADP with nearly $9 billion in revenues and about 570,000 clients, targets the enterprise market. DO2 provides electronic invoicing software and with its acquisition, ADP, will be providing solutions to CFOs and finance executives. It looks as though ADP is trying to roll up various pieces of the CFO/finance organization’s workflow. I recently suggested that ADP should acquire Salary.com, which has about 3,500 enterprise customers.

ADP last week reported its second quarter results. Q2 revenue was $2.2 billion, about the same as last year. Profit increased to $315.8 million or $0.62 per share from $300.5 million or $0.59 per share last year. Analysts expected earnings of $0.57 on revenue of $2.17 billion. In the fiscal year-to-date, ADP bought back shares for nearly $152 million and ended the quarter with $1.8 billion in cash. Q1 coverage is available here.

ADP said “key business metrics in Employer Services — pays per control, client retention, and new business sales — declined year-over-year, but the rate of decline has lessened. Dealer Services posted increased new business sales and continued to improve its share of a consolidating North American marketplace.” According to the latest ADP National Employment Report, U.S. private employment decreased 22,000 from December 2009 to January 2010, the smallest drop since employment began falling in February 2008.

With the economy improving, ADP now expects pays per control to decline 4% during the fiscal year, a slight improvement from its prior view of a drop of 4% to 5%. It expects EPS of $2.39 and total revenue to be flat to slightly down, compared with the previous estimate of down 1% to 2%. The stock is currently trading around $40 with market cap of about $20.5 billion. It hit a 52-week high of $44.50 on December 2.