ADP’s All but Automatic Growth, and What’s Driving Iomega

Stock Exchange gives readers a chance to listen in as staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks and other investments.

Automatic Data Processing (AUD)

Chase Manhattan Monday: $77.50

Jim: If I could buy only one stock, Mike, Automatic Data Processing would be on my short list. Year in, year out, it’s a great pick.

Mike: Automatic Data Processing is the Cal Ripken Jr. of Wall Street, all right.

Jim: Folks sometimes misidentify the company as Automated Data Processing and assume its ticker symbol is ADP when it’s actually AUD. But one thing is crystal clear: This is a premier operation.

Mike: No question, its record is pretty hard to beat.

Jim: It’s startling, actually. ADP has reported double-digit gains in revenue and earnings per share for 149 straight quarters! That’s 37 years, going back to 1961 when ADP went public.

Mike: This is the classic Graham and Dodd stock.

Jim: In what way?

Mike: Benjamin Graham and David Dodd wrote a famous book, “Security Analysis,” that explains how to find value stocks, a book that’s touted by the likes of billionaire stock picker Warren Buffett. ADP is such a stock. It returns value. It’s something you can sink your teeth into. It’s the opposite of a speculative stock.

Jim: First things first. ADP, as its name implies, is a leading provider of computer services for other companies of all shapes and sizes. But small businesses, especially car dealers, use it a lot.

Mike: ADP handles payroll services, benefits computations, credit processing, that sort of thing. Many of our readers probably get their paychecks from ADP, printed on paper that has the “ADP” logo in the background.

Jim: Despite what the company’s string of earnings gains make you think, it by no means dominates its industry. No one does. In other words, it still has lots of room to grow.

Mike: How else to explain how its earnings string could continue so long?

Jim: But ADP said a while back that it won’t be held hostage to keeping that string alive. That raised eyebrows on Wall Street, to say the least.

Mike: Sort of like Ripken saying a year ago that he might sit out a game or two in 1998--as he finally did. So the question is: Are these two streaks coming to an end at around the same time?

Jim: I don’t think so, but this is the type of uncertainty that’s long been the polar opposite of what investors have gotten with ADP.

Mike: Maybe ADP is just being realistic. It’s always hard to maintain double-digit earnings growth when you’ve been doing it for 37 years, compared with, say, a company just starting out and working from a small base. But the market is probably safe in making the assumption that ADP will still deliver excellent gains.

Jim: Agreed. Whether it’s single- or double-digit growth, I expect ADP to keep generating very strong results.

Mike: And it doesn’t trade at a price-to-earnings multiple that’s anywhere near as high as some companies that get Wall Street all excited by posting two or three quarters of double-digit gains. ADP currently sells for about 34 times its fiscal ’99 earnings per share. Not cheap, but you’re paying for its consistency.

Jim: Now, there is one risk with ADP that makes me a little nervous: About 20% of the company’s revenue comes from its back-office automation work for the volatile brokerage industry.

Mike: In another words, if Merrill Lynch & Co. sneezes, ADP might catch cold.

Jim: You got it. And there’s been more sneezing and sniffling on Wall Street lately, given the market’s slide, than at a performance of Wagner. But I’m not overly worried about it, because ADP isn’t dependent on that business.

Mike: Not only that, if Wall Street brokerages get a bad case of the sniffles, they just might outsource more of their back-office business to people like ADP, to save money.

Jim: Yep. That’s ADP’s whole bag--that they can do many of these automation chores for less money than its customers can do them in-house.

Mike: All of which explains why ADP’s stock, which currently trades in the high $70s, has generally weathered the stock market’s slump this year. It took a hit last month--on no news that I could find--but it’s climbing again and is up a whopping 55% for the past 12 months.

Jim: Think about it: ADP has chalked up its remarkable earnings string through recessions, wars, merger manias, stock market crashes, you name it.

Mike: Know what else I like about ADP? It’s the opposite of those “story” or “concept” stocks that somehow manage to draw investors’ cash on a wing and a prayer, then naturally disappoint. There is no story here except solid, consistent earnings. No glitz, just performance.

Iomega (IOM)

Iomega Monday: $4.31

Jim: Speaking of disappointment, some readers asked us to look at Iomega, which has become yet another example of what happens when a stock gets hyped way out of proportion to its value. In other words, Mike, it’s been a forerunner of today’s Internet stocks.

Mike: Before you start attacking, let’s examine the business. Iomega makes removable mass-storage systems for personal computers. Their most popular items are the Zip and Jaz drives and disks. You can store lots of data on them, then put them in your pocket and carry them to another machine. Iomega’s products are very versatile, say, for people with computers at work and home.

Jim: This company made headlines in the ‘95-’96 period, not only because it was growing very quickly, but also because it caught the attention of what was then a burgeoning corner of the stock market--the Internet.

Mike: That’s right. This stock was mercilessly hyped on Internet chat rooms, which helped send its price soaring. Adjusted for splits, it went from less than two bits a share in ’94 to above $20 in 1996. The volatility was unbelievable, like we’re seeing today with Internet stocks. Then, Iomega had its legs cut out from under it.

Jim: Small wonder. When reality set back in, everyone realized that Iomega had lots of competition, prices were falling rapidly and that Iomega was having its own problems in-house. Its stock fell faster than you can say “zip.” Get this: It now trades for $4 and change.

Mike: Now, let me give you the bullish case for Iomega.

Jim: One exists?

Mike: Yes. Consider this: I’ve written two books in the last eight years. My first book fit on a single floppy disk--that is, one of those common 3 1/4-inch floppies. But my latest book, which is almost the same length, barely fits on two floppies. That’s because--as the rule for computers goes these days--that what Andy Grove giveth, Bill Gates taketh away.

Jim: And that means?

Mike: That as PCs get more powerful and faster, the software written for them--including word processing programs and spreadsheets--have gotten fatter and more voracious in terms of the data files they produce. This has led to a market for Iomega’s products, which can hold much more data than the traditional floppy disks.

Jim: That’s evident in Iomega’s growth. Its sales have gone from $140 million in ’94 to $1.7 billion last year. And lately it’s been selling more of its gear directly to the people who sell computers--those guys known as original equipment manufacturers, or OEMs--as opposed to retail shoppers.

Mike: Right. Nowadays it’s more than likely that when you buy a desktop PC, it comes equipped with an internal Zip drive as well as the conventional 3 1/4-inch floppy. But this has pluses and minuses for Iomega.

Jim: I would assume more OEM sales mean more stable sales growth overall.

Mike: It does, and this will also help the Zip drive become more of an industry standard. But profit margins on those sales are lower.

Jim: Uh-oh, sounds as if your bullish argument is fading fast.

Mike: Hold on. Iomega first took off under a chief executive named Kim Edwards. He was just the kind of guy needed to ramp up production and promote the hip marketing that put Iomega and the Zip drive on the map.

Jim: But there was a problem . . . .

Mike: Indeed. He wasn’t as good at keeping a leash on quality control or fine-tuning production to match changes in demand.

Jim: The mundane basics, in other words.

Mike: Exactly. So, Edwards left last spring and was replaced by an interim CEO, James Sierk, while Iomega looks for a permanent successor. But another result was a fascinating and quite horrifying problem known as the “click of death.”

Jim: And people say data storage is dull.

Mike: Iomega says it affected less than 1% of its customers, but that still runs into thousands of people. The click is the sound Zip drives make when they malfunction. Instead of all your saved data spewing out, all you get is that sound.

Jim: The problem even sparked a class-action lawsuit against Iomega, which says the suit’s claims are “unfounded.”

Mike: Anyone who has backed up a hard disk’s worth of data on floppies, or put his last book or her dissertation on a floppy or removable drive, knows the feeling of nausea that the click of death can cause.

Jim: Yes, but to me, the reliability matter is chump change compared with Iomega’s other problems. There’s no discounting this company’s rapid growth, and its drives are popular. But this is one more computer-peripherals industry that is now full of rivals who are slashing prices to gain market share, and in which it’s getting harder to stand out from the crowd. That’s why Iomega lost $73 million in the first nine months of this year.

Mike: After it earned $115 million in all of ’97.

Jim: I just don’t see Iomega getting back to consistent profit growth any time soon. It’s not the Zip’s reliability that bothers me, it’s Iomega’s lack of earnings reliability that bothers me.

Mike: I’d buy the stock. This is still a big business. Iomega is still the leading maker of drives in this segment. It’s shipped nearly 18 million Zip drives alone, and it’s got a new management team turning things around. And with the stock so cheap, it’s hard to imagine that there’s anywhere to go but up.

Jim: It’s true Iomega still has a strong market position, and its balance sheet is clean. But, Mike, you’re bottom fishing for the wrong reasons.

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Do you have a stock you would like to see discussed in this column? Michael Hiltzik can be reached at michael.hiltzik@latimes.com; James Peltz can be reached at james.peltz@latimes.com. Or write to either at Business Section, Times Mirror Square, Los Angeles, CA 90053.