Is Bill Ackman's Involvement In ADP A 'Buy The Rumor, Sell The News' Moment?

Automatic Data Processing ADP shares rallied to as high as $115.75 in pre-market trading on Friday, up from Thursday's closing price of $111.77.

The optimism lingered, as the stock opened at $113.50. However, the stock couldn't sustain its early gains. After languishing in the red, the stock was seen trading with modest gains at time of publication, up 0.33 percent at $112.15.

The Rumor

On July 27, ADP stock spiked 9.1 percent to $115.63 after advancing to an intra-day high of $120 amid rumors that activist investor Bill Ackman, who runs hedge fund Pershing Square, was building up a stake in the company. In the process, the stock moved out of the $95-$106 trading range it was in since December 2016.

Source: Y Charts

Short seller Spruce Point Capital sent out a tweet on the same day, which read, "Ackman takes stake in $ADP, smart move we think they're taking share vs.$ULTI (also in process of suing ULTI in court over unfair practices)."

ADP said it had no comment regarding the rumored buy by Ackman.

The Confirmation

After being tight-lipped on the speculation all of last week, ADP confirmed the news on Friday. The company said in a release that Pershing is seeking effective control of the company through five board seats at the company's 2017 annual meeting, while also seeking the ouster of its CEO Carlos Rodriguez.

ADP indicated a communication from Pershing on August 1 said Ackman now owned an 8 percent stake in the company, largely in derivatives.

In the release, ADP defended its CEO and board and reinforced its confidence in the board's ability to deliver shareholder value.

Pershing seems to have asked ADP to defer the deadline for the nomination of directors by 30 to 45 days, in order for it to nominate its slate of directors, including Ackman.

Why Sentiment Soured?

Only last week, investors bid up the stock by over 13 percent (intraday) on the rumor of an activist investor's interest in the company. Why aren't investors equally enthusiastic about the development after the rumor was confirmed?

This looks like a classic example of the stock market adage, "buy the rumor, sell the news." This adage is based on the concept that market operates on a forward-looking basis, as traders discount future events rather than harping on what has already happened or is happening.

In this case, traders reacted to the rumor of Ackman's stake, which led to the stock gaining 6 percent from the time rumor first spread until the time it was confirmed. In fact, the stock was up about 12.2 percent (on a closing basis) before pulling back.

With the rumor confirmed, some traders may have preferred locking in their gains, resulting in some selling, although the modest gains suggest that all investors may not be yet ready to throw in the towel. In the coming days, it may be clear whether those who flocked to the stock may desert it, although much of it would depend on how the ADP-Ackman drama pans out.

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Image source: CNBC appearance