ADT CORP (THE) ADT S
October 05, 2012 - 12:18pm EST by
cablebeach
2012 2013
Price: 38.00 EPS $1.69 $1.85
Shares Out. (in M): 235 P/E 22.0x 20.0x
Market Cap (in M): 9,045 P/FCF 36.0x 29.0x
Net Debt (in M): 2,226 EBIT 732 795
TEV: 11,271 TEV/EBIT 15.4x 14.2x
Borrow Cost: NA

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  • Spin-Off
  • Home security
  • Fragmented market
 

Description

We are baffled by the valuation at which ADT is trading and recommend shorting the stock here at $38.50 / share.

 We recognize that seemingly everyone loves this stock and that this is a non-consensus call.

 We have followed TYC and the security alarm industry for years, and while we think it’s a good business, we don’t think the valuation is justified at current levels.

 This is a valuation short; no particular catalyst, just proper price discovery as the market gets its arms around the newly spun-off ADT stock.  The spin-off was completed on September 28 and regular-way trading began this past Monday, October 1, 2012.

 What the market sees:

  • recurring-revenue business model
  • low penetration of the product (20% of households nationwide)
  • high EBITDA margins (50%) and extremely high incremental margins (75%)
  • interesting growth opportunities via Pulse, SMB and home healthcare
  • beneficiary of a recovery in the housing market
  • NOL’s that result in cash tax rate of 6-8%
  • a new spin-off
  • all this in a stock trading for less than 7x EBITDA

 What we see:

  • ADT’s EBITDA is artificially inflated relative to its Free Cash Flow due to its accounting treatment for customer acquisition costs
  • Much of the cost of acquiring new accounts is capitalized and therefore does not show up in EBITDA
  • Capex is 30% of revenue for this business
    • the resulting free cash flow that is generated from $1 of EBITDA is much lower compared with virtually every other business model with which investors are familiar
  • As for the NOL’s, we value them on a tax-affected, present value basis and do not capitalize them as part of ongoing free cash flow
  • On this basis, ADT trades for 36x 2012 Free Cash Flow and 29x 2013 FCF
    • Can someone please tell us why this is a cheap stock at 29x 2013 FCF?
    • Even if we do run deferred taxes through the cash flow statement (effectively capitalizing them), ADT is trading for 20x 2012 FCF
  • On an RMR basis (recurring monthly revenue), ADT trades for 47x
  • As for the business fundamentals, the industry penetration rate has been ~20% for many years and not showing any sign of accelerating
  • The SMB growth story has also been touted for years; nothing new here
  • Housing market recovery won’t move the needle
    • While a new home sale creates an opportunity for a new alarm sale, it also can result in the disconnect of an existing system
  • And while Pulse is a great product, as the breadth of the product offering expands, so too does the competitor base, namely telecom and cable companies; although their competitive impact has been negligible thus far, bulls on ADT seem dismissive of this risk

 Our view of fair value:

  • We think fair value for ADT is 30-35x RMR, which implies a share price of $23 - $28 today (27-40% lower than current levels)
    • A year from now at 30-35x RMR, ADT would be worth $25-$30 per share (22%-36% lower than current levels)
  • Broadview Security (CFL) traded for ~29x RMR for the brief period it was a public company
  • CFL was the best company in the business and a bite-sized acquisition candidate
  • It was acquired by TYC in Jan 2010 for 42.5x RMR
  • Our 30-35x RMR fair value estimate for ADT still implies ~18x FCF

 RMR Multiples

  • RMR is the convention by which security alarm businesses are valued within the industry
  • There’s been a lot of (mostly small-sized) M&A in this industry over the years, and the best way to value targets was based on their recurring revenue
  • Since different security alarm companies use different capitalization policies for new customer acquisition costs, comparing on an EBITDA basis doesn’t make sense
  • Also, since most acquisitions involve porting over the acquired company’s customer base without any of the overhead, revenue was a more relevant metric
  • RMR also makes it easy to compare valuations between acquisitions of full alarm companies and acquisitions of just customer accounts being sourced from dealers
  • Historically, corporate acquisitions have been done in the space for 30 – 60x RMR with the average ~45x
  • As noted above, ADT acquired CFL for 42.5x RMR
  • Why should ADT trade at a premium to takeover multiples as a standalone public company? 
    • We think the odds of ADT getting acquired are less than 10% (see discussion of LBO prospects below).

 Unit economics

  • Units typically cost ADT $1,100 net upfront cash cost to install (including sales commission and net of customer installation revenue)
  • Average ARPU across the entire portfolio is $39 / month right now.  Mid-range package is $36 today but higher-end Pulse offering can be $65 / month
  • Incremental margins are extremely high: 75-80% as the cost of adding an incremental user to shared monitoring centers is virtually costless
  • Attrition has been running at somewhat elevated levels due to the economic environment; I assume 12% attrition over the long-term
  • This economic model results in after-tax, unleveraged returns of 8-10%
  • So, why does this business deserve to trade at 29x forward free cash flow?

 Dispelling other myths

  • Myth #1: ADT is a bond-like investment
    • We have heard some bulls on ADT frame the story as an under-leveraged, bond-like investment. 
    • That if management were to lever up and increase the dividend pay-out, then ADT’s equity could trade on a yield basis
    • We find these arguments un-compelling for two simple reasons 
      1. This has been a very conservatively managed business historically; there is no indication that management wants to (or should) turn the company into a highly-leveraged yield vehicle
      2. ADT already trades at a 3% free cash flow yield.  Where is the upside?
  • Myth #2: The free cash flow generation is masked by growth investments in new subs
    • According to this thesis, if only ADT were to stop spending so much capex acquiring new customers, the free cash flow would explode and the true value would be revealed
    • Sounds great, but ADT currently churns 13% of its customers per year, which amounts to ~825k customers (technically, ADT defines churn as a % of recurring revenue, not customers)
    • So, just to keep the business flat, ADT has to acquire 825k new customers a year
    • If they can acquire new accounts from dealers for 30x RMR and the average ARPU continues to be $39 / customer, then that’s $965mm of “Maintenance Capex” per year; only $120mm of capex is true growth capex (and then there’s ~$35mm of corporate capex bringing to total to $1.1bn on EBITDA of $1.7bn)
  • Myth #3: ADT is an LBO candidate
    • The math simply does not work
    • Assume $40 deal price, 5x of debt, 36% equity ($4.3bn equity check)
    • Further assume, 5% revenue CAGR and modest margin expansion
    • Finally assume a 6.5x EBITDA exit multiple (which is 47x RMR, btw)
    • This results in a whopping 10% IRR.  That’s at a $40 deal price.
    • Also, if a deal were done at a 20% premium to current market, that would imply a $13bn+ transaction.  We haven’t seen too many of those happening lately.

 Business Description

  • ADT is the largest residential security alarm company in North America
  • ADT’s consoles protect homes and small businesses from intrusion (burglars) and fire
    • If an alarm is tripped, ADT automatically notifies local police or fire department
  • Market leader in large, highly-fragmented market with relatively low penetration rates
    • ADT is #1 in North America with 25% market share, next largest player has only 4% share
    • Security alarm systems are only present in ~20% of households (vs. over 80% for cable / satellite)
  • As of June 30, 2012, ADT had 6.45mm customers with an average ARPU of ~$39
    • Estimate ~6mm residential customers, 400k small business
    • 90% of revenue is recurring

 Positive Attributes of the Business

  • Recurring revenue stream
  • Highly fragmented industry with low household penetration rate
  • Home insurance subsidy
    • Most home insurance policies offer a discount if you have a home alarm system; typically ~$10 / month
  • Positive mix impact from growth in ADT Pulse
    • ADT’s new Pulse offering is an interactive system that allows users to control many features of their homes (security, lighting, thermostat) remotely via PC, smartphone or tablet
    • Monthy cost for a Pulse package can be ~$65, depending on features
  • Potential, although low probability, strategic takeover candidate for telecom / cable companies

 Risk / Reward

  • At $38.50 / share, we think further upside to ADT shares is limited
  • If ADT were to trade at 50x RMR a year from now, the stock would be worth $46 / share (15% move against the short position)
    • We think this valuation is ridiculous, and implies a 34x forward FCF multiple
    • We just don’t think this is realistic
  • If it trades at our target 30x-35x RMR, the stock will be worth $25-$30 / share (22% to 36% lower than current levels)
    • At these levels, ADT would still trade at ~20x LTM FCF, ~18x Fwd FCF
  • The biggest risk to our thesis is that ADT becomes more aggressive with deploying its balance sheet either by acquiring new subs at a faster rate or by acquiring a competitor with a few points of market share
  • While such transactions would accelerate growth, our math suggests even a $1bn acquisition would be no more than 5% accretive on an RMR-basis 
  • So we think realistically, a short position in the stock results in $9-$14 upside, with less than $5 downside

 Feedback welcome.

 

 

 
Capitalization     Valuation (w/ NOLs)            2012            2013
Shares                231   TEV / Revenue             3.5x             3.3x
Options (est)                  4   TEV / EBITDA             7.1x             6.7x
Shares                235   P/E             21.9x           20.0x
Share Price           $38.57   Price / CFPS           36.1x           29.0x
Market Cap.       $9,045   TEV / RMR        46.6x        44.4x
Gross Debt             2,526                 45.1x           43.0x
Cash & Equiv.              300          
Net Debt             2,226   NOL           $1,100  
TEV       $11,271   A-T PV per share           $1.52  
               
Summary Financials            
    Results FYE December 31,
               2008            2009            2010            2011         2012E         2013P
Revenue         $2,190       $2,248       $2,591       $3,110       $3,243       $3,399
COGS                  935           1,065           1,341           1,385           1,444
Gross Profit         $1,313       $1,526       $1,769       $1,858       $1,954
SG&A                  839           1,022           1,076           1,101           1,134
Other                      -                  -                  -                  -                  -
GAAP EBIT          $421          $474          $504          $693          $757          $820
Interest Expense                  82              107                90                90                95
Interest Income                  (1)                (1)                (1)                  -                  -
EBT                $393            $398            $604            $667            $725
Book Tax Expense                150              159              228              254              275
Net Income          $222          $243          $239          $376          $413          $449
D&A                  671              785              927              974           1,000
Amort of Deferred Sub Rev            (111)            (111)            (114)            (119)            (125)
FAS 123                      7                  8                  9                  8                10
Deferred Taxes                130              124              213                20                20
BDE / Other                  39                48                49                48                45
WC                      2              (23)              (21)              (10)              (10)
CFOps              $981       $1,070       $1,439       $1,334       $1,389
Capex (Dealer Accts, etc)            (736)            (801)            (902)         (1,093)         (1,090)
Free Cash Flow            $245          $269          $537          $241          $299
FD Shares                235              235              235              235              235              235
               
Customers (000's)           4,753         6,285         6,351         6,446         6,575
RMR              $161          $190          $230          $242          $254
Adj. EBIT            $402          $455          $532          $696          $732          $795
Adj. EBITDA          $948       $1,015       $1,206       $1,509       $1,587       $1,670
GAAP EPS         $0.95         $1.04         $1.02         $1.60         $1.76         $1.92
Adj. EPS           $1.38         $0.98         $1.09         $1.61         $1.69         $1.85
FCF / Share           $1.04         $1.15         $2.29         $1.03         $1.28
               
% Reported Rev Growth          4.1%          2.6%       15.3%       20.0%          4.3%          4.8%
% Gross Margin         58.4%       58.9%       56.9%       57.3%       57.5%
SG&A % of Sales         37.3%       39.4%       34.6%       34.0%       33.4%
% GAAP EBIT Margin       19.2%       21.1%       19.5%       22.3%       23.3%       24.1%
% Adj. EBITDA Margin       43.3%       45.2%       46.5%       48.5%       48.9%       49.1%
D&A % of Sales         24.9%       26.0%       26.1%       26.4%       25.7%
Capex % of Sales         32.7%       30.9%       29.0%       33.7%       32.1%
% Tax Rate         38.2%       39.9%       37.7%       38.1%       38.0%
% Adj. EPS Growth       (28.6%)       10.7%       47.8%          5.3%          9.2%
    
Notes:
  • We strip out the after-tax present value of the NOLs when calculating valuation multiples (i.e. give credit for NOL's on the balance sheet but not capitalize the cash tax shield on the cash flow statement);
  • We also adjusted the 2012 cash flow statement to strip out the benefit of the cash tax shield for comparison purposes; so that's a pro forma number, not what will actually be reported
  • We adjust historical and forward EBIT/EBITDA for restructuring costs, integration costs and pro-forma dis-synergies associated with the spin-off from TYC.  See the Appendix to recent investor day slides for full reconciliation.  Note that even though the company has guided to $30-$50mm of annual dis-synergies, we have only assumed $25mm because of TYC management's history of giving conservative guidance
  • The Broadview Security acquisition was completed in May 2010, hence the strong increase in reported financials in 2010 and 2011
 

 

 
 
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

It's a valuation short with admittedly no hard catalyst.  We think the market has struggled to get valuation right on some of these recent spin-offs.  ADT is particularly challenging since there are no comps and the company's unique capitalization policy makes the stock appear much cheaper than it really is if investors only look at EBITDA multiples.
 
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    Description

    We are baffled by the valuation at which ADT is trading and recommend shorting the stock here at $38.50 / share.

     We recognize that seemingly everyone loves this stock and that this is a non-consensus call.

     We have followed TYC and the security alarm industry for years, and while we think it’s a good business, we don’t think the valuation is justified at current levels.

     This is a valuation short; no particular catalyst, just proper price discovery as the market gets its arms around the newly spun-off ADT stock.  The spin-off was completed on September 28 and regular-way trading began this past Monday, October 1, 2012.

     What the market sees:

     What we see:

     Our view of fair value:

     RMR Multiples

     Unit economics

     Dispelling other myths

     Business Description

     Positive Attributes of the Business

     Risk / Reward

     Feedback welcome.

     

     

     
    Capitalization     Valuation (w/ NOLs)            2012            2013
    Shares                231   TEV / Revenue             3.5x             3.3x
    Options (est)                  4   TEV / EBITDA             7.1x             6.7x
    Shares                235   P/E             21.9x           20.0x
    Share Price           $38.57   Price / CFPS           36.1x           29.0x
    Market Cap.       $9,045   TEV / RMR        46.6x        44.4x
    Gross Debt             2,526                 45.1x           43.0x
    Cash & Equiv.              300          
    Net Debt             2,226   NOL           $1,100  
    TEV       $11,271   A-T PV per share           $1.52  
                   
    Summary Financials            
        Results FYE December 31,
                   2008            2009            2010            2011         2012E         2013P
    Revenue         $2,190       $2,248       $2,591       $3,110       $3,243       $3,399
    COGS                  935           1,065           1,341           1,385           1,444
    Gross Profit         $1,313       $1,526       $1,769       $1,858       $1,954
    SG&A                  839           1,022           1,076           1,101           1,134
    Other                      -                  -                  -                  -                  -
    GAAP EBIT          $421          $474          $504          $693          $757          $820
    Interest Expense                  82              107                90                90                95
    Interest Income                  (1)                (1)                (1)                  -                  -
    EBT                $393            $398            $604            $667            $725
    Book Tax Expense                150              159              228              254              275
    Net Income          $222          $243          $239          $376          $413          $449
    D&A                  671              785              927              974           1,000
    Amort of Deferred Sub Rev            (111)            (111)            (114)            (119)            (125)
    FAS 123                      7                  8                  9                  8                10
    Deferred Taxes                130              124              213                20                20
    BDE / Other                  39                48                49                48                45
    WC                      2              (23)              (21)              (10)              (10)
    CFOps              $981       $1,070       $1,439       $1,334       $1,389
    Capex (Dealer Accts, etc)            (736)            (801)            (902)         (1,093)         (1,090)
    Free Cash Flow            $245          $269          $537          $241          $299
    FD Shares                235              235              235              235              235              235
                   
    Customers (000's)           4,753         6,285         6,351         6,446         6,575
    RMR              $161          $190          $230          $242          $254
    Adj. EBIT            $402          $455          $532          $696          $732          $795
    Adj. EBITDA          $948       $1,015       $1,206       $1,509       $1,587       $1,670
    GAAP EPS         $0.95         $1.04         $1.02         $1.60         $1.76         $1.92
    Adj. EPS           $1.38         $0.98         $1.09         $1.61         $1.69         $1.85
    FCF / Share           $1.04         $1.15         $2.29         $1.03         $1.28
                   
    % Reported Rev Growth          4.1%          2.6%       15.3%       20.0%          4.3%          4.8%
    % Gross Margin         58.4%       58.9%       56.9%       57.3%       57.5%
    SG&A % of Sales         37.3%       39.4%       34.6%       34.0%       33.4%
    % GAAP EBIT Margin       19.2%       21.1%       19.5%       22.3%       23.3%       24.1%
    % Adj. EBITDA Margin       43.3%       45.2%       46.5%       48.5%       48.9%       49.1%
    D&A % of Sales         24.9%       26.0%       26.1%       26.4%       25.7%
    Capex % of Sales         32.7%       30.9%       29.0%       33.7%       32.1%
    % Tax Rate         38.2%       39.9%       37.7%       38.1%       38.0%
    % Adj. EPS Growth       (28.6%)       10.7%       47.8%          5.3%          9.2%
        
    Notes:
     

     

     
     
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    Neither I nor others I advise hold a material investment in the issuer's securities.

    Catalyst

    It's a valuation short with admittedly no hard catalyst.  We think the market has struggled to get valuation right on some of these recent spin-offs.  ADT is particularly challenging since there are no comps and the company's unique capitalization policy makes the stock appear much cheaper than it really is if investors only look at EBITDA multiples.
     

    Messages


    SubjectAdditional questions
    Entry10/05/2012 04:18 PM
    Memberjso1123
    Thank you for the write-up.
     
    Can you please explain your unlevered IRR calculation and the key inputs?  $39 ARPU, 7 year customer life, 80% incremental margin and 35% taxes gets me to a different result.  Also,
     
    What is your view on the ARPU of new subscribers vs. subscribers that are churning?  On the chuyrn rate of Pulse customers vs. "normal" customers?  Management has said that early indications are that Pulse customers churn at a lower rate than their existing base, so should this also be incorporated in your IRR calc?
     
    If newer customers are higher ARPU, higher margin and churn less, then the MCX number you quoted is probably too high.  Ignoring the margin and churn points, a $50 ARPU for new customers vs. a $35 ARPU for churning customers implies that you'd only need to add 70% as many new customers to keep revenue constant. 
     
    What do you think the ultimate cash tax rate will be for ADT going forward even after they burn through their NOLs?  Do they have any ability to continue to offset cash taxes with accelerated depreciation?
     
     

    SubjectRE: ADT questions?
    Entry10/11/2012 11:53 AM
    Membercablebeach

    Thanks for your extensive comments and questions.  We understand that you are long the stock and do appreciate hearing your perspective on the name.  We’ll try to address as many of your questions as we can in this post.

    We value stocks based on free cash flow.  While we look at other multiples such as EBITDA, P/E and specialized metrics like RMR, ultimately free cash flow is what drives value (at least for us).  We think that any attempt to value ADT on an EBITDA basis is severely misguided.

    We believe our assumptions for sub growth, ARPU acceleration and margin expansion aren’t materially different from the bulls in the name.  We differ, however on these two key points:

    1. EBITDA is the wrong metric on which to value ADT due to its capitalization policy for Subscriber Acquisition Costs, which results in recurring capex amounting to 30% of revenue.
    2. ADT’s free cash flow has been over-stated in recent years due to its unsustainably low cash tax rate of 6-8%.
    1) Capitalization Policy Means EBITDA is Poor Proxy for Free Cash Flow

    As we noted in our initial post, ADT capitalizes much of its Subscriber Acquisition Cost (SAC), to the tune of 30% of revenue.  To put this in perspective, consider the following valuation multiples for other stable, high quality businesses:

      TEV / (EBITDA - Capex)
            2012       2013
    Apple        9.5x        7.6x
    Clorox      12.4x      11.9x
    Costco      15.3x      13.9x
    DirecTV      11.3x        9.8x
    Google      13.1x      10.9x
    IBM      11.1x      10.1x
    JNJ      10.4x        9.4x
    McDonalds      14.4x      12.8x
    Starbucks      19.5x      16.0x
    Time Warner      11.4x      10.4x
    Walt Disney      14.2x      11.6x
         
    Average      13.0x      11.3x
    ADT      21.8x      20.7x

    SubjectRE: RE: ADT questions?
    Entry10/11/2012 11:58 AM
    Membercablebeach

    Thanks for your extensive comments and questions.  We understand that you are long the stock and do appreciate hearing your perspective on the name.  We’ll try to address as many of your questions as we can in this post.

    We value stocks based on free cash flow.  While we look at other multiples such as EBITDA, P/E and specialized metrics like RMR, ultimately free cash flow is what drives value (at least for us).  We think that any attempt to value ADT on an EBITDA basis is severely misguided.

    We believe our assumptions for sub growth, ARPU acceleration and margin expansion aren’t materially different from the bulls in the name.  We differ, however on these two key points:

    1. EBITDA is the wrong metric on which to value ADT due to its capitalization policy for Subscriber Acquisition Costs, which results in recurring capex amounting to 30% of revenue.
    2. ADT’s free cash flow has been over-stated in recent years due to its unsustainably low cash tax rate of 6-8%.

    1) Capitalization Policy Means EBITDA is Poor Proxy for Free Cash Flow

    As we noted in our initial post, ADT capitalizes much of its Subscriber Acquisition Cost (SAC), to the tune of 30% of revenue.  To put this in perspective, consider the following EBITDA-capex multiples for other stable, high quality businesses:

      TEV / (EBITDA - Capex)
            2012       2013
    Apple        9.5x        7.6x
    Clorox      12.4x      11.9x
    Costco      15.3x      13.9x
    DirecTV      11.3x        9.8x
    Google      13.1x      10.9x
    IBM      11.1x      10.1x
    JNJ      10.4x        9.4x
    McDonalds      14.4x      12.8x
    Starbucks      19.5x      16.0x
    Time Warner      11.4x      10.4x
    Walt Disney      14.2x      11.6x
         
    Average      13.0x      11.3x
    ADT      21.8x      20.7x

    Are the risk/growth profile of ADT’s future cash flows so superior to the other companies on this list to justify this valuation premium?

    Said another way, if ADT’s SAC-related “maintenance” capex (i.e. capex used to replace attrition) were expensed instead of capitalized, ADT would currently be trading at 14x 2013 EBITDA. 

      

    2) Cash Tax Rate

    The ~$500mm of unlevered free cash flow you reference in your post assumes ADT’s cash tax rate remains 6-8%.  We make the following observations:

     

    • ADT’s cash tax rate has been low the past few years due to the bonus depreciation rules contained in a series of government stimulus bills.  This has enabled ADT to deduct up to 50-100% of its capex against taxable income since 2008.  Bonus depreciation is set to expire in 2013.
    • The bonus depreciation rules don’t permanently extinguish cash tax payments for these years; it merely delays them by allowing for accelerated depreciation.  In the process, ADT has created a $600mm net deferred tax liability, which on a present value basis fully negates the value of the NOLs being inherited from TYC.
    • Mgmt has indicated they are exploring other measures that would allow ADT’s cash tax rate to remain below the statutory rate once its NOLs are fully utilized.  We look forward to learning more about this on the company’s next earnings call.
    • However, the fact remains this is a near 100%U.S.based business (w/ small Canadian business).  Why would ADT’s cash tax rate remain at 10% to 15%, even 20% once the NOLs are extinguished in two years’ time?
    • Here’s what ADT looks like when valued on free cash flow and assuming a 30% cash tax rate:


        Price / FCF per Share
            2012     2013
    Apple       13.3x     12.5x
    Clorox       22.3x     18.2x
    Costco       25.3x     21.1x
    DirecTV       15.3x     12.6x
    Google       17.9x     15.0x
    IBM       15.9x     12.0x
    JNJ       11.8x     12.4x
    McDonalds     22.6x     18.6x
    Starbucks     30.1x     26.4x
    Time Warner     10.6x       9.8x
    Walt Disney     21.6x     16.9x
           
    Average    18.8x    15.9x
    ADT      31.6x    33.8x

    The bulls that are valuing ADT at 8x 2014 EBITDA to arrive at $60 price targets are implicitly saying they believe this business should trade for 35x forward free cash flow.  We think a free cash flow multiple of half that is more appropriate.

    We think the stock is trading where it is today because in spin-off situations, EBITDA is the easiest metric to use between the time a spin-off is announced and when it is completed (i.e. for all the analysts doing sum-of-the-parts based valuations).  But EBITDA is precisely the worst metric to use to value ADT.  The fact that there are no publicly traded comps for ADT makes it easier for analysts to fall into this trap.  Given how many event-oriented funds own this name for the spin-off and based on an EBITDA valuation, we think ADT could trade very poorly if the market hits an air pocket.

    Other thoughts:

    On the balance sheet

    Since management has recently stated its commitment to remain investment grade to bondholders and rating agencies, we think it’s unlikely that they will reverse course and lever up the balance sheet anytime soon.  We think it would take at least a year of underperformance by the stock for an activist to make a credible case that the company should change its approach.

    On unit economics

    We arrived at the 10% IRR by using straight-line depreciation and a 38% tax rate; in fairness, accelerated depreciation (MACRS, not bonus depreciation) and a 35% cash tax rate are more realistic.  This results in a low teens IRR.

    We agree that Pulse has a positive mix affect on ARPU and will accelerate ARPU growth in the coming years; this is reflected in our numbers

    We also assume that churn will decline to 12% in our unit economic model, a generous assumption given current 14% rate

    We understand that the ARPU of subs that are churning is lower than both the existing company average and that of new subs; thus, there is natural ARPU growth overtime; already baked into our numbers

    We also point out that attrition is measured in recurring revenue dollars, not number of customers, so for those building their subscriber models the attrition of actual customers is higher than the reported attrition rate due to the aforementioned lower ARPU associated with departing customers

    On the cash tax rate

    If we’re wrong and the company can somehow manage to sustain a 25% cash tax rate vs. the 30% we’ve assumed, it will still be trading at ~30x Forward FCF

    Again, we look forward to hearing what the company has to say about this on the upcoming quarterly call


     


    SubjectADT Activist Filing - Corvex
    Entry10/25/2012 07:24 AM
    Membermojoris
    http://www.sec.gov/Archives/edgar/data/1546640/000119312512433991/0001193125-12-433991-index.htm
     
     

    SubjectRE: ADT Activist Filing - Corvex
    Entry10/25/2012 07:32 AM
    Membermojoris
    Activist Presentation Link:
     
    http://www.sec.gov/Archives/edgar/data/1535472/000119312512433991/d429924dex996.htm
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