ADT INC ADT
August 19, 2020 - 4:40pm EST by
ril1212
2020 2021
Price: 11.50 EPS 1.05 1.1
Shares Out. (in M): 830 P/E 0 0
Market Cap (in $M): 9,545 P/FCF 0 0
Net Debt (in $M): 8,750 EBIT 0 0
TEV ($): 18,295 TEV/EBIT 0 0

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Description

 

We are long ADT and think the shares have room to almost double from these levels to our $22 target.  It has been written up on VIC several times in the past and they have a great deck on their IR website so we won’t go too deep into the details of the business.  For those that need a quick refresher, it is the largest residential security firm in the US, it is about 5x the size of the #2/3 players.  Having followed the business for several years prior to it being acquired and then ipo’ed in 2018 it has been interesting to watch the bear thesis evolve and constantly, in our opinion, be proven incorrect.  However, our enthusiasm for the stock now rests on it’s new partnership with Google and the macro housing environment that we think will play out over the next several years as a result of COVID.  The thesis from here is:

 

·         The partnership announced with Google on August 3rd is a game changer.  Their interest and equity investment clearly shows the value of ADT’s “Do it for me” (DIFM) network of dealers and installers as a separate channel from the Nest’s core “Do it yourself” (DIY) offering.  In addition, one of the key tenets of the short case has always rested upon Google/Amazon eventually bleeding ADT out, this seems unlikely now.

 

·         One of the consequences of COVID has been a flight from urban areas into the suburbs and home sales data has picked up accordingly.  At the same time inventory levels of existing homes on the market have remained historically low as people are not in a hurry to move.  This is a blue sky scenario for home security as new accounts are likely to pick up and disconnection is likely to remain relatively muted.  We expect organic growth of US subscribers to accelerate due to this.

 

·         The short interest remains elevated at 18% of the float.  A lot of this is likely due to leverage and the overhang from Apollo’s ownership, but there have been constant market share fears (telcos entering the space, DIY products, etc) that have not panned out.

 

·         This is less material to the thesis from here but it should be mentioned that mgmt is at the tail end of “upgrading” the subscriber base which has resulted in lower attrition and high margins and the temporary expense of lower subscriber growth.  Point being, this has been a headwind over the past 3-4 years that should abate going forward.

 

·         At 10x cash earnings or 8x EBITDA the stock is pricing in none of the above in our opinion.  If the market starts to believe that the business has both housing macro tailwinds and secular growth from the expansion of connected home systems going in it’s favor the stock should re-rate materially.

 

 

 

Google Partnership

 

·         GOOG will invest $450m in ADT equity and they will each invest $150m in marketing and development.

 

·         Most importantly, the new program with be co-branded, so ADT will undoubtedly gain a new channel of leads/traffic off the GOOG platform.

 

·         There will be no revenue sharing, so GOOG will not be extracting any trailing economics from hardware sales.

 

·         All new subs sourced from the partnership will be connected/smart home consumers that typically carry ARPUs 10-20% higher than traditional subscribers.

 

·         The end goal 2-3 years out is to develop this into a fully connected home with each device contributing incremental monthly revenue dollars.  So far no other platform is able to offer this in a streamlined fashion.

 

To sum it up, this is a big win for ADT.  Its a highly incremental and large funnel of new customers they can convert over the coming years.  GOOG’s willingness to take an equity stake and not demand a revenue share shows their true interest in the space and the network ADT opens up to them.  

 

 

 

Housing Tailwind

 

·         COVID has brought on an exodus from urban areas to the suburbs.  Almost every part of the value chain has confirmed that transactions have accelerated from their April lows to be up y/y in a material way.  Realogy stated on their Q2 call that open contracts were +30% in July and most of the public builders saw new orders +30-50% in the same month.  Meanwhile rents in large cities have gone the opposite direction.  These new buyers tend to be younger and more affluent which makes them more likely to be interested in a smart security system.

·         Another consequence of the work from home era and the extra share of wallet available from a lack of family travel spending is increased spend on home repairs/upgrades.  Getting setup with a connected home system or adding more devices to a platform would clearly fall under this umbrella.  Indeed, on their Q2 call ADT mentioned the number of new subs rose each month sequentially throughout the qtr. 

 

·         Relocation is one of the main reasons for customer churn and due to the pandemic the amount of people moving is close to an all time low, ie—the extra household formations are having to turn to new builds, as evidenced by the inventory metrics below.  This is helpful for ADT’s churn and margins until life normalizes or existing home prices rise high enough to entice more owners to move.

 

 

Summary

 

We think the fade off the initial spike after the deal was announced creates a great entry point for a business that is now exposed to favorable secular and cyclical trends trading at a discounted valuation.  The market is going to focus on subscriber growth and once ADT can demonstrate acceleration there the stock should trade a valuation at least inline with telcos (15x on avg) and likely closer to in home services businesses that have the same housing driven characteristics like SERV (25x). 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

-accelerating subscriber growth

-more details on the GOOG/ADT marketing program 

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