|Shares Out. (in M):||12||P/E||23.8x||13.4x|
|Market Cap (in $M):||128||P/FCF||15x||9x|
|Net Debt (in $M):||-14||EBIT||8||9|
AlarmForce was written up by hb190 in November 2009. There’s a decent description of the business in that write-up, and also a good discussion of the company in that write-up’s thread.
In July of 2013, the company’s board fired its founder and CEO Joel Matlin. The board also fired Joel’s son Adam Matlin, who was the company’s VP of Marketing and Sales, and Joel’s stepson, Robert Stepak, who was working in product development. CFO Anthony Pizzonia stepped up to be interim CEO, and the company is conducting a search for a new CEO. Joel is suing the company for $11.3 million for wrongful termination.
These events followed deterioration in the company’s operating performance. Gross customer acquisition cost was $606/customer in fiscal 2008 (years end in October), but $732 in fiscal 2012 and $746 in fiscal 2013 (these costs exclude roughly $5 million spent to roll-out a new video product, which has added 7,000 customers). Churn was 11% in fiscal 2008, but 13% in fiscal 2012 and 14% in fiscal 2013. Net customer growth was 15% in fiscal 2008, but has slowed to 5% in fiscal 2013.
The events also followed an unsuccessful attempt to sell the company. In August 2012, the company announced that it had hired a banker, and that there was interest from corporate and financial buyers. But early in July 2013, the sale process was ended by the company without any offers publicly disclosed.
Both Joel and the board are opaque about these events, as they are lawyered up, and presumably bound by NDAs. But uncertainty can make a decent investment opportunity, and the downside and upside cases here offer a good risk/reward.
Any investor visiting Joel and Adam during 2011 and 2012 would have found them to be curiously non-analytical about their marketing spend. Entering the US with the alarm product, and rolling out the video product, were both new projects with marketing budgets devoted to TV, radio and earned media. Given the highly granular nature of the customer base, it should have been easy to calculate in near real-time the effectiveness of a radio spot in Ohio, or the endorsement of a local police chief in a Florida newspaper. But that kind of analysis was never disclosed to visiting investors, and appears to have not been disclosed to the board. One suspects that the analysis did not exist.
Joel and Adam took the view that marketing was best conducted according to gut feel, and that sunk costs in a given market made it important to keep spending in that market until a tipping point was reached. It was clear that customer acquisition costs in some of the US markets were well in excess of $1,000/customer, but any probing about possible exit from unattractive markets was answered by, and I quote, “failure is not an option.”
It’s not entirely clear why the sale process failed. There is a fairly liquid M&A market for alarm companies at a multiple of 30-35x recurring monthly revenue (RMR). For AlarmForce’s $4 million of RMR, and adding $14 million of net cash, that would imply a sale price of $11-13/share. No buyer emerged at this price, which is surprising. Asking around suggests that buyers were put off by AlarmForce’s poor management systems, including inventory tracking and marketing analysis. It is telling that the board appears to have unanimously backed the termination of Joel and his family members within weeks of the end of the sale process.
How should investors think about this situation? If the business is permanently worse, then the cash flows available to shareholders might be as follows (note that the EBITDA numbers add back marketing costs, which AlarmForce expenses, unlike many competitors, who capitalize them):
|Customers||142,400||As of January 2014|
|EBITDA/Customer||$180||Averaged $183 during 2008-13; $210 in Q1 2014|
|Annual Churn||14%||11-12% during 2008-09; 14% in 2013|
|Customers to Replace||20,000||Churn was 18,700 in 2013|
|Customer Acquisition Cost||$750||Averaged $591 during 2008-10; $746 in 2013|
|Cash Cost to Replace||$15.0 million|
|Pretax FCF||$10.6 million|
|Taxes||$3.7 million||35% tax rate|
|FCF||$6.9 million||"Steady-state" FCF|
|Shares Out||12.0 million|
|FCF / Share||$0.58|
At today’s share price of $10.70, net of $14 million of cash on the balance sheet, that is a 6% yield, which is decent downside protection given the recurring nature of the cash flows (91% of revenues are contracted). Note that this downside protection was even better with the stock nearer $9/share.
If the board and new management succeed in returning the business to historical levels of profitability and churn, then cash flows might be as follows:
|Customers||142,400||As of January 2014|
|EBITDA / Customer||$210||Averaged $183 during 2008-09, $210 in Q1 2014|
|Annual Churn||12%||11-12% in 2008-09; 14% in 2013|
|Customers to Replace||17,000||Churn was 18,700 in 2013|
|Customer Acquisition Cost||$600||Averaged $591 during 2008-10; $746 in 2013|
|Cash Cost to Replace||$10.2 million|
|Pretax FCF||$19.7 million|
|FCF||$12.8 million||"Steady-state FCF"|
|Shares Out||12.0 million|
|FCF / Share||$1.07|
This would be an 11% yield on today’s $10.70/share price, which would be cheap given the recurring nature of the cash flows. It would also be cheap given the attractiveness of growing the customer base achieving those economics. In the downside case, the IRR of a new customer is under 10%. But in the upside case, assuming that there are opportunities to grow the customer base and retain the attractive economics, the IRR of a new customer is north of 20%. Using an 11% FCF yield to invest in 20%+ IRR new customers is a good thing over time.
AlarmForce’s strong balance sheet gives investors the luxury of waiting to see what happens to the economics under new management. It also gives management time to professionalize the company’s operations.
What are the downside risks?
The face of the company in many of its video ads is Joel Matlin. He is now an angry ex-CEO, and may interfere with the branding of the company going forward.
It’s possible that technology will disrupt the alarm business. Dropcam has a video product that has gotten a lot of attention, though its usefulness as an alarm is limited (hard to place on a door; no central monitoring or direct connection to the police). Cable companies say that the alarm business is a priority for them, though their offerings seem high cost relative to AlarmForce’s. Google may do something big in this area to add to thermostats. All of these seem well-mitigated by the low cost and focus on security of the AlarmForce service.