|Pricing Target||Thursday PM|
|Lead Banks||Goldman & Morgan|
ADT has been around for a long time - they were founded in 1874 and pioneered the current security monitoring business in 1920. They are the giant in the home and commercial security market with over 8 million customers and 18,000 employees in 200 locations.
The company has a checkered history - they were found guilty of monopolistic practices in 1964 which required them to change their business practices and pay fines and damages to the government, customers and competitors.
In 1997 Tyco acquired ADT and then spent $2B to acquire the #2 security business (Brinks Home Security/Broadview) which was merged into ADT. Then in 2012 Tyco split their businesses up and ADT debuted as a public company on the NYSE.
Just a few years later, In 2016, Apollo paid $7B (a 50% premium) to acquire ADT and combine it with another large security business they owned called Protection 1. The ADT "American Success Story" slide is a bit misleading when they boast about "hitting a 2 million customer milestone in home automation" since these customers basically came with the merger with Protection 1.
The merged entity was bloated and inefficient with a reputation for high cost and average service. Apollo knows how to put together a bunch of businesses, get them working together and then improve operations so they can resell it at a higher price. Thanks to their overwhelming size and scale they had time to work on improving operations.
To their credit management owns up to how bad the "old ADT" in 2015 was and has followed a familiar and proven set of management methods to get out of the rut they were in.
Specifically, they got out of the office and into the field, focused on measuring and improving customer service, retained more customers and implemented new measurement systems to monitor and respond more rapidly as a service organization.
We can see that the team has done well with job #1 which is to stop losing customers.
Investors can expect ADT to continue to make slow and steady improvements in their operating metrics and improve their cash flow generation. In the near term, we can see them focus on modest customer additions, getting more commercial clients, continuing to improve operations and adding subscriber options like higher upfront payments and some lower-cost channels.
ADT sees the Tyco/Johnson Controls acquisition as creating some low-hanging fruit for them to pick in the commercial security market. Conversely, Tyco is not looking for more residential business. At least at the upper end of the market, ADT should have an advantage.
But how will ADT handle the growing penetration of “connected homes” and products like Alexa? More modern security monitoring companies like Alarm.com (ALRM), SimpliSafe (Private East Coast) and iSmartAlarm (Private West Coast) are in a strong position vis a vis adding security to the connected home too. SimpliSafe is a fairly established company due to their $57M raise in 2014. Since then they have grown to a level that probably makes them ready for a public offering soon.
[UPDATE: Never mind Ring which has raised a staggering $209M in VC!]
The Smart Home and Security
The internet of things (IoT) and home automation is the elephant in the room for ADT. The connected home is still very immature but substantial investments over the past few years - most notably by Amazon and Google, have made into a real, fast-growing market.
ADT doesn’t have much to fear from traditional security monitoring competitors - they all are fairly similar and ADT wins by being the default choice for full service 24/7 systems.
Thanks to ubiquitous home WiFi, smartphones and smart “hub” devices like Alexa it is becoming much easier for people to install, run and monitor these systems. Some are purely DIY with no monthly fee (like iSmartAlarm) while others are more modern versions of ADT with lower prices and no contracts (like SimpliSafe.)
ADT is in a better position to be “technology agnostic” when it comes to home security and automation. For example, SimpliSafe has a suite of hardware products that work well together but they don’t work very well with other brands of home automation and security equipment.
DIY systems like iSmartAlarm offer “zero monthly fee” solutions and rely on the user to review and respond to notifications. These systems appeal to some customers who want some security and monitoring but don’t want to pay a fee for someone else to handle alarms and alerts. The major shortcoming of these systems is that if something happens when you are away, asleep or otherwise occupied it might take you a while to respond - long enough for your house to burn down or be ransacked. But in many cases a little prevention is all people require.
The big question for ADT and the connected home is how they can leverage their army of service agents. New security monitoring customers will come but not in droves. Management describes some intriguing expansion areas where they may employ M&A.
Networking and cybersecurity are key elements of the connected home which are poorly managed and supported today. Most home broadband and WiFi systems are “plug and pray” when it comes to integration and support. Part of the reason for this is the fragmentation of the market - the cable company will help keep your cable modem working (and maybe your WiFi router if you purchased it from them) but they won’t help with security. Customers are expected to configure these systems and also run discrete security software packages on their computers.
ADT is in a strong position to provide ongoing cybersecurity services to home and business networks. It’s a large market that can also include ongoing services like backup and recovery which most homes and business do poorly.
ADT may simply be paying lip service to these areas to add some sizzle to the story. In the next several quarters they can drive most of their business performance internally, but in the near future, their growth will depend on them leveraging their position to add new revenue streams and capabilities beyond security monitoring.
There are some other fairly large opportunities that don’t seem to be on the ADT radar screen. For example, an adjacent market area open to ADT is organizational emergency response (corporate and government.) This is a market that Everbridge (EVBG) is leading. They claim there TAM is growing to $41B by 2020 which puts it on par with security monitoring and services.
Management also doesn’t mention applications in healthcare like home patient monitoring or personal emergency response systems (PERS.) We don’t have a TAM for this one handy but with a rapidly aging population in the US along with measures to try and contain healthcare spending, this could be another expansion area.
The ADT IPO is likely to "work" in that institutional investors like the "built-in cash flow growth" from improving operations. They are a large safe play on a large market. There will be plenty of competition at the lower end of the market but at the higher, full-service end of the market there are few competitors with any scale.
Longer term we will be watching to see how ADT moves to expand their opportunity in the lower end of the market or in adjacent areas like cybersecurity. Their roadshow slide looks like a smorgasboard of options so either they don't know yet or they don't want to give anything away.
The proposed valuation weights in at about 3x market cap/sales, 6x market cap/EBITDA, 5.5x EV/sales and 10x EV/EBITDA. That last number, 10x EV/EBITDA seems high and has to factor in some amount of improved operations and growth over the next year or two.
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