ADT - ADT

[thefatbaboon]

Haven't decided if this is a long ADT idea, a short ASCMA idea or a long ADT short ASCMA pair.

 

ADT is the largest home security business - with 6.5m subscribers.  Vivint and Monitronics (Ascent Capital, small Malone co. ex Discovery), numbers 2 and 3, have around 1m subs.

 

ADT has a Mkt Cap of $5.5bn and $4.5bn in debt.  Total EV $10bn.  EV per sub = 10bn/6.5m = $1,540

 

Compare ASCMA with Mkt Capt $1.1bn and $1.5b in fairly expensive debt.  Total EV $2.6b.  EV per sub = 2.6bn/1.05m = $2,500

 

Subs pay around $40 per month.  And there is a fairly well developed market where security companies buy subs from local dealers for 30 - 34 times the monthly revenue - around $1,300.  Both ADT and Monitronics buy subs at the same prices.  ADT has slightly worse churn - but nowhere near enough of a difference to explain the EV per sub difference.

 

Either ASCMA is over valued or ADT is cheap.

 

Haven't decided if I like this industry.  They sure have to spend hard to stand still.  But if ADT shut down, ceased acquiring and generating subs, they'd get about $3,900 dollars out of their subs.  Thats about $25bn.  "Costs to serve" would take about a third of that. Leaving about $16bn for the stakeholders (taxman held off by some noels).  Anyone else been looking at this space?

 

 

 

 

 

 

 

 

 

[prevalou]

From memory, ASCMA and ADT are not exactly in the same business. ASCMA only  buy contracts from an independant exclusive network and ADT often does the complete work (marketing, installation, etc.).

EBITDA margins are a lot higher for ASCMA but amortization is different from ADT. So it is difficult to compare EV per sub in both cases.

[Stevieoopsie]

Despite being a Malone junkie and all, I think ASCMA's business model is ridiculous.

 

Unlike the old TCI where they could over-depreciate the assets and generate free cash while reporting GAAP losses, the D&A that ASCMA reports is very real. This is because alarm companies outsource customer acquisition to local dealers and capitalize their marketing costs (EBITDA consequently is almost an irrelevant metric here). They amortize that cost and have to spend on "maintenance capex" regularly in the form of acquiring new subs to replace their churn every year.

 

For example, they lost 90k subs to churn in 2012 (I'm using 2012 numbers because they acquired a bunch of subs through an acquisition in 2013 making the numbers difficult to compare) and spent $305 million acquiring 202k subs for an SAC of $1.5k per sub. That means the "replacement cost" associated with the 90k sub loss required 90k x 1.5k = $135 million. They reported $163 million in amortization so they only over-amortized slightly.

 

If you add the over-amortized portion of $28 million to their GAAP loss of $28 million that year you can get a rough proxy for "adjusted earnings" of $0, which means in economic reality they only broke even in 2012. I'm puzzled by the enthusiasm over the stock because with their huge leverage, an interest rate spike could easily put this business under a ton of stress, and there is very little earnings power. Growth doesn't create value, especially the way they are expanding now - aggressively acquiring subs at uneconomic terms.

 

ADT like other alarm businesses has atrociously bad returns on capital, which isn't surprising given this is almost a perfectly competitive industry with very few barriers to entry. It's slightly better because it has a stronger "brand" and benefits from scale economics, but it's still bad. The stock doesn't look particularly expensive at this point but you can pay more or less the same multiple for much better businesses currently. I also think their management is not very sophisticated with capital allocation, as they got pushed by a bunch of activists into doing a huge levered recap where they bought back a ton of shares at a very high multiple over the company's "real earnings".

 

With that said, I wouldn't short ASCMA given Malone's involvement (not surprisingly he's selling his stock as well http://www.businesswire.com/news/home/20131025005827/en/Ascent-Capital-Group-Purchases-351734-Shares-Series#.UzbzufldVp4). With a positive feedback loop underway (raising capital @ 2x book, buying subs @ 1x to show growth and raise more capital), it's very difficult to tell when people will start to value this thing rationally.

 

 

 

 

 

[thefatbaboon]

Prevalou,

 

I think it is ok to compare subs.  ADT has other ways of getting subs - but they buy off dealers for a lot of their churn needs. 

 

Stevie,

 

That's pretty much exactly how I'm seeing things.  ASCMA is ridiculous.  Where subs you can buy for 1.3k-1.5k are effectively being valued at 2.5k.  On the other hand where ADT is trading now seems close to the economics of the underlying market: i.e.. buying ADT is like buying subs at 1.5k.  If the economics of sub purchases that all these home security co.s are doing are reasonable - then buying ADT is reasonable.  Whats the average life on these suckers with their 13%-15% churn?  About 96 months?  Pay 1.4k today for 2.6k back over 8 years (after netting out 1.3k cost to serve). Looks like a 6% roc…wow, that's terrible…have I made a mistake?

 

 

[prevalou]

ASCMA buy the subs for less than 3 years revenue and the subs last more than 10 years (average life 8 years). If marginal EBITDA is 70% (marketing cost is insignificent here), roa is not zero, far from it.

[Stevieoopsie]

On $238 mil of EBITDA  in 2012, they capitalized $305 million of marketing.

 

On $304 mil of EBITDA in 2013, they capitalized $235 million of marketing and spent $479 million on an acquisition which is mostly capitalized marketing (since the primary purpose of acquiring a company is to board its subs)

 

I wouldn't call that "insignificant".

 

Suppose ASCMA owned all the dealerships and did their marketing in-house, based on my estimate in the previous post their "maintenance marketing" (amt. required to keep revenue constant) in 2012 was $135 mil, so REAL EBITDA was $238 mil - $135 mil = $103 million and real EBITDA margin was $103/$345 = 30%

 

They consumed something like $70 mil in financing cost that year and if you throw in maintenance capex on fixed assets and some other things they effectively made nothing that year.

 

[prevalou]

Your calculation understates true profitability for at least three reasons:

1) the news subs ASCMA  buys have not the same features as the old ones (more services like automation, health, etc.)

2) In a no growth industry, price for the subs would be probably less because growth attracts competition, so marketing expense as you call it would be less.

3) In a no growth state, variable costs would be less

[saltybit]

Nice writeup on the idea http://yetanothervalueblog.com/2019/08/quickie-idea-adt-might-not-be-secure-but-it-is-cheap.html

[Saluki]

I looked at this briefly a couple of months ago and put it in the "too hard" pile. 

 

Yes, it's very cheap and it's selling for less than half it's IPO price.  Yes, it's got a large market share in a very fragmented industry.  Yes, it's got a very sticky product (my dad has lived in his place for 20 years and has been paying ADT).

 

But, if my dad moved and wanted to get home security on his new place, he would surely get ADT again, but what if I wanted it? I've seen the new ADT stuff (a screen vs the light up LED panel that my dad has) and if I had to choose that or Nest or SimpliSafe, I'm  not sure the "brand" of ADT would have any sway with me.  So I don't know how strong that moat is.  I do see "The Property Brothers" doing ads for ADT on my Hulu all the time, but when I go on YouTube and look at the demos for their high end product vs Nest, I'm not convinced it's a great product. 

 

 

[walkie518]

I looked at this briefly a couple of months ago and put it in the "too hard" pile. 

 

Yes, it's very cheap and it's selling for less than half it's IPO price.  Yes, it's got a large market share in a very fragmented industry.  Yes, it's got a very sticky product (my dad has lived in his place for 20 years and has been paying ADT).

 

But, if my dad moved and wanted to get home security on his new place, he would surely get ADT again, but what if I wanted it? I've seen the new ADT stuff (a screen vs the light up LED panel that my dad has) and if I had to choose that or Nest or SimpliSafe, I'm  not sure the "brand" of ADT would have any sway with me.  So I don't know how strong that moat is.  I do see "The Property Brothers" doing ads for ADT on my Hulu all the time, but when I go on YouTube and look at the demos for their high end product vs Nest, I'm not convinced it's a great product.

agreed, and I don't think the product is any better than anything similar, but there should be some value in the brand as it is somewhat synonymous with "home security."  How much is it worth?

 

Studies show it takes 60 years for ppl to forget a brand... that ADT linked up w/"The Property Brothers" provides validation to the brand for consumers who don't know or care to know the nuances? 

 

Should the company continue to cash flow w/o hiccups, keep leverage high, and buyback stock, whenever deleveraging happens, the stock could do quite well?

[Jurgis]

I think if you want a system that connects to first responders (police/fire dept), you'll likely get ADT or whatever other old brands are.

If you want local/cloud/AI monitoring only with DIY setup, then probably get one of the new systems.

Full scale ADT is likely (much?) safer, but also more prone to false positives and costs if police/etc is called on a false positive.

There's quite a bit of ADT hate based on that.

Though this is anecdotal.

 

[dwy000]

ADT's historical strength was the connectivity (ability to detect an alarm remotely and call first responders) and the stickiness was that it was hooked up thru the phone line.  Nearly impossible to replace without ripping wires and having a service person spend hours at your home.  Now that everything is internet connected they seem like just another competitor in the space and one that, frankly, hasn't kept up with the competition.  The Nest and Ring and SimpliSafe products are amazing.  ADT seems loathe to compete with and cannibalize their own product for fear of killing the golden goose (read up on Kodak there ADT, read up on Kodak).  And then you have the cable companies piling on.  We went with Comcast (xfinity) home security because they bundled it so cheaply with the other products we have and it connects in through their broadband.

 

With almost 100% margins on monthly monitoring, it appears to be a race to the bottom on hardware and monitoring price.