VVNT - Vivint Smart Home Inc

[Jurgis]

Anyone has deep(er) insights into this one?

 

Looking at their latest 10Q, their growth is slow: ~8% YoY. Earnings are negative. 9mo OCF and FCF are positive though. At ~210M 9mo FCF, it seems to be trading cheap at ~4.3B market cap. There is ~2.8B debt, so EV is higher at ~7.1B. So then it depends on what one thinks about debt in these times.

Should I be skeptical about the OCF/FCF numbers? Or is this an underappreciated buy in an expensive market?

 

I guess counterargument is that if they slow grow, they can’t really pay off debt anytime soon.

Also the space seems to be very competitive and it's unclear to me how much brand/moat/any other advantage they have.

 

One thing is that I get a lot of fake/fishing/spam that claims to install/provide their products cheap/free. Similar to ADT spam though, and it doesn't necessarily mean that ADT is a great company/investment. But spammers think that there is some name/brand recognition... 8)

 

Disclosure: I have warrants that are 10x from my purchase.

[5xEBITDA]

Ah yes, the alarm monitoring companies. A rite of passage for any analyst. I've traded ADT, Vivint, and Monitronics (Brinks Home Security) debt and equity at different points over the last several years.

 

ADT is the industry incumbent with largest market share, they were previously an Apollo company. Vivint is #2 in the industry and was a private, Blackstone owned company until it became public earlier this year via a SPAC transaction. Fun fact - this deal fell apart several times and nearly didn't get done, which I'm happy to explain in more detail. COPS is a private company and provides wholesale monitoring services in addition to providing product to private families. They're likely the #3 player. Monitronics, which recently emerged from bankruptcy (and likely heading right back in) is somewhere in the #4 / #5 range for market share.

 

Alarm companies have two product lines - products and services. Products include the sale of physical alarm monitoring devices and are either wired or wireless. Margins on product sales are low. These guys don't do the manufacturing of the product, they buy from someone like Resideo. Wired products need to be installed by a technician who comes to the customers house, and wireless devices are typically DIY but can still be installed by the company. Services include revenues received from performing the actual alarm monitoring and is the core of the business. Monitoring contracts are typically struck at 3-5 year length with three being most typical. I recall monthly monitoring rates are currently in the $40 - $50 / month range at the moment. In this industry this is referred to as recurring monthly revenue (RMR). Margins on the servicing side range between 50 - 60% because there is little to no overhead required for servicing, it mainly just maintaining a call center. The servicing side generates significant EBITDA and supports the whole business.

 

KPIs in the alarm monitoring business include attrition rate, payback period, and creation multiple. The best companies in the space have low attrition, low payback periods, and low creation multiples. At any given time, attrition rates range between 11-13%, which I think Vivint tends to be on the lower end. Creation multiple equals customer acquisition cost divided by contracted RMR, and a good creation multiple is considered to be lower than 30x (no matter what anyone says). So, if customer acquisition cost is $1,200 and a contract is struck at $40, your creation multiple for the contract is 30x. 30x divided by 12 = 2.5 year revenue payback period. A 25x creation multiple yields a 2 year revenue payback period. If you have a contract with a three year term, you prefer the 25x creation multiple vs 30x because the difference is one full year of capturing post-breakeven, pure cash IRR vs. only 0.5 years. As you can see, if you can successfully re-contract a customer post their initial term, it is nothing but bottom line as you've already recouped your CaC and costs incurred to retain a contract are typically low.

 

Customer acquisition cost is a tricky thing to manage as your greatest expense is going to be lead generation - i.e., how do we find people to turn onto our service. For a long time this was a spam call / door knocking sales business. The public alarm companies, for a long time, didn't do much direct origination themselves. They relied on a network of alarm dealers to originate contracts themselves who would then sell the contracts to Vivint, ADT, etc. These would generally be college kids who show up at someones door and try to sell the products. This was generally not a great set up for the actual servicers because they needed to be the dealer a spread in order to get the contract. Say a dealer creates a contract a 30x, maybe he won't agree to sell the contract for anything less than 35x. Great, you have a contract but it has a 3 year revenue payback, so you need to hope you can renew this guy just to have a shot at making an actual profit. However, if the dealers are your primary source of contracts you can only squeeze  them so hard on the spread they'll accept, especially if they have a reliable  pipeline. Some FTC litigation in 2017 basically disrupted this by making an example out of some dealers who were violating the no call list and some other things. Now, almost all public companies have foregone their dealer networks in favor of becoming DTC. ADT, the largest in the industry, has basically been a textbook example of trying to turn a fully loaded cargo ship when trying to describe their success with becoming DTC. You essentially need a silicon valley marketing team, and the best operators have poached guys like that. It truly is a different business model requiring a very specific, modern skill set. Monitoring companies are dinosaurs. I personally think Vivint has done a good job at this.

 

So, all else equal - if you manage low attrition and low creation multiples, you've effectively built a high margin, contracted cash flow stream with potential for infinite margins. Are you ready to buy as much alarm company equity and debt as you possibly can?!

 

There is always a rub with this stuff. Here is the rub. Despite the wonderful unit economics I just described, these are deceptively capital intensive businesses because you need to make a large up front cash payment in order to secure a three year contract with potential to make actual cash for all, or some, of year three. Because attrition is a real thing, the portfolio of an alarm monitoring company is always in terminal decline. In fact, I personally think it is inappropriate to value these things with a cash flow multiple unless they are actually growing subscribers (some are not). You might be generating $100 million in 60% margin EBITDA, but you don't actually generate any free cash flow because your subscriber acquisition cost may also equal $100 million. "Steady State" free cash flow is a phrase used in the industry which refers to the amount of capital expenditures it takes just to offset your natural attrition in any given year before adding new contracts. One thing to note is that some companies expense their subscriber acquisition costs (same as CaC) through the income statement while others capitalize to the balance sheet, so you have to make sure you know what you're looking at. If it is expensed, it is added back to EBITDA.

 

Here is the other rub. As I'm sure you've thought of at the moment...couldnt you just...turn off CaC and run this business for cash, and suddenly you have 100% EBITDA to FCF conversion? Kinda! At least, the high yield market believes you can. Between ADT, Vivint, and Monitronics I think there is more than $10 billion worth of debt. The high yield market loves lending to these companies because for the most part they have contracted cash flows and capital expenditures that looks pretty easy to turn on and off when you want. So, the problem of being an equity owner here is that it takes A LOT of work to get EBITDA to a point where you are generating positive levered free cash flow after subscriber acquisition costs and cash interest expense. Monitronics thought they could just turn off their capital expenditures and avoid bankruptcy, but it didn't work. It especially doesn't work once attrition starts going the wrong way. Fun fact, I don't think Blackstone made a single cent off Vivint until it went public via the SPAC and used proceeds to pay down debt (otherwise they were going to file bankruptcy :)).

 

How does one value these companies? Forget an EBITDA multiple. You will almost always lose money if you look at these things on an EBITDA multiple because they look cheap. I know guys who bought bonds at 60 cents of Monitronics because it was something like 4x EBITDA while ADT was around 6-7x or something, and those bonds got a zero recovery in the bankruptcy. There are two methods I use to value these companies. One, if the company is not adding subscribers, you need to determine the net present value of the monitoring portfolio on a "run off" basis, i.e., you just run it for cash utilizing certain attrition rate and margin assumptions. Two, if the company is adding subscribers, you do the same thing with the current monitoring portfolio and then subtract the NPV of the current book from the enterprise value and look to see what multiple of EBITDA or RMR you are paying for "growth" potential. I guess this is gray zone for using an EBITDA multiple, but I suppose if I looked at Vivint and determined I was effectively paying 3x for growth potential or something I might determine that's fair and take it for a spin.

 

Keep in mind, these stocks are very volatile around earnings because theres so many KPIs released that people care about. I've found these equities tend to trade on attrition rates mostly, followed by FCF.

 

Vivint, I know, is somewhat of a darling at the moment because they've been putting up real free cash flow numbers over the last few quarters. I'm not up to speed on the Company these days, but I think it is for the most part real but also in part to a new service they have where a third party does contract financing for customers, which helps Vivint boost their margins. Don't hold a gun to my head on this though.

 

I know no one asked me for this part, but I think the future of this business is eventually heading to securitization of the monitoring contracts. Operators with a proven history of low attrition and creation multiples should eventually be able to do this, and I think Vivint is likely the closest one to that goal. This would be a game changer in my opinion, because an ABS would have significantly lower cost of capital vs. the high yield financings these companies currently have, and all of that benefit would accrue to equity holders.

[Jurgis]

5xEBITDA, wow, I owe you a beer or a dinner. That was a ton of value post. 8)

[5xEBITDA]

5xEBITDA, wow, I owe you a beer or a dinner. That was a ton of value post. 8)

 

I so rarely get to pontificate on alarms :(

[Jurgis]

5xEBITDA, wow, I owe you a beer or a dinner. That was a ton of value post. 8)

 

I so rarely get to pontificate on alarms :(

 

You can do that for all the dinner or beer.  8)

[5xEBITDA]

5xEBITDA, wow, I owe you a beer or a dinner. That was a ton of value post. 8)

 

I so rarely get to pontificate on alarms :(

 

You can do that for all the dinner or beer.  8)

 

This is an acceptable fee!

[Pelagic]

Wow that was a hell of a post 5x.

 

They almost come off sounding like upstream O&G companies where decline is high and you might make a lot but you need to spend it on drilling to keep production up.

 

If placed into run-off mode though, isn't there a certain % of customers who just aren't going to switch - lazy, happy with it, location, etc.? People tend to be lazy/brand loyal with stuff like this. I guess you'd run into the problem of paring back expenses to match the now smaller customer base but if you let cash build up from the core base and then go back on an customer acquisition spree when financials are right you might be able to make some money. I guess that's where having an independent dealer network came in.

 

 

[5xEBITDA]

Wow that was a hell of a post 5x.

 

They almost come off sounding like upstream O&G companies where decline is high and you might make a lot but you need to spend it on drilling to keep production up.

 

If placed into run-off mode though, isn't there a certain % of customers who just aren't going to switch - lazy, happy with it, location, etc.? People tend to be lazy/brand loyal with stuff like this. I guess you'd run into the problem of paring back expenses to match the now smaller customer base but if you let cash build up from the core base and then go back on an customer acquisition spree when financials are right you might be able to make some money. I guess that's where having an independent dealer network came in.

 

Yes, comparing to an E&P where you harvest low-decline PDP while spending development capital to convert PUDs is a good comparison.

 

There will always be some people who don't switch, you're right. I think its sort of reflected if you look at the attrition curve...if you start with 100,000 subscribers with 11% attrition, you still have 63,000 subscribers after five years which is still a good amount.

[Spekulatius]

A better analog May be a really crappy SAAS business - high acquisition cost, low retention , but comparatively high margin.

 

Didn’t Malone own an alarm business rollup at some point that went belly up?

 

Another big concern - these new smart cameras ( Ring etc) with automatic motion detection operating cloud based etc make traditional monitoring obsolete or at least create new competition which eats into the incumbents market share.

[5xEBITDA]

A better analog May be a really crappy SAAS business - high acquisition cost, low retention , but comparatively high margin.

 

Didn’t Malone own an alarm business rollup at some point that went belly up?

 

Another big concern - these new smart cameras ( Ring etc) with automatic motion detection operating cloud based etc make traditional monitoring obsolete or at least create new competition which eats into the incumbents market share.

 

Yea he owned Monitronics for a long time via Ascent Capital Corp. Malone was largely out of the picture before they filed, though. Agree that the Rings of the world are competition. The one draw back of those products is that they won't (or have very rudimentary capabilities so far) actually call 911 for you if there is a problem. They'll send you a notification there is a problem, then its up to you to do the rest. The pitch for more traditional monitoring is for better peace of mind, and the demographics targeted are typically older who don't want to mess with the smartphone thing.

[lnofeisone]

Wow this was super helpful 5x and I'll gladly self-invite myself to this dinner where you can pontificate on the alarm companies (I'll get few rounds, of course).

 

Question about Vivint - they partnered up with Vivint solar (Sunrun company) a few years back and I am curious if that has increased customer stickiness and/or improved customer acquisition? I'm guessing solar panel purchasers tend to be more affluent (at least have to own the home).

[5xEBITDA]

Wow this was super helpful 5x and I'll gladly self-invite myself to this dinner where you can pontificate on the alarm companies (I'll get few rounds, of course).

 

Question about Vivint - they partnered up with Vivint solar (Sunrun company) a few years back and I am curious if that has increased customer stickiness and/or improved customer acquisition? I'm guessing solar panel purchasers tend to be more affluent (at least have to own the home).

 

The thing with Vivint Solar is pretty immaterial to the business, I don't think it really matters. This is from their 4/27 Proxy.

 

Agreements with Solar

 

The Company is a party to a number of agreements with its sister company, Vivint Solar. Historically, some of those agreements related to Solar’s use of certain of Legacy Vivint Smart Home’s information technology and infrastructure services; however, Vivint Solar stopped using such services in July 2017. In August 2017, Legacy Vivint Smart Home entered into a sales dealer agreement with Vivint Solar, pursuant to which each company agreed to act as a non-exclusive dealer for the other party to market, promote and sell each other’s products. During the year ended December 31, 2019 Legacy Vivint Smart Home charged $9.2 million of net expenses to Vivint Solar in connection with these agreements. The balance due from Vivint Solar in connection with these agreements and other expenses paid on Vivint Solar’s behalf was $2.2 million at December 31, 2019.

 

On March 3, 2020, the Company and Vivint Solar amended and restated the sales dealer agreement to, among other things, add exclusivity obligations for both companies in certain territories and jurisdictions, expand the types of services each company is permitted to render thereunder, and to permit use of the services offered by Amigo, a wholly owned subsidiary of the Company, in connection with the submission and processing of leads generated pursuant to the agreement. The amended and restated agreement has a one-year term, which automatically renews for successive one-year terms unless terminated earlier by either party upon 90 days’ prior written notice.

 

On March 3, 2020, the Company and Vivint Solar entered into a recruiting services agreement pursuant to which each company has agreed to assist the other in recruiting sales representatives to its direct-to-home sales force. The parties will pay each other certain fees for these services which will be calculated in accordance with the terms of the agreement. The Company and Vivint Solar have also agreed under the terms of the agreement not to solicit for employment any member of the other’s executive or senior management team, any dealer, or any of the other’s employees who primarily manage sales, installation or services of the other’s products and services. Such obligations will continue throughout the term of the agreement.

 

On March 3, 2020, Amigo entered into a Subscriber Generation Agreements with Vivint Solar and the Company to facilitate the use of the Amigo application for the submission and processing of leads generated pursuant to the amended and restated sales dealer agreement.

 

In connection with the amendment and restatement of the sales dealer agreement and the execution of the recruiting services agreement, the Company and Vivint Solar terminated the Marketing and Customer Relations Agreement, dated September 30, 2014 (as amended from time to time) and the Non-Competition Agreement, dated September 30, 2014 (as amended from time to time), in each case effective as of March 3, 2020.