Secure the Bag

by Overheard Wall Street
  • Intro
  • ADT
    • History
    • Bulls
    • Bears
  • Key Metrics
  • Recommendation

Intro

Everyone is worried about security.

Whether that is home security, cyber security, or just securing your anonymous Twitter account so that Elon doesn’t realize the king of trolls is just a 12-year-old kid tweeting from their parents’ basement.

The security industry in the US is a bit of a hidden giant, however, bringing in ~$50 billion in revenue in 2022 and is estimated to grow to $55 billion by 2025.

Does anyone buy a security system for their apartment complex unless they own a home?

Probably not.

Most of the time, the apartment complex has a security system for the entire building, not just individual apartments.

Even if you don’t have a security system, it seems like there is one name everyone has heard of.

You either love them and would never switch or despise them and their entrapping business practices:

I grew up with an ADT system in my childhood home. I installed an ADT system in my first house. It wasn’t until I moved that I realized I could have saved about $3,000 using one of the newer security firms…

ADT is an interesting beast, living in the old ways of charging customers massive install costs and ongoing monitoring, maintenance, and upgrade costs.

New security firms charge you for the equipment but allow installing and monitoring on your own.

Most of these newer security firms are still private companies, and for a short period, so was ADT.

But recently, ADT has been in the news with equity funding coming from Google and StateFarm, and we decided to dig in a little and see if there is an opportunity for investors.

ADT

While wordy, I find the business description in a company’s 10-K to be a helpful summary of the business and understanding its advantages, if any.

ADT Inc. is a leading provider of security, interactive, and intelligent home solutions serving residential, small business, and commercial customers in the United States. With the acquisition of Sunpro Solar in December 2021, we are now also a leading provider of residential solar solutions. Our mission is to empower customers to protect and connect to what matters most - their families, homes, and businesses - by delivering safe, innovative, and sustainable lifestyle-driven solutions through professionally installed, do-it-yourself (“DIY”), and mobile or other digital-based offerings supported by our 24/7 professional monitoring services.

The ADT brand is among the most recognized and trusted brands in the security industry. This is a critical competitive advantage and contributor to our success due to the importance customers place on reputation and trust when purchasing our products and services. The strength of our brand is based upon a long-standing record of delivering high-quality, reliable products and services; expertise in system sales, installation, and monitoring; and superior customer care, all driven by our industry-leading experience and knowledge.

ADT’s income is divided into two main categories: installs and monitoring services.

Roughly 80% of revenue comes from monitoring services, including Consumer & Small Business (CSB) and Commercial.

CSB is the most significant portion of ADT’s revenue – which makes sense. ADT focuses on providing home security to families and homeowners.

Interestingly, the revenue increase seen from ADT in Monitoring Services was due mainly to increasing prices and customers selecting higher-priced services in the new year.

It is impressive that an already expensive service compared to others operating in this space, can raise prices and have customers continue to pay up!

  

History

It’s worth mentioning because the story here is unique – but ADT can trace its history back to 1874 to Edward Calahan, who invented the stock ticker.

After finding a burglar in his home, Calahan invented an “alarm” system that would send a telegram-based alert if someone entered his house.

This alarm system was a telegraph-based “call box” that would signal the local police office if triggered. This excited Calahan’s neighbors because he quickly connected this system to 50 other homes and birthed the “American District Telegraph” company (ADT) in 1874.

ADT may have been the first private company to send policemen on “rounds” around the neighborhood – simply walking around streets and making sure that no one was attempting to burgle the houses on that street.

This led to a more centralized monitoring system in the 1940s, allowing thousands of customers to link to one central location for home monitoring and protection services.

They expanded this monitoring into an automated burglar and fire alarm system, eventually coming up with the iconic blue sign many see in yards stating, “Secured by ADT.”

In 1997, ADT was acquired by Tyco International, a Swiss international security firm that hoped to expand its security portfolio into the US with this acquisition.

Shortly after this, in the early 2000s, Tyco discovered that its executives were stealing millions of dollars and went through bankruptcy proceedings that forced them to spin out portions of the business.

Sidenote: the CEO and CFO of Tyco International were accused of stealing $150M from the business and when on trial, claimed that the board of directors approved these compensation packages.

ADT was spun out from Tyco in 2012 as a separate entity and traded publicly until 2016, when Apollo Global Management bought ADT in an epic take-private deal.

Apollo paid $7 billion for ADT in 2016, a 56% increase over the public price, paying $42/share to acquire the entire business and take it private.

Then in 2018, Apollo brought a small portion of ADT back onto the open market (most likely to appease investors who wanted some liquidity), trading at $12/share.

Since then, ADT has done nothing impressive – struggling to grow revenues and losing 19% over the last ~ four years:

Bulls
  • StateFarm and Google collectively invested approximately $2.25 billion into ADT to expand the technology offerings and provide cross-selling opportunities.
    • If you have ever gotten home insurance, you know that sometimes you can get a nice discount on the insurance if your home has automation features and a security system. StateFarm just completed a deal to acquire 15% of ADT at an average price of $9/share for $1.5 billion.
      • This investment will open the door for StateFarm to access more homeowners needing insurance and ADT access to more homeowners who may not have security through StateFarm’s customer base.
      • This should be an incredibly beneficial relationship, but it was only finalized at the end of October.
    • Google invested $450M into ADT in 2020 to offer some of its Google Home products (thermostats, cameras, locks) as a part of the install package offered by ADT. So far, this relationship has been working well, and Google wants to invest another $300M with ADT to expand its offerings.
      • The better the technology that ADT offers, the more likely it will be able to expand its offerings and bring in new customers seeking technology enhancements.
      • This has already been a tailwind for ADT in 2022. It should only continue, given Google’s expansive suite of technology and integrations.

Bears
  • ADT is 71% owned by Apollo Global Management today. And with StateFarm now holding 15% of the free float of ADT, that leaves very little room for shareholders.
    • While we can consider ADT a public company, since a portion of its stock trades publicly, it is a private equity-backed company. Apollo has the final say in every decision for ADT, and unless they have plans to sell soon, no investor will get much out of ADT until then.
  • ADT is a classic example of a privately backed company that is weighed down with excessive debt. Apollo can only take an entire company private by slapping on as much debt as possible to fund its acquisition.
    • Since then, ADT has been steadily improving the bottom line, reducing its annual losses yearly, but the debt is still relatively large.

Key Metrics as of 11.4.22
  • Current Price: $8.49
  • Cash: $45M
  • LT Debt: $8.9 billion
  • Net Income: ($36.8M)
  • LT Debt/Equity: 297.8x
  • LT Debt/Total Capital: 74x
  • LT Debt/Total Assets: 57.3x
  • NTM:
    • Revenue: $6.8 billion
    • EBITDA: $2.5 billion
    • Net Income: $613M
    • EV/EBITDA: 6.2x
    • P/E: 13.2x

Conclusion/Recommendation

Our advice would be to stay away from ADT.

It is a storied name with a vibrant history, but since Apollo’s acquisition, it has gone nowhere.

This StateFarm deal could be the catalyst that ADT needs to grow its customer pipeline. And the continued interest from Google might spur additional technological resources that homeowners like to see.

But overall, there is little here after considering the giant share owned by Apollo.

There is not a great option available for a pure-play home security option. Even Vivint, a direct competitor to ADT, which offers more smart home technology offerings and security, is majority owned by Blackstone Private Equity (46%) and Fig LLC Private Equity (12%).

Securitas AB, a Swedish security company with operations globally, is the one company that is not majority owned by a private equity firm and has been consistently profitable over the last 5+ years.

This may be one to examine further!

For now, stick to cybersecurity firms over home security investments.

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