Takeaway: We hosted our ADT Best Ideas Short BlackBook call on Wednesday

Replay: CLICK HERE for video & audio replay

https://app.hedgeye.com/feed_items/67347

Top Points from our Call:

  • Under pressure: changing secular demand curve, down-sloping cyclical indicators
  • Under pressure: rising competitive intensity, shift to software based, new brands entering
  • Under pressure: path to de-lever has to get through KOCH Securities (still around), additive to 1H18 interest expense, and cost $175m+ in cash to redeem over and above the $750m set aside
  • Under pressure: starting in 2018 management is no longer paid bonuses on improvement in churn (despite IPO on the basis of churn improvement)
  • Under pressure: 20-25% of the customer base churned (gross) during the 7-quarters the company was privately held
  • Under pressure: growing SAC & new low price points in 2018 into a contraction of market growth rates with rising competition and potential disruption from DiY channel will likely end the way it did when ADT was public last time, with rising gross SAC per incremental user, and a tough revenue + FCF outlook
  • Under pressure: despite optically improved churn, 100% of pro forma monitoring revenue growth in 2016 and 2017 was the impact of Pulse + pricing; Pulse already 35% of residential installed base, some evidence of slower growth of Pulse now
  • Under pressure: components from ‘Special Items’ separating GAAP and non-GAAP FCF seem recurring

ADT has twin long term tail risks: Apollo selling 86% of the equity & Amazon eating their lunch. In the short term we think ideas about de-levering are overly hopeful, and we see the battle between churn & SAC as a rock-hard place debate with SAC per gross add likely to rise like it did the last time ADT was public.

Aging, levered stocks in our universe with risk of disruption, and that face revenue growth challenges, tend to trade with high FCF yields and low EV/FCF multiples. ADT is arguably the riskiest among them due to the cap structure (~86% seller).  The stock is now ~17x current year unlevered FCF (using GAAP FCF base) which is actually much closer to the higher end of the range of where this group trades. We see considerable downside risks as easy y/y revenue comps come to an end (2Q), SAC rises, churn improvement slows, the de-levering process takes longer and costs more than bulls appreciate, and GAAP FCF suffers.