Takeaway: Revenue up on M&A (in-line with us), OCF ahead as they didn't pay interest expense on KOCH

ADT reported revenue of $1,117m and FCF of $174m (GAAP), versus Street revenue of $1,107m, and our revenue and FCF of $1,116m and $144m. Churn improved from 13.7% to 13.6%, in-line with our estimate. Net debt improved to $9.3b bringing Enterprise Value to ~$16b.

Looking at the pieces, we highlight three points:

  • Revs in-line with us, upside due to M&A we had factored already. Revenue right in-line with our estimate, growing 2% y/y organically, with ~$100m of trailing 3 quarter M&A spent helping add 2-300bp of revenue growth y/y. The company acquired a string of integrators on the commercial side, all non-recurring revenue.
  • They added 13% charge to the credit card by not paying KOCH which also over-states OCF and gross cash, and under-states interest expense. GAAP FCF $30m ahead of our estimate but mainly thanks to $15m of one-time benefit from a legal settlement, plus the non-payment of $23m in quarterly cash dividends to the Koch Investors which gets recognized in interest expense
  • Announcing the redemption of Koch Securities is definitely a plus. But…at the same time, is it a good capital decision to not pay the $23m quarterly cash dividend which now becomes $26m owed and implies that the fair value takeout for the Koch Securities jumps even more? At the end of 2017 the Koch Securities had a ~$924m takeout value. The carrying value just jumped $26m, so the takeout value jumps even more, which means that ADT will require something like $200m+ in debt in order to fund the redemption of the Koch Securities, adding weight to an existing debt pile that won’t get any lighter until after May 2019 when they can refi the 9.25% bonds for a net $50m annual interest expense improvement. AND - guess what? They will incur $200m of borrowings to refi the KOCH securities but since they are not showing us interest expense with KOCH in it, there is no add back to FCF from that action 

I wonder why they didn’t pay? It just means the takeout cost is even higher and they have to borrow even more. And is it a good capital allocation to charge another 13% to the credit card for one quarter of non-payment? ADT will need to borrow more money to repay the incremental KOCH penalties above the $750m set aside. All for the benefit of not showing interest expense $23m more higher?

More after the call