ADT acquires Red Hawk, touts commercial now ~25% of revenue... Our first reaction to the ADT acquisition of Red Hawk was ‘hey, that’s cool, ADT stock has been really weak, and management is actually doing what we said they need to do, increasingly buying up a position in commercial. Cool.’ Yeah, that’s the optimistic Ami, always looking to be optimistic even on my second best Short in 2018.
Our second reaction needs bullets:
- ~$300MM REVENUE IN 2018? Well, the business had ~$250MM in revenue as of April 2012 when Comvest acquired it in a fire sale from UTC, and ~$240MM in revenues as of February 2016 when they made their first acquisition, so the direction of organic growth for this asset is suspect, in our view.
- ‘RECENTLY GROWING DOUBLE DIGITS’? Acquired System Sales Corp in Feb 2016. Acquired Integrated Systems in Jan 2017. Acquired Alarm Tech Solutions in Feb 2017. Acquired DPSI and ATCI in Jan 2018. Acquired SDT July 2018. You see my point? It ain’t organic growth!
- MORE NUMBERS: SDM (industry magazine) cites $227MM in revenue for the full year 2016 and $220MM in 2015 (the references in bullet 1 were from the Red Hawk management team as quoted in Security System News articles). Can that be right? SDM further cites $264MM in 2017 revenue, of which ~$106MM of recurring revenue, and the 2018 acquisitions seem to be mostly for integrators, which goes into non-recurring revenue.
- That ADT is borrowing to do this acquisition makes it all the smellier (see 8-K), since they are adding to a net debt pile in exchange for mostly non-recurring revenue with an iffy organic growth rate.
The last point here on Red Hawk:
The press release states “Red Hawk represents one of the few last independent large national commercial integrators.” Is that like, ‘last’ in the sense of the last pearl discovered in an over-fished ocean floor, or is that the last tomato in the bin at the grocery store that no one else wanted?
Welcome to the CEO role, Jim.
On estimates:
The Street is looking for ~$650MM of FCF in 2019. We are having trouble getting into that zip code as we are sub $500MM. But our FCF estimates for 3Q18 are above Street, as Street is looking for close to $0MM, in what is typically an ‘ok’ cash flow quarter.
What’s it worth?
Bulls may reason that ADT is a premium brand with #1 market share in its core residential business, with stickier than expected Pulse subs (rising subs despite rising ARPU), and a path to reduce the leverage burden in May 2019 by re-financing the remaining 9.25% notes. At 20x forward unlevered FCF we get ~$12-13 for the stock.
The Bears can counter that ADT is #1 in a business they are desperately trying to mix-shift away from in the ongoing pivot towards commercial which started with the acquisition of P1, and even after this acquisition, the residential business is still 75% of ADT. Further, the commercial side of the industry is near fully penetrated which means growth is cyclical with new business creation, and step function growth is only going to happen with M&A. ADT has been buying up integrators at ~0.7x revenue, integrators which sport a much lower gross margin and OCF envelope than the monitoring business.
How does this story end? Painfully. ADT resi will increasingly come under pressure as alternatives are brand new in this market and will only grow in share from here. After the May 2019 refi there are no obvious ways to improve FCF other than yet another workforce reduction. And why would anyone want to pay 20x unlevered FCF for a heavily levered company facing existential threats in its core, using every dollar of spare cash to pivot to a new business with low organic growth, all the while a large owner is waiting to hit 'sell' on 86% of the company? Don’t you think that is worth closer to ~10x FCF rather than 20x? We sure do.
Please call or e-mail with any questions.
Ami Joseph
Managing Director
Yosef Vaitsblit
Analyst
