Brink's Home Security Spinoff: Too Far, Too Fast 12 comments
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In late October, investors in The Brink’s Company (BCO) received a spinoff of the company’s home security division. The new stock listed as Brink’s Home Security Holdings, Inc. (CFL) has performed very well over the last 8 months, rallying as much as 50% above the closing price on its first day of trading. The transaction was designed to unlock the value of the home based business which may have been overlooked due to the larger secured transportation and cash logistics side of the parent company.
It is a bit baffling how well this strategy worked. Investors in BCO received one share of the new CFL for every share of the parent company they owned. And now 8 months later both stocks are well above their levels from when the spinoff occurred. Now both companies are certainly strong firms with positive cash flow and a well respected brand name. But economic weakness which has pressured growth rates does not appear to be showing up in the stock price.
For Brink’s Home, this is especially confusing since the company relies heavily on consumers and to a lesser degree on new construction for its future revenue growth.
During the first quarter revenue came in just a bit higher than last year at $136 million. Adjusted Earnings were $0.40 per share, a sharp 43% increase over the first quarter 2008. A good bit of this increase in profitability was due to the fact that the division did not have to pay hardly any royalty to the parent company. This type of earnings growth is nice, but not necessarily repeatable since next year there will be little comparable difference in the royalty payment.
Management noted that growth is being pressured by a weak economy in general, and specifically the portion of the business that protects new construction is slow. It’s hard to imagine this business line getting much better in the near future with the likelihood of rising interest rates, a deeply entrenched consumer, and employment continuing to be weak.
Logically, it seems that home security could be an opportunity for some consumers to cut back on expenses and lower expenses. This may be to blame for the fact that net new subscribers were lower than the growth seen in previous quarters.
CFL looks especially vulnerable after a failed breakout attempt last week. The $30 level has proven to be resistance twice now, and a weakening market picture could take the wind out of optimistic investor’s sails. The stock is currently trading at 22 times expectations for this year, and earnings are actually expected to decline in 2010. It’s very hard to justify a growth multiple on this company if growth turns out to be non-existent.
Brink’s Home currently has no debt and adequate cash on hand to fund its capital expenditures. The company will spend a good bit of marketing costs in the third quarter as it launches a new brand image. It will be very interesting to see if a new campaign can jump-start growth even during a difficult economic environment. If the stock market begins to decline again and home values do not pick up, it is unlikely that consumers will be easily convinced to spend more on security systems.
It wouldn’t surprise me to see analysts set a stock target for this stable company at $14.75 or so. That would represent a multiple of 12 on future earnings of $1.23. While it sounds a bit pessimistic to expect a 50% drop in the stock, I don’t see why investors would currently pay 22 times earnings for this company.
My recommendation would be to consider opportunities to short this highly priced stock while keeping a tight stop just a bit above $30.
Disclosure: Author does not have a position in CFL
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This article has 12 comments:
-90% of this business's earnings are locked in, every year, and for many years into the future
-CFL is still profitably growing at 5+% top line. How many other businesses are accomplishing that feat these days?
-EV/Recurring EBITDA is 3.9x, P/Recurring Earnings is 10.0x, EV/(EBITDA - Maintenance Capex) is 4.0x. All figures include adding $100M of cost for the rebranding initiative.
-Avg customer life is 14 years, and has been nearly unchanged since the onset of the recession (attrition up about 150bps).
-Since the divestiture, CFL can now effectively start to roll up the *many thousands* of very small security monitoring businesses.
-Outstanding management team, that fortunately, doesn't make economic decisions as poorly as Mr. Scheidt.
(and if people didn't look to recent price action to assess value, you wouldn't be claiming that CFL should go down because the stock has rallied off those low prices)
Anyway, I'm not doubting the stable nature of this business. Just the inflated stock price. It's abnormal for a steady (but not rapidly growing) firm to trade at such a premium. One of two things is likely to happen in the coming 6 to 12 monts:
1) The company grows into this multiple by surprising ME and the consensus of analysts and growing earnings relatively quickly in 2010..... OR
2) the stock drops to a point where it is more in line with the current earnings picture.
But my bet is that in a few months we will not see such a high multiple on this stock. So which is it? higher earnings or a lower stock price? Only time will tell.
Thanks for the comments,
Zach
zachstocks.com
To answer your question -- I choose "C" both higher earnings, and continued multiple expansion for 2009. 4.0x recurring cash flow is cheap. Do an extremely conservative DCF analysis, assuming management turns off the growth spigot, and runs the existing subscriber base into the ground. By any projection, you still get a stock worth mid-20s. The "high" P/E of ~20? Most of that is depreciation from 1.3 million subscriber investments that the parent made. (Thank you BCO!). It's not recurring capex.
Anyway, differences of opinion are why there are buyers and sellers. If you feel strongly about your short trade, though, how about this: If CFL drops below 15 in the next twelve months, I'll buy you a new Brink's Home Security system. Or ADT if you prefer. If it rises above 55, you give me a free subscription to your newsletter. Sound fun? :-)
I'm expecting that $14.75 would mark the floor - and obviously the stock could be above the floor on 6/30 but still have my thesis be correct. By the same token, the stock wouldn't need to go to $55 for you to be right. I think $40 would still prove your point.
So how about this, a close below $20 (a 33% drop) is a victory for me, and a close above $40 (a 33% increase) is a victory for you. If you win, I'll give you a complementary year to the ZachStocks Growth Model (zachstocks.com/zachsto.../) and if I win you hook me up with a security system (base model) with monitoring... and NO, you don't get the access codes :-)
Sound like a plan? I love a good natured competition.
Thanks for a differing opinion with a little humor,
Zach
zachstocks.com
EBITDA from recurring services = $83.5M (adj. for $5.1M nonrecurring) * 4 = Run Rate EBITDA from recurring services of 334M. = ~4.0x Mkt Cap + Net Debt + Rebranding Liability (EV). Although this doesn't include the cash impact of attrition during that year (ie, just multiplying by 4 to annualize isn't perfect. And, Q1 being a seasonally slower growth period, the margin may be slightly higher than in Q2 & Q3). But it's close.
Attrition does not impact cash flow, by itself, because it is primarily a noncash charge to COGS (impairment charge on capitalized subscribers).
Looked at a different way, Q1 Cash Flow From Operations was $66.6M + $10.0M Tax expense - $5.8 Deferred Taxes = $70.8M Pre-Tax Cash Flow (unadjusted for extraordinary items). Investing cash flow of ($47.2)M consisted of $42.2M in subscriber investments and $4.9M of other (maintenance) capex.
I guess you could say that using run-rate as the basis is more aggressive than TTM, but for a growing long term subscriber business, I personally think it's most appropriate.
Do post up if you think I'm missing something.
Steady state cash flow (ie, zero net growth, at Q1 attrition rate of 7.1%/year) is >$57.6M per quarter. The "greater than" because subscriber disconnects are at below avg prices.
Calculation:
$83.3M adj. EBITDA from recurring services.
- $22.9M subscriber investment to replace disconnects ($42.3M*(23.3/43.0).
- $3.0M estimated maintenance capex for corporate
=$57.6M pre-tax steady state cash flow per quarter.
@ $29.00/share, and adding $100M for the rebranding liability, this results in a steady-state cash flow multiple of 5.8x (at 7.1% attrition, which will be a little higher throughout the year).
5.8x no-net-growth cash flow multiple = 1/5.8 = 17.1% REAL yield.
As a bond, would a market leading business like Brink's sell a perpetual bond, financing the entire cap structure with a real yield of 17.1%?? Is the WACC 17.1%?? No way.
I think you are dead-on with the steady state cash flow per quarter number. I get to an annual number closer to $200 million since I'm assuming a slightly higher churn rate going forward to be conservative.
Either way the point remains that CFL is very cheap since that churn rate is unlikely to go up any further due to their high quality customer base.
I'm assuming you've also closely read the prospectus, too. It has quite a few interesting details on the nature of the business, industry that aren't discussed in the K or Q. Market size/share and growth potential for CFL, as well as detail on what actually drives subscriber growth. Check it out if you haven't yet.