Why I'm Bullish on Brink's Home Security

Below is my analysis on Brink's Home Security (NYSE: CFL):

1. Is this a good business run by smart people?

a. Company & Industry Overview

Brink's Home Security was established in 1983 and is the second largest company by revenue to offer alarm monitoring services in North America. The company is a full service provider and it installs services and monitors the security system. It currently has 1.3m customers in the US and Canada. Residential customers make up 90% of the install base. In October 2008, the company was spun off from The Brink's Company (BCO). while the corporate parent focused on its traditional guarding and cash management business.

According to Freedonia (2008):

• The market for central station alarm monitoring services grew 7.6% per year over the 2002 ~ 2007 period to USD15.2b. However, revenues are projected to advance 3.9% annually through 2012 to $18.4m.
• Growth in revenues is linked to sales of alarm system and related hardware.
• 75% of the revenues were generated by residential customers. Demographic movements towards city centres with perceived high crime rates has fueled the increase in sales

2004 source: SecurityGrowthConference.com

The industry is dominated by many players: the five largest players in North America are ADT, Brink's, Protection One (PONE), Stanley Convergent Security Solutions and Monitronics. In Europe, Swedish Securitas is also a major vendor in the “mobile and monitor” segment. According to the company report and SDM Magazine, May 2008, the top five companies held 39% of the alarm monitoring market share.

A comparison of the leading vendors (click select images to enlarge):

b. TOWS Analysis

Opportunities

• Continued adoption of intrusion and fire monitoring services due to concern about crime and safety within the home. Many consumers perceive that local law enforcement personnel are overburdened and worry that they will not be sufficiently protected. According to Security Conference 2004, only 18% of residential homes have an alarm monitoring system.

• Strong demand from emerging regions. For example, in 2007, demand for ADT’s alarm monitoring system in Asia grew double-digits. ADT’s revenue from international customers constitute 52% of total revenues.

• Increasing usage of Personal Emergency Response Service Alarms (PERS), especially by the elderly population and those with medical or special needs. (ADT Companion Services Program is an good example of PERS for people requiring 24 hour monitored protection)

Threats

• Increased regulation on Registration (Background check) and Training of security personnel. Increased local statutes on False Alarm. Some cities have moved towards a model where they only respond to alarms that have been verified by the resident, neighbour or by the monitoring firm.

• A sustained economic meltdown will hurt businesses and consumers. Even though this industry has high customer retention rate due to the monthly recurring charges, all the major alarm monitoring companies are affected by the slow down, some more than others. This could result in an industry to fight over a smaller number of contracts and lead to higher discounting.
  • ADT’s Sensormatic retail monitoring system is impacted by the steep fall in the retail industry.
  • Protection One’s recent Q1 loss was blamed by the management on “amortization of customer accounts”, meaning bad debts. They attribute instability in the housing market as impacting new sales and higher attrition rate.
  • In Europe, the consensus on Securitas is that while the effect is not dramatic yet, it exhibits late cycle characteristics, ie. lags the overall economy. And the company will continue to dial down its sales forecasts.

Strengths

• Recognized brand with strong credentials. Brink's home security has been in the alarm monitoring market since 1983. It is a recognized brand with various certifications, the more important one being listed by Underwriters Laboratory (UL) on the basis of its response time and other parameters. To be listed, firms must comply with requirements on construction, operation, manning and protection.

• Strong financial picture. Financially, Brink's Home is in great shape, it does not have debts, its business has a monthly revenue stream of cash-flow. In the most recent quarter, the RMR (recurring monthly revenue) rose by 8.4 percent to $41.5 million as it saw 5.7 percent increase in accounts. Looking at a more traditional measurement:
  
  

In the past, Brink's would pay 7% of its revenue from US customers as royalty to the holding company (and 3% of revenue for Canadian operations), this has shrunk to 1.25% until Oct 31st 2011 where it will cease to pay royalties. This will result in bottom line savings between 1.4m to 2m. This is important as this is a capex intensive business.

• High quality customers = low attrition rate: Brink's has higher quality customers. This is reflected by the lower attrition or disconnect rate than its peers. Lower attrition rate will boost revenue, while avoiding the higher costs of acquiring/converting customers. According to TMF-HG, Brink’s focuses on single-family residential homes and seeking clients with high credit quality. It has also avoided buying up smaller players with poorer quality customers. As a result, many of the Brink's customers have been using its service for more than 15 years.

Weaknesses

• By the end of October 2011, Brink's Home will lose the branding. While they plan to go on a major re-branding exercise, there is no assurance that the new brand will be successful.

• While being concentrated in the residential market is a stated aim, it may be a weakness when Brink's expands overseas where the majority of the business comes from commercial customers. This is not so much a weakness as a characteristic of the overseas market.

c. Management

Most of the management has been with Brink's Home Security or Brink's Co. for at least the last ten years. This is a good sign, as we want experienced managers to continue to lead the new spin-off company.

All except one of the board directors are also Brink's co-directors.

As per Yahoo.com, what is interesting is that insiders own less than 1% of Brink's Home, but in Brink's Co., insiders own about 6% of the company, including board directors. When I checked on the sale of shares, I did not see any of the Brink's Co. directors selling large quantities of CFL. Since one share of CFL was issued for each share of BCO, I am puzzled why the 6% insider ownership of the spun off Brink's Home was not reflected.

The CEO and CFO has about 5m and 3m worth of stocks credited as part of their key Employees' Deferred Compensation Program, this is a form of executive compensation nest egg. The employee will remain until retirement and also refrain from competing after retirement.

Source: SEC.gov

Open market purchases by insiders have occurred during November 2008 between $14+ ~ $16+. However, the quantities aren’t significant.

d. Financial Ratio Comparison

What is interesting is that Brink's and Tyco share similar ratios just like Protection One and Monitronics. Securitas is unlike any of them.

Well, Brink's shows very good ratios among the companies. One issue which troubled me was why capex was higher as a percentage of operating cash flow which affected free cash flow (and the FCF/revenue ratio).

Looking at the SEC cash flow statements among the companies, I found that for Brink's, deferred acquisition costs and deferred acquisition revenue were listed under operating activities. For Protection One, both the items were listed under investing activities, while for Monitronics, the deferred revenue was listed under operating activities while the cost item “purchases of subscriber accounts” was listed in investing activities.

If we include this customer acquisition costs / revenue into the free cash flow calculation, the picture becomes quite different:

2. What is the company worth?

a. Relative Valuation

Since direct alarm/monitoring peer comparison is difficult, I decided to compare Brink's against the broader security peer group. Based on the FY09 EPS from consensus analyst estimates, Brink's should be trading at an average of 12.32x the forward FY09 EPS of 1.33, this translates to a price of $16.38.

I decided to use a whole firm comparison with the EV/EBITDA ratio. Based on the above, Brink's is trading at discount to its peers, calculating using the average EV/EBITDA, Brink's should be trading at $36.10.

In the above two ratios, which is more useful, a forward P/E which is based on forward projections or a trailing EV/EBITDA which measures last twelve months enterprise cash flow?

Clearly valuation based on peer comparisons is a good place to start but it isn’t definitive. And in the above case, it can be conflicting where Brink's is undervalued and overvalued at the same time. (I didn’t use the popular price to book value as it is clear that we are counting on Brink's for future growth.)

b. Discount Cash Flow

Using the above data from the annual report, the compounded growth rate for the past 4 years is 14.8% a year.

Rather than come up with a single valuation number, I am going to plot two scenarios, the first is realistic/conservative and the second is pessimistic.

The first scenario assumes that even though there is a recession looming, the 14.8% EPS growth is sustainable for the next 10 years. This is largely because from the spin-off, the managers are no longer encumbered by HQ and are motivated to create value for shareholders.

This continues until year 11 when it drops to a paltry 5% growth for the next twenty years and then on the 30th year, the company ceases as a going concern. (Never mind that Brink's Co., the ex-parent, has been around since the 1800s). Based on this, Brink's has an intrinsic value of $33.02.

The second scenario assumes that the rebranding exercise is a failure, and consumers really liked being associated with security trucks rather than some broadband security name. As a result, despite the best in class managers who are motivated and unencumbered, they can only muster a 7% annual growth in EPS for the first ten years, then like the previous scenario, it slips to a 5% growth for the next twenty years before ceasing on the 30th year. Based on this scenario, the intrinsic value is calculated at $19.15.

The intrinsic value from the above DCF scenario ranges between $19.15 to $33.02.

Summary of Valuation

Looking at the various valuation ranges, I would narrow the IV to between $20 ~ 33. If I apply a 25% margin of safety, I would put the buy price between $15 ~ $25.

3. How attractive is the price for this company? What should I pay for it?

Brink's was spun off around $20 in October; it crashed to a low of $14+ and most recently hovered around $27.70. The price gains ranged from 38%+ from $20 to almost 100% from the $14+ price. The rapid price appreciation came about with Brink's announcing good results for Q1 FY09, quarterly earnings grew 19% while revenue grew 5.7%, and even though Brink’s missed earnings estimates, the market rose 9.2% on the day of the announcement.

In my opinion, everybody suddenly discovered what a hidden gem Brink's was and bid up the price.

The diagram above shows where Brink's is positioned. At the current price of $27.70, I would wager that Brink's is fully valued. It is smack in the blue quadrant which denotes that it is within in the Intrinsic Value range (20 ~ 33), but outside of the buy-in price range of $15 - $25.

There is a current short percentage of float of 4.5%, which is still tiny compared to MIDD (11%)or BWLD (32%). Should the price appreciate ahead of itself, I’d expect the short % to go up.

4. How realistic is the most effective catalyst?

Well, the most realistic catalyst is the fact that Brink's was spun off, and management is determined to make a break with the ex-parent company by quickly embarking on a re-branding exercise. As I write this, the company has been renamed Broadview Security. This article from Advertising Age gave some clues on what is to come.

Security top of mind

The shift comes during a recession when home-security brands are top of mind as consumers increasingly fear crime… People are looking for proven suppliers with reputable names."

… there's "a lot of institutional strength to the former name," adding that is why the company is moving forward quickly, ensuring it has plenty of time to transition customers. To make the transition easier, the new company plans to use the tagline "The next generation of Brink's Home Security."

… Broadview's three-year transition phase is generous, as most brand transitions are given about 12 months. Broadview is also taking a different direction, he said, by introducing the new name immediately as most brands undertaking a similar task have relied on a more drawn-out transition. "Clearly, they've said, 'We've got a hot market at the moment, so we need to [take] the opportunity we have right now,'" Mr. Crutchfield said. "It's the perfect time for them to make a clear statement about this enterprise."

The second catalyst is none other than the recession. The slowing economy will weed out the weaker players, who acquired customers at any price, and who are saddled with debt. I doubt if Brink's is going to acquire companies, but this is a good time to have shakeout in the industry. Brink's has zero debts, and an industry-leading low attrition rate. It may be adversely affected by the slow down but it will emerge much stronger.

5. What is the margin of safety if the catalyst does not materialize?

It is unrealistic to model a perpetual no-growth scenario, which puts Brink's at $10, which is also the same level as book value per share. The monthly recurring revenues are growing and I do expect the company to at least make the long term growth rate of at least 5%.

I use 5% to be consistent with other long term growth rates of international corporations, at only 5% I would expect the share price to drop to about $17. If I bought Brink's at the high end of the buy price at $25, the drop is about -32%; if I bought at $20, the drop is about -15%.

Disclaimer: I currently do not have a position in this company. This article was shortened to fit submission requirements. For questions, please email me at [e-mail].

Comments

[bigmoney:]

these sort of companies might be like a put option on society. As society becomes "coarser", shady characters proliferate, and anxiety increases, they will want more and more security.

Jul 05 10:46 PM

[Lee Jones:]

Great report, lots of detail, but…..

You forgot to identify a serious risk to both revenue and costs that could impact the entire alarm security sector, including CFL. Industry insiders call it the “Liability Bubble” because of probable conflict with consumer protection laws.

Emergency response by local police has been a critical part of the core infrastructure for decades throughout North America. It now is gone, or going away. Customers have been lead to believe that “when the alarm goes off, help will come to the site”, more specifically “emergency response by local police”.

It is not true, and most industry leadership know it, which suggests deceptive business practices. Millions of alarm users (out of 30 million) are expecting emergency response, but are getting very slow or no police response, maybe just a “courtesy” site inspection.

The current business model of industry leaders like CFL is outdated and will take decades to fix at serious risk to revenue and costs.

Lee Jones
Support Services Group
949-361-3300
[e-mail]

Jul 10 11:43 AM

[Dan Braem:]

Threats - you forgot one big one.

Comcast is entering this sector, which the pipes in the ground to enter this business on the cheap.

I don't think Verizon is far behind.

Jul 22 12:12 PM

[locksmiths:]

great indepth information.

Oct 24 10:36 AM