(Author's note: I functionally sold out of my ADT position in all accounts this morning; however, I am technically long a fractional share of ADT in one personal account that my broker will liquidate in the coming days. Thus, I feel that "no position" is a more appropriate disclosure than "long ADT", although I did want to provide this clarification for maximum transparency.)
When I called ADT (ADT) "an attractive LBO opportunity" a week ago, little did I expect a deal to be announced so soon. Better to be lucky than smart, I guess - I've been calling ADT a great value since $30-ish in spring 2014, and it's been quite the tease since then, jumping to over $42 this past April, then giving it all back. I wanted to write up a quick piece discussing why I liquidated my shares this morning at a 4-5% discount to the $42 deal price offered by Apollo Global Management (NYSE:APO).
Where I Was Right...
What was frustrating as an ADT shareholder is that the stock wasn't gaining any traction despite all the metrics moving in the right direction. As I discussed, revenue growth/gross adds were a little below where I would have liked to see them, but with ARPU rising and attrition falling, the business was clearly not collapsing - which was the fundamental premise of the bear thesis. (Over 20% of shares outstanding were short going into earnings.) I'm also unsurprised to see that the combined company (Apollo previously purchased Protection 1) will operate under the ADT brand name, which has strong resonance with consumers.
I've also thought for a while that ADT was a better fit in the hands of private equity owners with high leverage. Security accounting is tricky, for one thing, and with a fairly limited public comp set, generalists don't have much incentive to learn it. Second, the model is actually even more valuable when you can basically perpetually defer cash taxes via minimizing periodic FCF - which is, obviously, the opposite of what most public market investors like to see.
... Where I Was Wrong
I am honestly quite surprised that Apollo managed to get the deal done with high yield markets where they are. While I thought ADT was a very attractive LBO candidate at the price it was trading at, my caution was always size - twelve-billion-dollar deals are not exactly garden variety. I thought that it might take a consortium of buyers to pull it off.
Per the press release, Apollo is putting up $4.5 billion in equity (roughly what ADT's market cap was prior to the deal announcement), with the rest of the purchase financed by debt. Financing is fully committed, but I'm not sure that would hold if the global economy or credit availability truly rolled over.
I was also wrong on the price a PE firm would be willing to pay - the deal price is pretty darn close to my estimate of standalone fair value (a little south of 45x RMR / 7x EBITDA) and substantially lower than historical multiples that have been paid in transactions. From a valuation perspective, the risk/reward of continuing to hold doesn't look great to me - I'll let the merger arb guys have it. Yes, the spread is good for over a 10% annualized return as of the time of this writing, but the premium here is very big. Call it capitulation, but I really don't have any interest in sticking around only to see the deal hit some hiccup and shares plummeting back below $30.
As for the go-shop: I continue to believe that a sponsor could still extract meaningful value even at a higher per share price; given the 3.0x EBITDA leverage here, even a 5-10% boost in deal value would result in a significant bump to the cash realization for ADT shareholders. $48-50 would likely still be workable.
However, this deal is already pretty large, the premium already looks generous (notwithstanding that the valuation isn't super high), and there's probably no better buyer than Apollo given that it is technically a strategic as well as a financial buyer. Those more interested in/expert at merger arb can weigh in here, but bumps usually don't end up being all that big.
Maybe I'm still just a sore loser from Dell - I thought, at the time, it was daylight robbery, and indeed, the sponsors appear to have done quite well - but despite significant protests from well-regarded shareholders like Mason Hawkins and Don Yacktman, the eventual bump was so small as to be basically a joke. With ADT, I don't think there's nearly the same "community of interest" - and I'm not optimistic that shareholders will really revolt here.
Ultimately, you can construct your probability matrix however you want, but I think the most likely outcome is that the deal goes through (4-5% gross return, more than that annualized). There's a small probability of a 10-20% bump, and an equal or probably bigger probability that something happens in the credit markets and the deal doesn't go through, in which case shares would likely fall back to $30 or below. That's not an attractive risk-reward to me. I have much better places to allocate the money, so while I'm annoyed about having to take a tax hit on some of the shares I purchased after earnings, it is what it is - I'm taking my money and moving on.
It sounds churlish to complain about being offered a 50%+ premium, but I do think the sponsors are getting a sweet deal here. Such is life, and while I haven't calculated my overall IRR on owning ADT, it's still an acceptable return in what has been a choppy market (and a welcomed source of liquidity at a time when I have a great place to deploy it).
I learned a lot from following ADT, and I'm sure that it - or one of its peers besides Monitronics - will eventually come public again. Until then, I'll have one less stock to work on.
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