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Brink's Home Security Spinoff: Too Far, Too Fast

Maybe4less2,
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.

Brink's Home Security Spinoff: Too Far, Too Fast

One final point on valuation:

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.

Brink's Home Security Spinoff: Too Far, Too Fast

Doublet, I think I see what you're saying, and yes, some of of that subscriber investment is actually filling the hole from attrition. About $25M worth in Q1.

Brink's Home Security Spinoff: Too Far, Too Fast

Zach, sounds like a plan. I won't pay for the monitoring, just the hardware installation. Now....let's hope for my sake that Brink's starts to offer free installation packages like some of the weaker players. :-)

Brink's Home Security Spinoff: Too Far, Too Fast

Yes it is.

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.

Brink's Home Security Spinoff: Too Far, Too Fast

No problem Zach. Putting yourself out there with stock picks every day is a tough job.

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? :-)

Brink's Home Security Spinoff: Too Far, Too Fast

One other thing: Is the stock up 50% since the spinoff? Yes. What was the stock market like, and how many hedge funds were facing forced liquidations, in October and November. It's no surprise that the first trades were at low prices when a spinoff occurs in that market environment.

(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)

Brink's Home Security Spinoff: Too Far, Too Fast

Quick! Somebody tell me if there is an inverse ETF tracking Zach Scheidt's investing career! Logically, how on earth did this man pass his CFA exams? This stock is very undervalued, and in a sector poised for growth if the "rebound" doesn't last. But don't take my word for it -- study the financials yourself...

-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.