Nearly 6 months after our initiation of ADT (ADT) with a Buy at $32.62 per share, ADT agreed to be acquired by Apollo Global (NYSE:APO) for $42.00 per share equivalent to: (1) a 29% premium to our Buy price (2) a 56.3% premium to the ADT unaffected price; (3) 44.3x RMR multiple; and, (4) 6.9x LTM EBITDA (post SAC) multiple.
The transaction price significantly undervalues ADT based on a variety of transaction analysis. However, it is unlikely that an improved offer will emerge, and it's likely the ADT shareholders will approve the transaction. The recurring nature of the ADT revenue and profits should also reduce any potential financing risk.
Since being Spun-out of Tyco (NYSE:TYC) in 2012, ADT repurchased 73mm shares (45% of the current ADT shares outstanding) for $3bn at a cumulative blended average price of $40.54. The offer price represents a 3.6% premium to the cumulative blended share repurchase price.
In November 2013, ADT acquired 10.24mm of ADT shares (6% of the current ADT shares outstanding) from Corvex at a purchase price of $44.01 per share (a 5% premium to the Apollo offer price). In the 2015 Annual Report, ADT highlighted there was a class action lawsuit appeal in front of the 11th Circuit Court of Appeals in regards to its repurchase of shares from Corvex. It is likely the Board approved sale of ADT at a discount to the price paid to repurchase the Corvex shares could provide impetus to the plaintiffs.
Historical transactions multiples in the home security sector imply an ADT transaction price per share between $48.49 and $77.87.
In May 2015, Apollo acquired Protection One (#4 player) and ASG Security for $1.5bn and $475mm respectively and RMR multiples of 50.8x and 47.5x respectively. In November 2012, Blackstone (NYSE:BX) acquired Vivint (NYSE:VSLR) (#3 player) for $2bn at 58.3x RMR.
ADT is the market leader (25% mkt share) with best in class footprint in a large, fragmented, potentially underpenetrated and growing industry. North American Security Alarm Industry has grown at a 6% CAGR (1996 - 2009) and the North American Monitoring & Service market has grown at an 8% CAGR (2000 - 2013).
The transaction is expected to close by the end of June 2016 which implies a current / annualized return of 5.3% / 19.2% respectively. Despite being the market leader in home security, we estimate limited regulatory risk given the highly fragmented industry and significant growth opportunities. The limited transaction risk and returns should present risk arbitrage investors an attractive investment opportunity.
ADT Historical Share Repurchase Overview
Since being spun-out of Tyco in 2012, ADT repurchased a total of 73mm shares (44% of the total shares outstanding) for nearly $3bn implying a cumulative blended average repurchase price of $40.54. The Apollo transaction price represents a 3.6% premium to the cumulative blended average ADT repurchase price. Assuming a Board of Directors only approves and executes a share price when the share price is below the intrinsic value, the current transaction price is likely well below the intrinsic value of ADT, and does not include a transaction premium. By agreeing to sell ADT to Apollo at a price that is approximately equal to what ADT paid to acquire its own shares, the ADT Board of Directors effectively states that it has destroyed ADT shareholder value in the last 3 years.
Furthermore, on November 25th, 2013 (Fiscal Year 2014), ADT announced it had acquired Corvex's (an activist investor which had invested in ADT) 10.24mm ADT shares for $44.01 per share. As of the end of FY 2015, there was a class action suit in appeal against ADT in the 11th circuit court in regards to the Corvex transaction. It will be interesting to see how the current sale at $42.00 per share (unanimously approved by the ADT Board of Directors) will impact the legal proceedings.
ADT historically highlights its customer IRRs in every year of the relationship. Over 8 years the IRR is approximately 29% while in year 4 the IRR is 11%. In addition, ADT publicly states that it measures all M&A transactions "against quantifiable economic, operational and strategic criteria - target IRR of >12%". (Source: May 2013 ADT Investor Day Presentation page 73)
In the table below, we assume an 11% IRR, slightly below the 12% target, on both the FY 2013 and FY 2014 share repurchases to reach an implied ADT share price.
The above analysis highlights that based on the ADT IRRs, the minimum intrinsic value per share of ADT today would be approximately $52.71 (51.1x RMR Multiple). By accepting the $42.00 per share offer, the ADT Board highlights it has destroyed shareholder value given it paid $44.00 per share to repurchase a significant number of shares from Corvex more than 2 years ago which would be worth approximately $60.19 adding back the ADT annual return requirements.
Ignoring the return requirements on invested capital, M&A transactions require a "transaction premium" of approximately 25% to 35%. The below chart highlights the implied ADT share price based on adding a transaction premium to the historical annual share repurchase price (excluding the required rate of return, the IRR, on the repurchase).
The share repurchase plus transaction premium analysis suggests an ADT fair value transaction price range based on the historical annual share repurchase price plus a transaction premium of between $45 and $55 per share.
Combining the share repurchase plus IRR plus M&A analysis yields an ADT Transaction price of $65.89. Conservatively assuming the 2014 share repurchase price of $38.54 and adding; (1) the 11% IRR requirements yields an intrinsic value per share of $52.71. Thereafter, a 25% transaction premium to the intrinsic value per share yields an ADT transaction price of $65.89 per share which represents a 57% premium to the current Board Approved transaction price and a 59.1x RMR transaction multiple.
As an interesting side note while the Board is clearly admitting to destroying shareholder value since the spin-off from Tyco by accepting the Apollo offer, it has simultaneously paid ADT executives Annual and Long Term Incentives in every single year since the spin-off from Tyco. Clearly, the ADT executive incentive compensation was not aligned with shareholders (i.e. the Board of Directors created a compensation framework which rewarded executives for destroying shareholder value).
Historical Comparable Transaction Multiples
The home security sector has recently been subject to a significant number of M&A transactions with particular interest from Private Equity or Private Equity like companies. Apollo, Blackstone, Bain, H&A, and Ascent Capital have spent approximately $10bn in M&A in the security sector since 2010.
The table below highlights the comparable historical transactions and the relevant information.
Assuming the 48.5x total industry average historical RMR transaction multiple implies and ADT transaction price of $49.11.
Assuming the 50.8x RMR multiple which Apollo paid to acquire Protection One less than a year ago would imply an ADT transaction price of $52.94.
Assuming the 8.2x EBITDA transaction multiple which Ascent Capital paid for Monitronics would imply an ADT transaction price of $55.57, while assuming the total historical average EBITDA transaction multiple of 10.4x would imply an ADT transaction price of $78.88.
The historical transaction analysis indicates ab ADT takeover value of $43 to $79 highlighting the undervaluation of the Apollo offer for ADT.
One of the Employee / Investor presentation slides filed by ADT, highlights the problematic valuation. The below chart highlights the presented slide in the ADT presentation (in the red dotted lines) and additional information provided by Soulor (shaded in blue) which highlights the transaction valuation problems:
ADT has 4x the subscribers of Protection 1 but generates 6x the revenue of Protection 1 highlighting a richer ADT customer base. While ADT only has 4x the customers and 6x the revenue of Protection 1, ADT generates 9x the EBITDA of Protection 1 highlighting the better profitability of ADT.
Apollo is acquiring ADT at a 12% discount to what it paid for a smaller, lower paying customer base, and less profitable comparable company less than a year ago.
In addition, ADT has $2.5bn of Federal NOL Carryforwards and $1.2bn of State NOL Carryforwards which we estimate are worth approximately $6.00 per ADT standalone share. It is likely that as a result of the combination, the NOL usage will be quicker driving a higher value per share.
Conclusion: Transaction Price Undervalues ADT
The ADT Board approved sale to Apollo for $42.00 per share significantly undervalues ADT, but delivers our original share price target in a short time frame. Based on the ADT management current guidance, historical share repurchases, ADT publicly stated IRR requirements, and precedent transaction multiples, a minimum fair value transaction price for ADT would be between $45 and $55 per share.
There are limited transaction risks from a regulatory or shareholder perspective.
The current price of $39.88 implies a current / annualized spread of 5.3% and 19.2% respectively which could be an attractive risk arbitrage investment opportunity. The spread highlights the market does not anticipate an improved offer and potentially estimates some financing risk.
For additional fundamental analysis and overview of ADT and the Security Industry, please refer to our research note and presentation from July 2015 on http://www.soulorresearch.com/research/.
Appendix: ADT / Apollo Transaction Overview
Parties To The Transaction:
· ADT Corporation / ADT:NYSE ("Target" or "ADT").
· Apollo Global ("Acquirer" or "Apollo") referred to as Prime Security Services in Merger Plan.
Offer Terms & Conditions:
· $42.00 in cash per ADT Share for all ADT Shares.
· No ADT Dividend to be paid to ADT shareholders between the execution of the Merger Agreement and the Closing of the Merger other than the quarterly dividend announced on January 7, 2016 payable on February 17, 2016.
· Affirmative vote by a majority of all ADT outstanding shares at a Special Shareholders meeting.
· Hart-Scott-Rodino Antitrust.
· Canadian Competition Act.
· Delivery to Apollo of ADT payoff letters related to ADT Credit Facility.
· Representations and Warranties.
· Materiality Qualifiers.
· Transaction has received executed equity and debt commitment letters financing the transaction.
· Apollo committed to provide up to $3.575bn equity contribution.
· An affiliate of Koch Securities agreed to purchase $750mm of preferred securities from Apollo.
· Bank group committed to provide $8.445 acquisition debt and a committed secured revolving facility of $255mm.
The sources and uses table clearly highlights the debt to equity conversion in the Apollo LBO transaction. Post deal an apples for apples ADT will operate with 4.8x Net Debt to EBITDA compared to the current 3.0x Net Debt to EBITDA. When ADT was spun-out of Tyco, it had approximately 1.5x Net Debt to EBITDA which was increased to 3.0x as a result of the Corvex activism.
Go-Shop Provision & Termination Fee:
· ADT may solicit alternative acquisition proposals through March 26, 2016.
· Before accepting an alternative acquisition proposal, ADT Board of Directors must provide Apollo 3 business days to come up with a superior acquisition proposal.
· Should ADT accept an alternative acquisition proposal during the Go-Shop period, ADT would need to pay Apollo $87mm.
· Should ADT accept an alternative acquisition proposal during the No-Shop period, ADT would need to pay Apollo $228mm.
· Should ADT fail to receive shareholder approval for the current transaction, ADT would need to pay Apollo $30mm.
· Should Apollo fail to close the merger when required to do so, Apollo would need to pay ADT $421mm.
ADT Board Approval:
· ADT Board of Directors unanimously approved the transaction.
Defined Non Material Adverse Effects:
"No events, developments, changes, effects or occurrences relating to, arising out of or in connection with or resulting from any of the following shall be deemed, either alone or in combination, to constitute or contribute to a Material Adverse Effect:
(NYSE:I) general changes or developments in the economy or the financial, debt, capital, credit or securities markets in the United States or elsewhere in the world, including as a result of changes in geopolitical conditions,
(ii) general changes or developments in the industries in which the Company or its subsidiaries operate,
(NASDAQ:III) the execution and delivery of this Agreement or the public announcement of the Merger or other transactions contemplated hereby, including any impact thereof on relationships, contractual or otherwise, with customers, suppliers, distributors, partners or employees of the Company and its subsidiaries, or the performance of this Agreement and the transactions contemplated hereby, including compliance with the covenants set forth herein and any action taken or omitted to be taken by the Company at the express written direction of or with the prior written consent of Parent or Merger Sub after the disclosure to Parent and Merger Sub by the Company of all material and relevant facts and information; provided, that this clause shall not apply to any representation or warranty set forth in Section 3.1(a), Section 3.5, Section 3.6(a), or Section 3.10,
(iv) changes in any applicable Laws or regulations or applicable accounting regulations or principles or interpretation or enforcement thereof,
(NYSE:V) any hurricane, tornado, earthquake, flood, tsunami, natural disaster, act of God or other comparable events or outbreak or escalation of hostilities or war (whether or not declared), military actions or any act of sabotage, terrorism, or national or international political or social conditions,
(vi) any decline in the market price or trading volume of the Shares (provided, that the facts, circumstances, developments, events, changes, effects or occurrences giving rise to or contributing to such decline may be deemed to constitute, or be taken into account in determining whether there has been or will be, a Material Adverse Effect), or
(NYSEMKT:VII) any failure by the Company to meet any published analyst estimates or expectations of the Company's revenue, earnings or other financial performance or results of operations for any period, in and of itself, or any failure by the Company to meet its internal or published projections, budgets, plans or forecasts of its revenues, earnings or other financial performance or results of operations (provided, that the facts, circumstances, developments, events, changes, effects or occurrences giving rise to or contributing to such failure may be deemed to constitute, or be taken into account in determining whether there has been or will be, a Material Adverse Effect); provided, however, that with respect to clauses , (ii), (iv) or , such facts, circumstances, developments, events, changes, effects or occurrences shall be taken into account to the extent they disproportionately and adversely affect the Company and its subsidiaries, taken as a whole, compared to other companies operating in the industries in which the Company and its subsidiaries operate.
Transaction Comments From ADT:
· Apollo already owns and has merged Protection 1 and ASG Security which operates under the Protection 1 brand.
· ADT will merge with Protection 1 and the combined company will operate under the ADT brand.
· Tim Whall President and CEO of Protection 1 will be the CEO of the new combined company.
· Apollo will keep the Boca Raton, Fl location as the headquarters of the new company.
· Purchase price reflects a significant premium to the current share price.
· Apollo is a sophisticated buyer who understands ADT business and supports the ADT strategy.
· Combined businesses will allow ADT to accelerate its key Strategic Initiatives (Smarter Growth, Commercial Expansion, Health, Canada, Canopy / SBA).
· Combined company will create exciting growth and development opportunities for employees.
Potential Alternative Bidders:
· Blackstone / Vivint: In 2012, Blackstone acquired Vivint which is the 3rd largest home security company with an approximate 4% US market share. However, Blackstone / Vivint were likely highly involved in the current ADT sale process which emerged with Apollo as the winning bidder. Apollo has invested more into the home security sector in the last 12 months through its acquisition of Protection 1 and ASG (i.e. Blackstone could have emerged as a winning bidder in those transactions and was likely called by Investment Bankers but ultimately did not outbid Apollo). While the transaction multiple for ADT is low relative to precedent transaction multiples in the sector, the size ( > $12bn) of the transaction will likely inhibit further private equity interest.
· Monitronics / Ascent Capital: Ascent Capital which is a former Liberty Media entity in which Mr. John Malone still holds a significant ownership stake (over 16% of shareholder vote) is the 2nd largest home security company with a 4% US market share. Despite the strong strategic sense for a merger between Ascent and ADT, we think it is highly unlikely that Ascent could provide an alternative superior offer for ADT for the following reasons:
o Ascent Capital is a public company which is already highly leveraged (approximately 5x Net Debt to EBITDA) providing limited incremental debt funding capacity to the debt headroom at ADT (ADT net debt to EBITDA of 3x);
o Ascent public debt trades at a significant discount (Monitronics 9.125% $585mm senior notes trading at approximately 79 cents on the dollar) highlighting the potentially very high cost of leverage if ASCMA were to attempt to acquire ADT;
o Poor recent operational execution driving a more than 70% reduction in share price in last 12 months which also implies Ascent could very likely not issue equity to help fund the ADT transaction;
o In August 2015, Ascent Capital appointed a new CEO, Jeff Gardner, for Monitronics
o Complicated Ascent shareholder structure would be prohibitive to issuing equity in an acquisition of ADT; and,
o Ascent Acquisition of ADT at current prices would likely be dilutive to Ascent.
· Comcast: Comcast has a home security offering through Xfinity which holds an approximate 1% market share. While ADT is small ($12bn market cap vs $140bn market cap) and a transaction would be financially feasible, we don't believe the strategic rationale is very high. Comcast recently sought and failed to acquire Time Warner Cable and has focused its capital allocation decisions around the cable / infrastructure and the content sectors. In addition, we estimate organic growth of home security within the Comcast cable customer base would drive significant higher IRRs.
· Time Warner: Time Warner Cable has a home security offering which holds a 1% market share. However, TWC is currently being acquired by Charter Communications in a lengthy transaction (originally initiated in early 2014) which still has regulatory hurdles. We don't anticipate Time Warner would bid on ADT while undergoing the complex Charter transaction.
ADT Corporation ("ADT" / NYSE:ADT), is the 141 year old market leader in electronic security, interactive home and business automation and related monitoring services for residential and small business customers in the US and Canada. TYCO acquired ADT in 1997, acquired Broadview (the 2nd largest player in the North American Security sector) in 2010 and subsequently spun-out the North American residential and small business operations in 2012. TYCO sold its flow control business and currently continues as a global commercial fire and security business. Nearly 90% of ADT revenues are recurring. The North American Security Alarm and the North American Monitoring and Service industry as measured by industry experts Frost & Sullivan and Barnes Associates have grown by approximately 6% and 8% respectively over the last 20 years while market penetration has held between 15% and 20%. ADT has maintained an approximate 25% market share of the North American residential security sector for the last 8 years while the second and third leading players have each held between 3% and 4% market shares respectively. In addition, ADT is also the market leader in the small business security market with a 13% market share of the 50% penetrated market.
ADT Board of Directors (the people who approved the transaction):
ADT Open Market Share Dynamics:
The transaction price represents a 73% / 33.1% / 15.9% / 37.4% premium to the 3 month minimum, average, high and weighted average price respectively.
The transaction price represents a 73% / 23% / (2.1%) / (24%) premium / (discount) to the 12 month minimum, average, high and weighted average price respectively.
In the 2 days following the transaction announcement nearly 90mm ADT shares traded in the public markets representing nearly 53% of the total outstanding ADT shares or a majority of the votes.
Source Documentation: All Publicly Available Online
1) ADT SEC filings including annual reports, quarterly reports, definitive proxies
2) ADT quarterly earnings presentations
3) ADT May 2015 Investor Presentation
4) ADT December 2013 Investor Presentation
5) ADT Schedule 13D October 2012 (Corvex Activist ADT Value Presentation)
6) TYCO SEC filings and investor presentations
7) Vivint February 2015 J.P. Morgan Global High Yield Conference Presentation
8) Vivint February 2014 J.P. Morgan Global High Yield Conference Presentation
9) Vivint: APX Group Holdings Form 424B3 9/24/13
10) Vivint: APX Group Holdings Form S-4 9/12/13
11) Vivint: APX Form 10K 2014
12) Ascent Capital Group SEC filings including annual reports, quarterly reports, definitive proxies
13) Ascent Capital Group May 2012 Investor Presentation
14) Ascent Capital Group May 2015 Investor Presentation
15) Ascent Capital Group Livewatch Acquisition Investor Presentation March 2015
16) Ascent Capital Group Imperial Capital Global Opportunities Conference September 2014
17) Ascent Capital Group Imperial Capital Security Investor Conference December 2014
18) Ascent Capital Group Security Networks Acquisition Overview July 2013
19) Monitronics Management Presentation December 2012
20) USBX 2005 security presentation found online (no title)
21) ESX Nashville Tune Into The Future - Digging Deep in the RMR Valuation Landscape - June 25-29 2012 Presentation
22) Protection One SEC filings including the fairness opinion materials provided by Lazard filed in SEC documents when Protection One was acquired by GTCR
ADT, ASCMA, Vivint, Protection One all include numerous market estimates from various sources in their Investor Presentations some of which were used to estimate the market size, growth and attributes
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.