What Investors Need to Know About ADT Stock

Residential and commercial security giant ADT (ADT -2.04%) conducted an initial public offering in January to raise funds to pay down some of its substantial debt load and redeem preferred securities.

In this segment from the Industry Focus: Consumer Goods podcast, Vincent Shen is joined by senior Motley Fool contributor Asit Sharma as they provide an investment overview of the this leading name in the security industry.

A transcript follows the video.

This video was recorded on April 3, 2018.

Vincent Shen: This company recently went public for a second time through an initial public offering. Ticker is ADT, easy enough to remember. They serve 7.2 million residential and commercial customers with security and monitoring services. That makes it one of the leaders in this space, absolutely. ADT actually priced its IPO on January 18th. From the start, the company has been running into some speed bumps. The IPO itself was originally slated to price between $17 and $19 per share, but it ultimately came in under the range at just $14, raising $1.5 billion.

At pricing, ADT had a market capitalization of $10.5 billion, but the key word there is that it had a market cap of around $10.5 billion. Even though the IPO priced below the range, in its two and a half months on the market, the stock has declined further to less than $8 per share, and that's basically cut the market cap in half to less than $6 billion.

We'll get more into the details and drivers behind some of that bearish public reception. But first, some background for the company itself. Asit, can you give listeners an overview of this company and this business?

Asit Sharma: Sure. I have to put in one really bad pun before I begin. I was listening to you, Vince, talk about how the stock had declined, priced below expected range and descended on down. No reason to be alarmed.

Shen: [laughs] That was bad.

Sharma: We had ADT, too, for a while. I think many of our listeners should have some experience with this company. Anyway, this is in the monitored home security industry. ADT, of course, is a giant in this field. It has two primary brands, its namesake brand, ADT, and Protection One. As Vince said, it serves residential and commercial customers, about 7.2 million customers. And it does this through two channels -- direct channel sales and indirect channel sales. Direct channel sales has a sales force of about 2,900 sales consultants. In its indirect channel, it uses about 300 dealers throughout the U.S. and Canada. These are ADT-authorized dealers. Outside of that, it has about 4,600 insulation and monitoring technicians. These people are based out of 200 sales and service centers in the U.S. and Canada. One thing we all know, those of us who have had any kind of security service, it's labor intensive to install and sometimes to maintain.

Now, it has a lot of its recurring revenue through monitoring centers. That's when you get an alarm, or maybe you have a kid like Vince who fat fingers the alarm, and you have to call in to a monitoring center. It has 12 of these in North America. These are staffed with an additional 4,200 customer service reps. Something interesting about ADT that I found out doing research for the show is, it's not a manufacturer, it's just a distributor. It purchases equipment from third-party suppliers and distributors, and then it installs this equipment in your home and maintains it when it needs to.

As for competition, you've probably heard of some of these names. I read through their annual report preparing for the show. Vivint Incorporated, Stanley Security Systems, which is a subsidiary of Stanley Black & Decker, Comcast Corporation, and also companies like AT&T are edging into the business. Some of you are probably familiar with Ring Security, which we will probably talk about later in this show. That's just been acquired by Amazon. So, there's a raft of competition.

Shen: Thanks, Asit. Something else to keep in mind, too, is this recent IPO is a deal that came about after the company was taken private in 2016. The New York Times has a quick summary of how ADT came to be, from an article in 2016 that I thought was interesting. I'll quote that here. They said, "ADT traces its roots to Edward A. Callahan, the man who invented the stock ticker in 1867. When Mr. Callahan, the president of Callahan's Gold and Stock Telegraph Company, found a burglar earlier in his home, he created a telegraph-based alert system. After more than a century of acquisitions and antitrust rulings, ADT was acquired by Tyco in 1997. Tyco decided to be broken up into three units in 2012, making ADT once again an independent company." And after that, they were taken private by Apollo, and two years later another IPO, which leaves us here.

So that deal in 2016 was a leveraged buyout, something that we talked about last week, in terms of the retail space. The Apollo deal was actually valued at $6.9 billion. So two years and a string of acquisitions and mergers later, ADT is currently playing catch-up still, in terms of the recent trading.

Going back to some of the business-focused aspects of this company, some of the things you mentioned like the customer contracts, I think it's interesting to note that the typical customer contract has a three-year term for residential customers and a five-year term for commercial ones. The big thing here is, after a customer pays an upfront fee, they also make those monthly payments for the remainder of their contract. Coupled with automatic contract renewals, as you mentioned, Asit, this business model generates a relatively stable recurring source of revenue. I think something like 90% of the top line comes from those recurring monthly payments.

But the flip side of the equation is that onboarding customers requires installation and other costs that the company has to bear upfront as well. ADT generally, I believe, needs about three years to break even on that initial investment in a new customer. So these longer-term contracts are definitely very important, but also retaining those customers is very important. And in the company's 10-K, ADT named some of those big competitors that you mentioned. In addition to that, there's a lot of new small companies that are entering the space. As a result, if you browse the company's press releases and their announcements in their investor relations page, you'll see that management is announcing a lot of collaborations with other companies that, for example, contract for its monitoring solutions, or they're working to integrate a lot of smart home features from big tech names, even like Amazon and Samsung. So the company has definitely changed quite a bit in the past few years. Again, there's a lot of deals and acquisitions in that time, not only for Protection One and ASG, that were really critical to the formation of ADT as it currently stands, but in 2017 alone, I think there were another four or five additional smaller deals. Many of those were intended to bolster their commercial offerings. Those were followed by two more deals in just the first few months of 2018.