Barely a month on the open markets, and ADT (NYSE: ADT) is already facing activist investor pressure. While the company has ticked up nearly 9% since its Oct. 2 debut on the New York Stock Exchange, one fund manager thinks things could improve. ADT is an attractive business to many, so why is there immediate pressure for change? Let's take a look at the complaints and the fundamentals of the No. 1 home security company in the United States.
The rundown
Activist investors are typically attracted to companies whose stock price has tumbled and whose investors have grumbled, whether it be about management or external factors. ADT hasn't experienced these issues, especially since it's a public newborn. But for Keith Meister, the manager of Corvex Management, things could be better. Meister isn't just any fund manager jumping on the activist train that has attracted many a manager in recent years; he is the disciple of corporate raider Carl Icahn. For years, Meister was the right hand of Icahn's operations. One can assume he knows what he is doing, given he has learned from one of the most experienced and active activist investors around.
The company's first 10-Q is scheduled to be released at the end of this month, but investors have been bullish on the company since its debut. Meister, whose fund has acquired a little over 5% of the company in direct ownership and options, wants the company to take some shares off the table in what's colloquially called an "equity shrink." Specifically, Meister believes that ADT shares are fundamentally undervalued and that the company should take advantage of the extremely low interest rates to buy back 45% of the outstanding shares. Apparently, Meister isn't the only one who believes more value could be extracted from the company with a buyback program, as George Soros' Soros Fund Management has authorized Meister to vote on behalf of the fund's 575,000 shares, which gives a nod of approval to the former Icahn worker's desires for the company.
At this point, it doesn't seem to be an antagonistic battle. ADT management released a statement saying they have had "constructive discussions" with Corvex Management regarding the company's capital structure and future leveraging concepts. This certainly differs from Meister's former employer, who has just waged battle with Netflix (NFLX +0.27%) and prompted the streaming Web services company to introduce a poison pill plan -- flooding the market with shares to dilute the activists' holdings -- in order to stave off any additional pressure. Icahn likely wants to sell the company to a larger competitor and make a quick profit on the $4.2 billion business that has seen shares drop substantially over the past couple of years.
Amicable or not, though, Meister still demands change from ADT. Is he right to encourage the company to take on additional debt and buy back the recently issued shares?
Strong evidence on either end
ADT is a great focused residential security play. The company operates in a sector that has little saturation and offers plenty of growth -- roughly 20% of U.S. homes currently have a security system. ADT is without doubt the nationwide leader in the business, which is heavily fragmented by regional and local security organizations.
It's a cash-flow-rich business, bringing in over $3 billion in revenue annually and an adjusted free cash flow (minus interest and taxes) of $629 million in 2011. Operating income has an impressive CAGR of 14% from 2007 through 2012 projections.
The company has adapted to technology trends by offering new services using smartphones and tablets. This goes head to head with some new security and home automation services offered by companies such as Time Warner Cable (NYSE: TWC). It appears that on most if not all fronts the company is doing well and should continue to grow at a substantial rate through the next few years.
But as Meister pointed out in a statement, equity shrinks have been a useful tool for public companies: "Stable growth combined with an appropriate capital structure, ongoing share repurchases and clear investor communication of leverage target and buyback strategy has led to significant outperformance."
It would appear that Meister is not interested in an Icahn-esque takeover of the company to engineer a quick sale or sell the company off in parts, or even change up the management team. Instead, both he and Soros just want to nudge the current management in a direction that they believe is more profitable for shareholders.
Whether the changes go through or not, ADT is a solid company in my book and should be on many an investor's radar.
