GOOGL - ADT: Security On The Rise

2023-08-09 14:24:45 ET

Summary

• ADT Inc.'s share price has improved after struggling due to the lack of tangible results from its partnership with Google and its move into the solar business.
• The company's fundamental performance has become more resilient, with sales and earnings improving in recent years.
• ADT recently announced the sale of its Commercial Business in a $1.6 billion deal, which will further reduce its debt and leverage.

In May of last year, I wondered where the security was in shares of ADT Inc. ( ADT ) . This came after shares had given up ground on all the gains since the announcement of a deal with Alphabet/ Google ( GOOGL ) in 2020.

The company continued to struggle along as the Google partnership still had to deliver on tangible results, while ADT furthermore was moving into the solar business as well. Amidst the many moving parts and question marks, it has been the lagging share price which improved valuations quite a bit.

For appeal to be found, real execution would be necessary, something which was a big "if." Today, at largely the same share price level, the fundamental performance looks a lot more resilient, with appeal clearly on the rise here.

A Recap

Since ADT's public offering in January 2018, shares fell from $14 per share to just the $5 mark in the summer of 2019, despite its leadership role as the largest security firm in North America.

Even as the company has a dominant market share, at around 30% at the time, the business was saddled with debt and was not posting GAAP earnings. This meant that appeal had to come from secure and growing cash flows, supported by supply and maintenance contracts.

At the time of the IPO, ADT generated $4.3 billion in sales on which it posted $2.3 billion in adjusted EBITDA, with the company supporting a $19 billion enterprise valuation at the time of the offering. While the EBITDA numbers and margins looked appealing, it was a heavy D&A component of $1.9 billion which made me cautious. After all, a half a billion dollar EBIT number had to support a $9 billion net debt load at the time.

The company grew 2019 sales in a modest fashion to $5.1 billion with EBITDA improving to $2.5 billion. The big breakthrough came in 2020 when the company announced a tie-up with Google's Nest in which Nest would invest $450 million in ADT in exchange for a 6.6% equity stake. Shares rose to $14 per share on the back of the deal announcement, as (takeover) hopes were high.

In the end, 2020 sales rose in a modest fashion to $5.3 billion, although that EBITDA slipped to just $2.2 billion, with similar numbers being replicated in 2021. Note that ADT furthermore acquired Sunpro Solar in a $825 million deal in 2021, adding solar to its line-up of offerings.

With Sunpro added to the business, the company guided for 2022 sales at $6.3 billion and EBITDA at $2.4 billion, with ambitious 2025 goals being set, a year by which revenues should have grown to $10 billion, with EBITDA estimated to grow to $3 billion.

Given the real questions on the realistic margins (not the EBITDA margin) I was looking for real earnings amidst many moving parts, as I was skeptical at $7 in May 2022. With Google still in play, I saw the potential, but was not yet convinced about ADT.

What Happened?

Since May 2022, shares of ADT initially moved up to the $10 mark by year-end 2022, after which they fell to a low of $5 per share in May, before now settling at $6 and change.

The rising share price in the fall of 2022 was aided by a big investment made by State Farm which bought more than 133 million shares for $1.2 billion, at a share price of around $9 per share.

In February of this year, ADT announced its 2022 results. Full-year sales were up 21% to $6.4 billion, largely in line with initial expectations. The company managed to post operating profit of $560 million, which compares to a largely break-even result in 2021. After taxes and interest expenses, the company posted a $173 million net profit, for GAAP earnings of $0.19 per share. Adjusted earnings came in at $0.24 per share, marking a huge improvement from a $0.25 per share loss in the year before.

Net debt at year-end fell slightly, from $9.7 billion to $9.4 billion, all while adjusted EBITDA improved to $2.4 billion in 2022, with leverage ratios falling by half a time from 4.4 times to 3.9 times. These achievements were pretty solid, as the company outlined a decent guidance for 2023.

For the current year, the company guided for sales to come in between $6.60 and $6.85 billion, with EBITDA seen at a midpoint of $2.575 billion, and adjusted earnings seen between $0.30 and $0.40 per share. After a somewhat softer first quarter, ADT reaffirmed the full year guidance alongside the first quarter results as reported in May.

A Big Deal

Early in August, ADT announced somewhat soft second quarter results, with revenues actually down by half a percent to $1.6 billion, although that meant adjusted EBITDA improved by 9% to $651 million, as adjusted earnings per share rose by ten pennies to $0.16 per share. This meant that adjusted earnings for the year came in at $0.30 per share.

The company cut the full year sales guidance to a midpoint of $6.4 billion, which is actually a quite a pullback, although that EBITDA and adjusted earnings are seen unchanged from the initial guidance, with the lower revenue number being due to a disappointing performance at the solar business.

Net debt ticked down to $9.3 billion which together with $2.5 billion in EBITDA resulted in leverage coming down further to 3.7 times, as the 917 million shares command a market value of $6.0 billion at $6.50 per share.

Given this prevailing $15.3 billion enterprise valuation, ADT announced a rather big deal alongside the quarterly earnings release. ADT has reached a deal to sell its Commercial Business in a $1.6 billion deal to private equity firm GTCR.

The business generated $1.2 billion in sales in 2022 and posted EBITDA margins of 10% with EBITDA reported at $127 million. The 10% margins are far lower of course than the roughly 40% margins posted by the entire business, although I have not been able to see the real profitability of the business.

The company claims that the divestment is accretive to earnings, with earnings power of the activities not enough to offset the lower interest payments after $1.5 billion in net proceeds are earmarked to reduce leverage. This should reduce leverage further to 3.3 times EBITDA.

Appeal Improves

Fast-forwarding between last year and today, we have seen shares trade largely stagnant and actually down a bit, all while the company has been reducing leverage a great deal, but moreover has seen structural GAAP earnings. Moreover, the commercial business divestment will tackle net debt and leverage substantially, all generally quite positive.

Hence, I am warming up a bit to ADT Inc. here, although the heavy adjustments to earnings and rapid changes in capital allocation (with meaningful acquisitions and divestments announced on a fairly regular basis) limit my upbeat stance.

Therefore, I am taking a somewhat cautious approach to the shares here. That being said, with appeal definitely set to be on the increase, I am actively placing shares on my watch list here.

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