Many have posted their advice on ADT Corp. (ADT, Financial) stock lately, and there are a lot of prognosticators who feel that now that it has taken a dive that its a buying opportunity. I would hesitate to buy this stock even now, despite the depressed price. Here is a summary of why:
1) Customer attrition. Let’s face it, it’s a problem. Management can't claim, on one hand, that home and business automation is a growth market, but on the other, that relocations and the rebirth of the housing market is the cause for so many disconnects. People need to live/work somewhere. If they are not coming back to ADT after they move, then they left for an alternative product. Additionally, what happened to the system that was in the previously occupied space? People moving seems like it should be an opportunity to double your customer count, resigning the new customer that moves into the old customer's house/business space, and signing the new customer after they move to a new space.
2) After ADT's first fiscal year, the company managed a slight increase in customer count, but this was also in a year in which the company acquired Devcon. Without this strategic signing, customer count would have dropped which as this most recent quarter results would indicate, seems to be the norm, not the exception. The issue of customer attrition has not been satisfactorily addressed to this point.
3) Customer ARPU is increasing and so are revenues. On the surface this seems like a good thing. In his most recent quarterly results the CEO states that 45% of the credit to the increase in revenue can be traced to increased Pulse take rates and the increased services customers experience with this product. The remaining 55% is a result of contract ARPU increases to the existing customer base. This increase was the result of standardized yearly contract increases that some customers may not notice or care about, but for those that do notice it, it could be an additional source of attrition. Per my comments in No. 1 and No. 2 above, the best reason to see revenues increase is because of more customers coming to the table, not because of increased rates for the same services provided yesterday at a lower cost.
4) Capital allocations for this company have changed radically in the last few months as a result of the stock repurchase program. The amount of debt the company carries on its balance sheet has gone up dramatically, yet the net effect on the stock price has clearly been negative, despite the buybacks. Dividends paid cost roughly 2% to 3% a year, the newly acquired debt costs about 6% and a lot of cash was expended buying back stock. Was this really a "make sense" move? Now the company's cash position is down, its stock price is down, and management is betting the ranch on increasing customer count and revenues in a fragmented, competitive market with low barriers to entry where everyone from your local electrician to big telecom and cable companies are entering. In exchange for being able to call the shots with regard to dividends paid based on quarterly company performance, the company is now locked into contractual debt instruments and a lowered cash position. I’m can't see the strategic value in this decision.
5) Many state that subscription based companies are models for successful investing. Some draw comparisons to pay TV and telecom companies. But there is a major difference between a company like ADT and a major telecom company, or even a pay TV company for that matter. It’s called "barriers to entry." The capital investment required to start a major national/regional TV, cable or telecom company dwarfs the investment required to run a company like ADT. ADT manufactures none of the equipment it installs; it is simply a reseller of equipment. Any electrician with a low voltage electrical license can do what ADT can do and charge half the price, even with home automation as an option.
6) This item was missed with all the publicity that the last quarter results call got, but no one has asked what the terms of the Vringo (out of court) settlement were. What is the cost of the settlement? Is it in the form of a lump sum payment? Continuing royalties? These are important questions that need to be made public.
7) Does ADT have any idea what its customer satisfaction ratings are like? With customer attrition approaching 14.2%, as a management figure, I'd be all over what the actual customer satisfaction rating is, yet I can find no published numbers on this metric, and management has not offered anything.
8) ADT has described home automation as a growth market. As any college MBA can tell you, however, the normal pattern for growth markets is increased competition and downward price pressure on products and services offered. Is ADT prepared to lower its prices to match the comparable offerings that competitors, small and large, are offering? ADT is the high priced player in my area. Does the ADT business model have room for downward price pressure and lower ARPUs/customer acquisition costs? Apple (AAPL, Financial) is one of the greatest innovators of the decade with products like the IPad, but companies offering similar products at lowered price points have forced the original innovator to pack more into the product at a cheaper price.
9) Finally, there have been releases indicating that the shareholders are seeking representation over the whole "stock buyback and Corvex Management" debacle. I won't go into the gory details of Keith Meister and his exit from the ADT board, but it’s been referenced by certain media outlets that maybe the SEC may get involved. I'm not judge and jury on this kind of thing, but there could be a case for it. What will the impact on the stock be as a result of these two potential events?
I’m not saying ADT can’t dig itself out of this hole, but I don’t believe this is the time to be getting into this stock. Sure, it’s more attractive at $30 a share than it was at $40 a share, but I don’t see a huge value in the products it’s offering yet. Paying $50 to $70 per month to be able to turn my lights on remotely from my office or turn off my heat? And the cost to install these systems via the ADT network is astronomical. These are things a timer or properly set thermostat can do at almost no cost with a little bit of forethought. Sure the gadget factor is cool, but not at this cost. I can figure out where my kid is without a battery of cameras around my house; all I need to do is activate my free “Find IPhone” app to know where my teenager is.
