ADT: A Disappointing IPO Could Spell Opportunity

It's not a huge surprise that ADT (NYSE: ADT), the surveillance company known for its blue octagonal logo that is seemingly attached to every American suburban lawn, fizzled in its public market debut. Or rather, its re-introduction to the public markets - the private equity firm Apollo Global, after owning ADT for less than two years, has decided to put it on sale again. When ADT originally floated ideal terms for its IPO, it was hoping to sell 111.1 million shares at $17-$19 apiece, far higher than what it actually executed: 105 million shares at $14 apiece. The company raised only $1.47 billion in its offering (it estimates $1.415 billion in net proceeds after standard underwriting fees). Even at new lower levels, the market still didn't like what ADT has to offer. Shares sank 12% in their first day of trading, closing at $12.39 and sinking even further in aftermarket hours.

But there's a silver lining here: ADT's loss could be investors' gain. I was wary of the ADT offering in the high teens, but now in the $12 range, ADT looks much more appealing.



Final offering details
Before diving deeper into analysis, let's run down the list of facts. Here's how the chips fell in the ADT offering:
- 105,000,000 shares sold at $14/share, raising $1.47 billion in gross proceeds
- ADT estimates to raise $1.415 billion in net proceeds after paying standard underwriting fees
- ADT sold 14% of the company's total market cap. Post-offering, there are 748,949,378 shares outstanding
- There is an open greenshoe option (at the standard 15% proportion) for the underwriters to create and sell 15.75 million more shares, creating the potential to raise an additional $220.5 million
- Lockup agreement will expire 180 days from the offering, or July 18. Apollo, which owns the remainder of ADT, can choose to dump shares past that date

As to how the company intends to spend its $1.415 billion in net proceeds:
- $649 million will be used to retire $594 million of long-term debt and pay the call premium
- $750 million will be used to pay off preferred securities
- The estimated ~$16 million of leftover proceeds will go to the balance sheet



Soft earnings release and valuation implications
Concurrently with its final offering filings, ADT also released preliminary results for fiscal 2017. This release makes the company far easier to analyze - in its earlier S-1 filings, the company only had year-to-date financials through September 2017, with no prior year comparison as the company had just merged with Protection 1. Here's a look at ADT's expectations for the full year 2017:

Figure 1. ADT preliminary FY17 results
Source: ADT SEC filing

Where does that leave us on a valuation basis, especially after the company's slide in the markets on Day 1? Using ADT's closing price of $12.39 and its 748.9 million of shares outstanding, as well as its most recently disclosed balance sheet as of September 30, we can calculate the company's current market cap and enterprise value:

Figure 2. ADT valuation update
Source: Author-created chart; data from public filings and market cap based on close of trading on January 19

Note ADT's huge fall from grace, especially in its market cap - initial press had estimated that the company's IPO would value it at $15 billion. Now with a market cap of $9.3 billion, ADT is much more digestible as a value play. Adding in the company's $10.8 billion of net debt, and subtracting out the company's intended debt repayment from IPO proceeds (noting, of course, that the company will "lose" $54 million to pay the call premium on its senior debt), we arrive at an enterprise value of $18.7 billion for ADT.

Using the midpoints of the company's guidance range for FY17 results, we calculate that ADT currently trades at the following valuation multiples:
- 29.1x P/E ratio. Note that there is an unusually large spread in ADT's earnings guidance - from a low of $86.8 million to a high of $550.8 million. If ADT achieves the high end of its guidance (typical IPOs that have done "soft releases" of results generally hit the high end or even exceed it, like Aquantia (NASDAQ: AQ)), its backward-looking P/E ratio will actually be a much more reasonable 16.8x - much lower than the S&P500's trailing P/E in the high 20s.
- 8.0x EV/EBITDA ratio. Given that a huge debt load is a prominent feature of ADT's capital structure, the EV/EBITDA approach is probably the best way to look at ADT's valuation. Note that a single-digit EBITDA multiple is fairly cheap among industrial companies.
- 4.35x EV/Revenue. A difficult metric for comparison, as ADT doesn't fit nicely into any specific industry category (much as it attempts to position itself as an Internet of Things (IoT) play, most investors would probably disagree), but a revenue multiple in the low ~4s for a company with a large market share and stable, even if unimpressive growth, is fair.

Seeing as ADT's valuation metrics have compressed meaningfully from its initial filings in the $17-$19 range, this is a company worth looking into again.



Final thoughts
Though the majority of IPOs do end up "popping" after their debut - the share pricing is designed to produce the pop - some IPOs do falter in early trading. But if history from the past few IPOs tells us anything, it's that in general, most IPOs do go up after an early stumble. Look at Stitch Fix (NASDAQ: SFIX), for example. Though the company is obviously not a trading comp to ADT by any means, as an online clothing e-tailer, the circumstances surrounding its IPO draw nice parallels. Stitch Fix, too, priced its IPO below its initial range ($15 versus an initial range of $18-$20), and in the first week of trading, Stitch Fix did sink to the $14 levels - just like ADT now. Fast forward to the present, however, and Stitch Fix is trading at $21 - a 40% jump over its initial IPO price, and that's even taking into account the pullback it's suffered in recent days (shares jumped over $25 at one point).

Now, with ADT's more "boring" business model, it's not likely to sustain any breathtaking leaps like Stitch Fix - but its wide business moat and market share shouldn't be taken lightly. An early fall does not necessarily doom ADT's momentum - instead, look at this as an opportunity to buy an iconic American franchise. I was previously planning on avoiding this IPO, but at current levels, I will be watching shares to buy on substantial dips.