Morgan Stanley, Goldman Sachs Bullish On ADT As Security Firm's Quiet Period Expires

ADT Inc ADT, the largest home security company, priced its January 2018 IPO at $14 per share — below the expected range of $17 to $19. On Tuesday, multiple Wall Street firms weighed in on the stock for the first time after the expiration of the quiet period.

The Analysts

• Morgan Stanley's Toni Kaplan initiated coverage of ADT's stock with an Overweight rating and $18 price target.
• Goldman Sachs' George Tong initiated coverage of ADT's stock with a Buy rating and $19 price target.
• Imperial Capital's Jeff Kessler initiated coverage of ADT's stock with an Outperform rating and $15 price target.

Morgan Stanley: Attractive Free Cash Flow

With a 30-percent market share, ADT offers investors a growing and recession-proof company that boasts a steady operating growth, accelerating cash flow and a "very compelling" valuation, Kaplan said in the initiation note.

Looking forward to 2020, ADT's free cash flow should reach $1 billion, up from $326 million in 2017, the analyst said. Over the same time period, the company will realize improved subscriber acquisition costs that will flow to its EBITDA through the following factors, Kaplan said:

• Lowering attrition.
• Commanding more upfront revenue. 
• An increasing commercial/DIY mix.
• Lowering equipment and installation costs.
• Improvements in sales force compensation and retention.

ADT's stock is trading at an 8.4-percent yield, which represents a "steep discount" to the comp set average of 5 percent, the analyst said. While some arguments could justify a discount, the 3.4-percent gap is "too large" and an $18 price target implies a 5.9-percent yield, Kaplan said. 

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Goldman Sachs: The Leader In An Attractive Market

ADT's 30-percent market share makes it not only the clear leader in the U.S. security industry, but is three times larger than its closest competitor Johnson and five times larger than its next largest competitor Vivint, Tong said in the initiation note. The company enjoys "meaningful" economies of scale and management is "appropriately focused" on driving profitable growth, rather than growing at any cost, the Goldman Sachs analyst said. 

Another key component in the bullish stance lies with ADT's transformation in 2016, Tong said. "new ADT" was created in 2016 through the combination with ASG and Protection One and an overhaul of the entire executive leadership team. Prior to the formation, the legacy ADT offered investors lackluster margins and poor free cash flows due to poor customer service, cost inefficiencies and operational inefficiencies, according to Goldman Sachs. 

The "new ADT" deserves plenty of credit for improvements such as the following, Tong said:

• Attrition fell from 16.5 percent in 2015 to 13.8 percent in the third quarter of 2017, and is expected to fall to 12.1 percent by the end of 2020.
• An improvement in longest call wait times from more than 90 minutes to less than 2 minutes.
• A focus on acquiring higher-quality customers.

Investors shouldn't necessarily be worried by the competitive landscape from much larger rivals like Comcast Corporation CMCSA, which offers similar security solutions, the analyst said. Cable companies like Comcast are lacking the necessary focus on home monitoring and will remain at a competitive disadvantage, Tong said.

ADT has shown a commitment to the sector "throughout its history," he said. 

Imperial Capital: A Less Bullish Outlook

ADT's prior reputation of being a "legacy alarm monitoring company" no longer applies, as the company is now considered a "leading provider of residential and commercial security and automation solutions," Kessler said in Imperial Capital's initiation note. The company is also backed by a "high performing" management team, which warrants a premium valuation, he said. 

While Kessler is bullish on the stock, a $15 price target is less bullish than Wall Street peers who see the stock moving as high as $19.

The analyst's $15 price target is based on 8x his fiscal 2019 EBITDA estimate, which takes into account the current trading multiples of other industry-leading services companies. Based on the stock's $12.68 closing price Monday, the market is valuing the stock at 7.7x the analyst's fiscal 2018 EV/EBITDA, which is within the historical range seen during its prior public iterations and in-line with other leading security companies.

The market could be underestimating ADT's "flexibility" with its estimated $250 million of growth capital expenditures, which is created by the difference between the total subscriber acquisition costs and maintenance capital expenditures, according to Imperial Capital. And the market could be overlooking any cash flow increases from even a small price increase for ADT's existing base, Kessler said. 

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Photo courtesy of ADT.