Sell-Side: ADT A Secure Investment

Despite shares of ADT Inc ADT trading at a discount to the offer price of $14, sell-side analysts are optimistic about the security company's prospects. Most sell-side firms, including Goldman Sachs, Morgan Stanley and Imperial Capital, initiated coverage of ADT with the highest possible ratings. 

The Analysts

• Bank of America Merrill Lynch analyst David Ridley-Lane initiated coverage of ADT with a Buy rating and $16 price target.
• Credit Suisse analyst Anjaneya Singh started ADT with a Neutral and $14 price target.
• Citigroup analyst Peter Christiansen initiated the shares with a Buy rating and $16 price target.

BofA: ADT Trades At 'Sizable' Valuation Gap 

Retention is the biggest free cash flow lever for ADT, with the company having lowered attrition by 250 basis points since its May 2016 leveraged buyout offer, BofA's Ridley-Lane said in a Tuesday note. 

The analyst estimates a 50-basis-point reduction per year. Other FCF levers include a reduction in per-subscriber acquisition costs, the addition of more commercial clients, operating efficiencies and deleveraging, Ridley-Lane said. 

BofA Merrill noted that ADT shares trade at a sizable valuation gap versus peers.

"We expect ADT to trade closer to peers as it delevers, reaccelerates growth and gains market share in commercial," the analyst said.

Key risks for ADT include increased competition and higher dealer concentration, according to BofA. 

Credit Suisse: Market Share Gains In Question

The visibility and resilience of ADT's business model is appreciable, Credit Suisse's Singh said in a note. About 90 percent of revenue is in contracts ranging from three to five years in length, lending significant visibility.

Attrition is comparable to other residential services and will improve under new management, the analyst said. 

Credit Suisse is wary of a less optimistic outlook for growth acceleration, given slow-moving industry penetration rates and the potential threat of new entrants.

"However, we still have some skepticism around how much of the low-hanging fruit has been picked and when ADT may be able to start gaining market share," Singh said. 

Citi: ADT's Business Model Underappreciated 

ADT's operational turnaround and business-to-many, or BTM, model is underappreciated, said Citi's Christiansen. The analyst said he expects the company's shift in focus to higher-return revenue sources — coupled with continuing efficiency gains and opening of less capital-intense product channels such as DIY — to lead to an achievable mid-40s levered and mid-teens unlevered FCF CAGR over the next three years.

Over time, Citi expects investors to better appreciate ADT's strong upside leverage from continued turnaround execution and sustainable increases in return on capital.

The Price Action

Since listing at $12.65 and closing at $12.39 on their Jan. 19, ADT shares have added about 2 percent.

ADT shares were down 4.22 percent at $12.15 at the close Tuesday.

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Photo courtesy of ADT.