$10-Billion IPO of Leveraged Buyout Queen Flops, Investors Bleed

But private equity firm Apollo makes $2.4 billion “on paper.”

On their first day of trading today, and despite a stock market that has been steamy hot, shares of ADT Inc., which sells home security systems, such as surveillance cameras, burglary alarms, and related services, and home automation devices, such as digital door locks and thermostats, plunged 14% to $12.05 Friday afternoon.

Private equity firm Apollo Global Management had acquired ADT via a leveraged buyout in February 2016, even as other leveraged buyouts were getting crushed. Paying a 56% premium, it shelled out $6.9 billion, then merged ADT with Protection 1, a much smaller US competitor it had acquired a year earlier.

Before the leveraged buyout closed, ADT had $5.3 billion in long-term debt. Now, 18 months later, after Apollo got through with it, and including the combination with Protection 1, ADT’s long-term debt has nearly doubled to $10.4 billion. This is the result of the leveraged buyout. The debt needed to fund the buyout gets loaded on the acquired company (hence the term, “leveraged” buyout or LBO).

The IPO ran into lukewarm reception yesterday from institutional investors, and ADT had to slash the share price from an original target of $17-$19 a share down to $14 a share to pull off the IPO. That price still valued ADT at $10.5 billion.

ADT ended up selling an initial 105 million shares and raised $1.47 billion. Underwriting banks have the chance to buy an additional 15.75 million shares. If they do, the maximum amount ADT could raise is $1.69 billion. That’s down about 25% from original estimates.

Reportedly, investors were “skeptical” about ADT’s claim that it is a service-oriented business that could continue to produce high margins. There is a lot of competition out there. ADT is the largest home security systems provider in the US and Canada with a share of 30%. But app-based systems, and companies like Google and Amazon, are barging in on its territory. There are worries that ADT, which has about 7.2 million customers, might not be able to maintain its customer base. It already admitted that it has lost customers.

Then there’s the worry about the $10.4 billion in long-term debt, which is no problem if cash flows are everlasting and super strong, but at the smallest set-back, this could get tough. Moody’s rates the company B1, four notches into “junk.” And if the company’s cash flow deteriorates, servicing and refinancing that debt will be difficult.

Furthermore, the junk-bond market is in a historic bubble, with financial conditions ultra-loose and borrowing very easy and cheap, no matter what the credit risks. But this is unlikely to continue as the Fed is directly and purposefully targeting these financial conditions. Investors who’re brushing off the risks of the junk-bond market tightening up are “fighting the Fed.”

Raising $1.5 billion in the IPO is helpful. ADT said it would use the proceeds to pay down debt. This could lower the debt to about $9 billion, which is still a huge pile. Going forward, if credit tightens, ADT has the option of raising more money by selling more shares, possibly at a much beaten-down price, thus painfully diluting its existing shareholders.

The market also gets to look forward to the share sales by Apollo, which will eventually want to unload its stake of nearly 85% that it still holds after the offering.

ADT got started in 1874 as the American District Telegraph Co. So it has been around for a while. In its S-1 filing with the SEC on January 18, ADT estimated that revenues in the year 2017 would be about $4.3 billion, and net income would be between $87 million and $551 million. The company said that over 90% of its revenue derives from recurring monthly payments from its contracts that are usually three to five years in duration.

A person “familiar with the deal” told Reuters that Apollo made a profit of around $2.4 billion on paper based on the IPO price last night – not including the 14% blow the shares took today.

PE firms are still sitting on many of their leverage buyouts from the LBO boom – the ones that, unlike Toys ‘R’ Us, haven’t gone bankrupt yet. And they’ve all been trying to unload them via IPOs. That Apollo was able to pull it off at all, and in such a short time, shows that the market is red hot.

Others have not been so lucky. Cerberus had to scuttle its IPO in 2015 of its grocery-store conglomerate that includes the combined leveraged buyouts of Albertson’s, Safeway, and some smaller chains. In the stagnating grocery business in the US, a price war has broken out, and Amazon has piled into it with its acquisitions of Whole Foods, even as German discounter Aldi is spending billions on expanding further in the US to where it will be larger than the combined stores that Cerberus has acquired. Albertsons’ IPO hopes are further dimming as customer traffic and same-store sales have dropped for the fifth quarter in a row, despite promos and price cuts. Read…  Albertsons/Safeway Loses Grocery War, Lidl Gives Up? 
 

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  28 comments for “$10-Billion IPO of Leveraged Buyout Queen Flops, Investors Bleed

  1. Nick Kelly
    Jan 19, 2018 at 3:57 pm

    ‘ADT estimated that revenues in the year 2017 would be about $4.3 billion, and net income would be between $87 million and $551 million.’

    Somewhere between 87 and 551 ??
    That’s quite a spread. If they think they know revenues will be around 4.3 billion, which expense do they not know, to the tune, possibly, of half a billion?

    • Jan 19, 2018 at 4:12 pm

      Maybe they’re still trying to finagle that huge “tax benefit” for 2017, and they’re not sure yet if it’s going to fly.

    • davidR
      Jan 19, 2018 at 4:23 pm

      For a nice recurring revenue subscription business with customers locked into three to five year terms a 2.02% net income is horrible. $551MM is a respectable 12.8%. Not low, but clearly not high tech.

  2. John seddon
    Jan 19, 2018 at 4:03 pm

    The comment on further expansion by Aldi is incorrect. Aldi has put on hold it’s current US expansion plans following disappointing trading returns. Expect further announcements as they review their position. Some sites acquired and not yet developed have been put on hold.

    • Jan 19, 2018 at 4:18 pm

      Could you cite a source or post a link for that? I have not found anything to document this move. The latest I have was from June 2017 about the expansion project.

      (BTW, this comment belongs under an earlier article about Albertsons.)

    • Jim
      Jan 20, 2018 at 1:55 am

      John, did you mean Lidl, rather than Aldi?

  3. Guido
    Jan 19, 2018 at 4:09 pm

    What an irony! A company that’s there to protect you did not get enough protection from the plunge protection team. It won’t even protect the buyers of the stock when prices meet earth.

    I think ADT’s business model is so prehistoric. Go-ogle and Amazon lurking about is a good hint that it should simply sell out its customers’ movements in and about their homes on the open market. Hell, spy on neighbors too. May be even give it away to google or amazon. This way, they can do to google and amazon what they’ve done to the freeloading customers— make them dependent. Then hope that one of them will buy it out for an inflated price.

  4. Maximus Minimus
    Jan 19, 2018 at 4:52 pm

    Excuse my ignorance, but have LBOs been always around? If I remember it correctly, they took off seriously in the nineties with light touch regulation.

    • Jan 20, 2018 at 9:42 am

      What REAL and PRODUCTIVE PURPOSE do these LBO-s serve — other than lining the pockets of rapacious ¨capitalists¨ ?

      Why are these LBO-s ¨legal¨ or allowed ?

      I have read numerous times over the last many years that the LBO-ed company is going under, while the corporate raiders escape with their BILLIONS, untouched. Should there not be a clawback of the ¨stolen¨ (my word) billions if the company goes under?

      I just DO NOT UNDERSTAND why these are legal, giving billions to rapacious ¨capitalists¨ , and ultimately destroying companies like Sears and Radio Shack ?

      Might there not be tax-treatment of the ill-gotten gains that discourages such bad public purpose ?

      Just because THEY can do it — does it mean that they should do it ?

      I am confused by all of this, really.

    • WSKJ
      Jan 20, 2018 at 3:46 pm

      In response to Maximus Minimus’s Q.:

      In Wall Street Words, Scott, 1997, writes that LBOs “…became popular in the 1980s when firms such as Beatrice Companies, Swift, ARA Services, Levi Strauss, Jack Eckerd, and Denny’s were acquired and then were taken private. With an LBO, a firm’s management often borrows funds using the firm’s assets as collateral….”

      On the same topic, this from the Gale Encyclopedia of U.S. Economic History, eds. Carson, Bonk, 1999: Montgomery Ward ” …fell into the hands of Mobil Corporation in 1976. Twelve years later, however, the largest management-led leveraged buyout in U.S. history at the time ($3.8 billion) transformed Montgomery Ward into a privately held company….”

      My surmise is that the flavors of LBOs change from one business cycle to the next (and something very like the LBO goes way back in history under other labels), but they will continue as long as the appetite for profit from OPM does.

  5. raxadian
    Jan 19, 2018 at 6:16 pm

    Wolf, could you give a list if all those companies that suffered a leveraged buyout and went under in 2017? Or at least the most important ones?

    • Jan 20, 2018 at 10:19 am

      I just glanced at my stuff – just the list of the PE-firm-owned retailers that filed for bankruptcy over the past two years and that I covered is pretty long – and fascinating. Or shocking? So I might actually put this in an article this weekend.

    • stan barber
      Jan 22, 2018 at 3:21 pm

      in UK we have guy called Green. he LBOd his businesses and cashed in nicely >1b in dividends and now the companies that he so gloriously LBOd are hollowed out as a hollow barrel of oil, rusted out for good measure.
      pension funds = dead
      people who funded pension funds = soon to die under a bridge
      LBOd companies’ cashflow = only servicing the debt.

      pays off to think of the scam first innit?

  6. Bill
    Jan 19, 2018 at 7:26 pm

    ADT is a relatively high-cost security company when it comes to the residential market. Its long-term auto-renewing contracts have also landed it in litigation. In response, in recent years, many do-it-yourself security companies have appeared. One, Simplisafe, advertises heavily on the largest national talk radio programs. So much so that it and others of its kind must be making significant inroads against the established dinosaurs like ADT. Unless ADT has the business security market sewed up better than the residential, I would not be optimistic about the company’s future.

    • DJ
      Jan 19, 2018 at 8:03 pm

      I bought a Simplisafe system. Customized by myself and self installed. Monthly fees much lower than ADT. No contract. Very happy.

      • c smith
        Jan 20, 2018 at 9:55 am

        Yes…the “app based” (as Wolf calls them) competitors are steadily eroding ADT’s market share, and the trend is accelerating. ADT’s historical success has been based on the homeowner’s unwillingness to do the work to set up and maintain a system of sensors and software. Easier to pay someone else (even a high monthly fee) to do it for you. Now that it can all be done fairly easily wirelessly, and maintained on a smart phone, ADT’s days are numbered.

      • Tom G.
        Jan 21, 2018 at 11:54 am

        If you have one of the original Simplisafe systems, you need to contact them for a replacement controller…the wireless implementation has some pretty fundamental flaws that make it trivial for anyone to remotely disable your security system. Unfortunately, the firmware cannot be field-updated, so the only fix is to replace the entire controller.

        ADT has good name recognition, and a strong network, but will still struggle to support $10B in debt in the face of strong competition and their tendency to increasingly crapify their product.

        On a larger house, a REAL house security system costs $3k – $5k to install. ADT’s $300 system with a pair of PIR sensors, a glass break sensor, a few door sensors and a control keypad is a joke.

  7. andy
    Jan 19, 2018 at 7:28 pm

    “revenues in the year 2017 would be about $4.3 billion, and net income would be between $87 million and $551 million.”

    And debt $10bn +, 85% share overhang and massive competition on the horizon.

    In investing parlance, this is called a dog.

    “Now, 18 months later, after Apollo got through with it, and including the combination with Protection 1, ADT’s long-term debt has nearly doubled to $10.4 billion. ”

    Wolf, why did debt double to $10bn?

    • Matt P
      Jan 19, 2018 at 9:24 pm

      Because Apollo paid themselves a big fat bonus for the acquisition and that was paid for by loading up the company with debt. That’s what all LBOs do.

      • c smith
        Jan 20, 2018 at 9:58 am

        Exactly. Apollo may be “up” $2.4 billion on their existing ADT position, but they already got paid on this deal big time.

    • Jan 20, 2018 at 10:28 am

      “…why did debt double to $10bn?”

      Apollo funded the buyout by borrowing a large amount of money. But this debt was not carried by Apollo. Instead, it was heaped on ADT. This is why it’s called a ” leveraged” buyout … because the acquired company is leveraged up to pay for its own acquisition. It’s very risky for lenders. But they keep doing it because they can make a lot of money on it on fees and interest.

      I don’t know in this case, but typically, PE firms also extract management fees and “special dividends” from the acquired company that the acquired company has to fund via debt. In this manner, they pull a big part of their profits out upfront.

  8. Petunia
    Jan 19, 2018 at 8:18 pm

    Apollo owns Fresh Market too.

  9. Rates
    Jan 19, 2018 at 10:10 pm

    To Memento mori:

    Another example of American exceptionalism.

    Best of the best surely.

  10. RG
    Jan 19, 2018 at 10:20 pm

    I actually received a notification from my on-line brokerage about the ADT IPO. Since I’m not a “whale” investor, I automatically know that any IPO I’m offered has to be a bad one. I was offered 5 IPOs in the past week, so “Yes” the IPO market is “hot” and desperately looking for investors.

  11. E markus
    Jan 20, 2018 at 3:17 am

    This is exactly how it happens with these LBOs: The investors study companies looking for industries that are healthy now, but are facing huge changes in the near future. These are companies that have considerable assets and those assets will be reduced when the impending market changes happen. The investors get to the party first and suck out all the value, then the market conditions do to the company what was going to happen anyway and it just turns into a mess with no money to clean it up.

    Look at ToyRUS. Thats a failing company with immense competition form big boxers and online sale. Long term they’re out. LBO sucked out the money ahead of time before the natural market conditions could do.

    Same will happen with ADT. As the article states, they are only starting to suffer as of the last year, but technology will render them extinct. The LBO got in there sucked out the assets and the lucked out in getting stock sold. Some one’s going to be on the hook in the next couple of years.

  12. Jan 20, 2018 at 10:24 am

    ADT reminds me of cable TV. I had both and now I have neither.

  13. mean chicken
    Jan 22, 2018 at 1:04 am

    Let’s see if I’ve got this down, b/c although it takes several paragraphs to explain one simple concept, by definition the subject trips over itself.

    Executive Summary: Private equity firm Apollo Global Management and others of the same cloth are churning out corporate welfare candidates and walking away with the stripped out cash?

  14. Greenhead
    Jan 22, 2018 at 1:02 pm

    When interest rates go up and the debt becomes unpayable, the lender (bank) takes a hit. But, don’t worry, the Fed will bail them out and the losses will be socialized. Nice formula.

Comments are closed.