ADT Finishes the Year Unchanged but With a Safe Future

ADT Finishes the Year Unchanged but With a Safe Future

Home and commercial security company ADT delivered fiscal fourth-quarter earnings on Wednesday that were largely in line with expectations. The company appears to be improving profitability with higher ARPU and continued adoption of its home automation product, Pulse. The quarter marks the end of ADT's first year as a stand-alone public company following the spinoff from former parent Tyco. While the stock moved barely a point in its debut year, there is plenty of evidence to suggest that this industry leader has the potential to provide long-term value to shareholders. Let's take a closer look.

Earnings recap
One of ADT's biggest value propositions to investors is recurring revenue, as it is a steady, predictable cash flow driver and responsible for more than 90% of sales. In the company's fourth quarter, recurring revenue bumped up to $777 million -- 4.7% higher than in the previous year's quarter. Excluding special items, EBITDA gained a hearty 7.5%, while net income grew just 2.1% to $96 million. Adjusted earnings per share came in at $0.4 -- 7% more than in 2012. Analysts expected the same.

The company's customer base continues to grow, now up to a new high of 6.5 million users. ADT's foray into home automation (a high-margin offering from the business) is showing encouraging results. The take rate for the product is now at 32%, compared to just 13% a year ago when it had been recently introduced.

ADT has been aggressively buying back stock since it entered the public markets, taking 15% of the outstanding shares off the table since its IPO. Looking ahead, management intends to buy $400 million worth at an even quicker pace.

So what lies ahead for the security giant?

Next step
Numbers-wise, ADT management is targeting 2014 revenue growth of about 4% to 5%, with a slight improvement in margins and an appealing 5% to 10% gain in steady-state free cash flow.

This will likely come from both organic growth in the home and small business sector and acquisitions. During the fourth quarter, the company picked up two more security companies, Devcon Security and Absolute Security. ADT may also increase its value by taking on more leverage, as was recommended earlier this year by activist investor and former Icahn soldier Keither Meister. Management is looking to take its leverage ratio up to three times from two. With the substantial cash flows and low cost of debt, this is a great idea.

ADT appears to be increasingly lean with a focus on forwarding cash to shareholders and improving capital allocation. Customer acquisition costs can still come down, but the recurring revenue is a cash machine and allows for plenty of upselling down the line. The market may have priced ADT shares a little too high at its outset, but investors should not shy away from this security business.

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