TheSecurityAnalyst

 

 

A couple of smart investors asked if I calculated the forward steady state cash flow of Brinks Home Security, based on its new filings with the SEC.  Smart alecs!!!  Seeing as how I am not in the business of projecting estimates and price targets, nor giving out buy-sell-hold recommendations, for now, that is not possible.  However, based on the new SEC Form 10 filings by Brinks Home Security Holdings, we have looked at what is reported pro forma for 2007, and adjustments for 2007 “steady state cash flow” generated by BHS in 2007 should be down slightly from “consensus” numbers out there.  Steady state cash flow is a more accurate reading of the profitability of a security monitoring company’s recurring base of business, with the one caveat that it does not account for new growth initiatives.  Recurring monthly revenues ended 2007 at $37.1 million, while as we noted in our last blog on Brinks Home Security, EBITDA was $196.6 million.  However, recurring monthly revenues, in and of themselves, do not indicate the profitability of that revenue stream, while EBITDA can be affected by accounting conventions, such as how much internal accounts vs. acquired accounts and what percentage of customer acquisition costs go to the balance sheet versus the P&L.

 

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Brinks Home Security Steady State Cash Flow Calculation for 2007

 

                                                                              Old                         New

                                                                                              2007       2007PF

 

Total revenues ($ millions)                                            484.4      484.4

Recurring Operating profit                                           208.9      168.9

Pro forma adjust (decline in fees to Brinks)                 27.2       27.2

D&A                                                                                      50.4       50.4

Amortization of Deferred Revenues                             (34.2)     (34.2)

Recurring EBITDA                                                        302.8      290.0

 

Investment in New Subscribers                                    (92.2)     (92.2)

Deferred Subscriber Acquisition Costs                     (23.8)     (23.8)

Deferred Revenues from New Subscribers                 47.4       47.4

Capital Expenditures                                                 (177.8)    (177.8)

Total New Cash Subscriber Costs                          (246.4)    (246.4)

 

Disconnects (millions)                                             0.082       0.082

Installations (millions)                                             0.181       0.181

Disconnects as a % of Installs (and costs)            45%         45%

 

New Subs Cost to Replace Disconnects (45% of

 Total new cash sub costs in 2007)                          111.5       111.5

 

Steady State Cash Flow (recurring EBITDA,

  Minus Replacement Costs)                                    191.3       178.5

 

Steady State Cash Flow Margin                           39.5%       36.8%

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Typical trading multiples for monitoring metrics in larger companies are 40x-50x RMR, 8.5x-10x EBITDA, and 9x-12x steady state cash flow.  Transaction multiples are commensurately higher, about 50x-60x RMR (again, limited to larger companies), 10x-13x EBITDA, and 11x-14x steady state cash flow.

 

Regardless of the adjustment downward in SSCF margin, to 36.8% from 39.5%, based on the filing, BHS still maintains the highest steady state cash flow margins we know of in public companies, and there are only a few private companies that can compare.  This is pretty impressive stuff, and a tribute to Peter Michel building the business in the 1990’s and Bob Allen continuing to build the business in the 2000’s.   ….now can we get back to discussing those royalty payments and the 3-year limit on the brand name…..???  

 

[…and while I am on a jag, I repeat: Why is Protection One, selling at such an unfair multiple to its peers? – There may be a lot of good partial reasons, described in our earlier blogs, but they don’t and shouldn’t add up to the valuation disparity we see -- particularly with the confidence the security industry has in P-1’s management team.  I just wish the financial community would loosen up on this thinly traded stock…]

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The Brinks Company is spinning off its Brinks Home Security (BHS) unit, and on May 30, BHS filed a “Form 10” with the SEC, representing its preliminary pro forma financials as well as its ongoing relationship with Brinks Inc.  Along with the financial pro forma’s, there are two “surprise” issues which popped up in the filing (you have to dig to find them):  (a) the loss by BHS of its “Brinks” brand in three years and (b) the royalties that BHS has been paying to Brinks – over $30 million in 2007 — which were formerly not reported (or at least never seen by me).

 

 First, as insinuated by management, and expected by me, pro forma operating income for 2007, net of expenses not allocated to the Brinks Companies anymore, declines a bit  – to $98.8 million from $116.7 million – a decline of $17.9 million.  We would expect similar declines in our EBITDA ($234 million), and steady-state cash flow ($190 million) results for 2007.  Again, the decline is due to unallocated corporate expenses now being allocated.

 

 One technical accounting discovery (the following all related to the FASB’s Staff Accounting Bulletin No. 104, which frankly has only served to confuse the numbers on long-term contracts like alarm companies, not help investors, in my humble opinion):  We would note that the company categorizes the “amortization of deferred revenues” related to active customer accounts — $34.2 million in 2007 — as a non-cash item already reflected in net income.  While this was already subtracted out of our steady-state cash flow numbers for 2007, we considered it outside of the net income calculation previously.  We will have to determine with management, whether this also should be subtracted from EBITDA.  The other deferral items (“deferral of subscriber acquisition costs” and “deferred revenues from new subscribers”) are still considered outside of net income and are not considered in the EBITDA calculation.

 

 OK – now to the good stuff!!  Brinks Home Security notes that under its “brand licensing agreement,” it has been paying 7% in North America and 3% outside of North America to use the Brinks name.  This will be reduced to 1.25% for the next three years, and is reflected in the filing’s pro forma’s by increasing operating income by $27.2 for 2007.  Great, guys, thanks for telling us that Brinks Home Security was paying Brinks 7%  or about $33 million in 2007– now that they are splitting off.  This was not an inconsequential amount.  Well I guess if Brinks armored was funding Brinks Home Secuirty during its first eight years of life, BHS can only return that favor.  Oh, and by the way, this makes for an even more compelling case for BHS as a excellent company.

 

 So, we also learn that after three years Brinks Home Security is going to have to find itself a new name.  A great brand, Brinks Home Security, will have to go by the wayside.   I will accept suggestions for a brand that can even come close to what BHS has now.  In addition, after five years, Brinks Inc.’s non-compete in the alarm monitoring industry ends (I would assume they would target the commercial space, if they were to enter).  Obviously the Brinks brand has been a contentious issue during all the debates and consultations over splitting up the company over the last two years.  But, I guess, if Brinks Home Security is no longer going to be part of the corporate fold, they are not  entitled to keep a brand name that is golden in residential circles.  Oh well, at least I assume they will do better at renaming themselves than Securitas Systems did in “re-branding” itself Niscayah.

 

 One final observation:  I have know Bob Allen, the president and CEO, and Steve Yevich, CFO for years, and believe they are top notch executives.  Brinks Home Security – or whatever it will be called – will be in good hands.  

 

 

 

 

 

 

 

We just happened to glance at our security monitoring valuation table today — you know the one that compares six of the largest companies on multiple valuation ratios — in advance of Protection One’s first quarter report, coming Wednesday, May 14.  I was shocked, and asked myself “where have I been for the last two months?”  Well, some of you know.  What I didn’t know was what a travesty of valuation I am witnessing in one of the better companies in the industry, run by one of the better managements in industry.

 

Yes, we all know the story:  there is little growth (with growth in true commercial/industrial offsetting slight shrink in residential), the balance sheet is levered more than Brinks, or Securitas Direct.  And, the float of 6.5 million (Quadrangle still owns nearly 20 million shares) keeps a permanent liquidity discount on the valuation.  With that said, Protection One is a well run company, maintaining RMR of $26.5-$27.0 million, consensus EBITDA of $115-$120 million (a 32% margin is not so bad), and steady state cash flow of around $75 million.  While a 20% SSCF margin is nothing to trumpet, neither is it so bad, particularly considering that P-1 management completely turned over the wasteland of a subscriber base they initially took on, and are now doing the same with the old IASG account base, another poor cash flow performer.

 

What’s the point of all of this?  Well, at an enterprise/RMR valuation of 26x, an Enterprise/EBITDA valuation of under 6x the company is selling as if this were a small, badly run, untouchable enterprise.  Compare this to Brinks Home Security (if one assumes it is 55% of the enterprise value of Brinks Cos) at 48.4x RMR, or 7.5x EV/EBITDA, or Securitas Direct (yes, we know they are mainly bought out by now) of 11.8x EBITDA and 49.9x RMR.  Or better yet, let’s take a look at ADT inside of Tyco – a company that fell and rose back to respectability in about the same time frame as P-1, at 9.2x EBITDA and 43.1x RMR (assuming ADT is 52% of the value of Tyco).

 

OK, I’ve made my point.  With all of P-1’s low growth, leveraged balance sheet, “poor” number 3 position in the industry, and little trading there’s lots to yawn about.  But at the current price and valuation it is trading at, relative to a truly respected management and a major position in the industry, some investors must be asleep at the switch.