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Fitch Downgrades ADT's IDR to 'BBB'; Outlook Stable
By: Business Wire
Nov. 27, 2012 02:00 PM
Fitch Ratings has downgraded the ratings of The ADT Corporation (ADT), including the company's Issuer Default Rating (IDR) to 'BBB' from 'BBB+'. The Rating Outlook remains Stable. A complete list of the rating actions follows at the end of this release.
The downgrade reflects ADT's recently announced $2 billion share repurchase program that will be funded by debt and free cash flow (FCF). The company's board of directors announced today the authorization of a $2 billion share repurchase program over a 3-year period. ADT expects to incur incremental debt to finance these share repurchases and has targeted a leverage ratio as measured by debt to EBITDA of 2x.
ADT expects to incur $650 million - $900 million of incremental debt in 2013 and return approximately $900 million to $1 billion to shareholders in the form of share repurchases and dividends. Based on the projected share repurchases and debt levels, Fitch projects ADT's leverage will increase from approximately 1.6x during fiscal 2012 (ending Sept. 28, 2012) to about 2x for fiscal 2013 and 2014. Interest coverage is projected to range from 13x - 14.5x over the next two years. Fitch had originally expected ADT to maintain leverage at around 1.5x and interest coverage above 15x.
The downgrade also reflects management's willingness to undertake a more aggressive financial strategy soon after becoming an independent company. These actions also provide some uncertainty regarding management's financial policies beyond the near term. Fitch will continually evaluate how management balances demands from its shareholders while maintaining its commitment to an investment grade profile.
ADT's ratings and Outlook reflect the company's strong brand recognition, its national footprint and leading market position, recurring revenue base, sustainable FCF generation and solid liquidity. Concerns include emerging competition from non-traditional security service providers, risk associated with operating as an independent public company, and contingent liabilities, particularly tax liabilities, related to the spin-off.
The ratings incorporate ADT's strong competitive position as the largest residential security provider in the U.S.. ADT currently has over six million customers and a roughly 25% market share based on company estimates. ADT's competitive position is supported by a nationwide network of over 200 branches, 4,500 sales professionals, and more than 3,800 installation and service technicians. Additionally, ADT has nearly 400 certified dealers that generate about 45% of the company's new accounts.
ADT's subscriber-based business requires significant upfront costs to generate new customers. Capital expenditures, including dealer-generated accounts and bulk purchases and subscriber systems, totaled $1.09 billion and $902 million in 2012 and 2011, respectively. Capital expenditures for 2012 represent approximately 33% of annual revenues. Fitch expects capital expenditures to approximate 35% - 40% of annual revenues in the next few years. Fitch estimates that new customers yield an average cash payback of three years.
ADT has shown the ability to generate sustainable FCF in spite of the large capital expenditures that it incurs. ADT's subscriber-based business and recurring revenue stream contribute to steady income and cash flow. Revenues have been relatively stable as approximately 90% of its annual sales are recurring in nature. ADT generated roughly $406 million and $537 million of FCF during 2012 and 2011, respectively. Fitch expects ADT will generate annual FCF (FCF: Cash flow from operations less capital expenditures and dividends) of approximately $275 million - $350 million during the next few years.
Fitch expects ADT will maintain liquidity of approximately $1 billion, consisting of cash and availability under a $750 million revolving credit facility. ADT does not have any debt maturities until 2017, when $750 million of senior notes become due.
Fitch believes that ADT's competitive position will remain strong in the near-to-intermediate term. However, ADT faces competition from non-traditional security service providers. Several cable and telecom companies have introduced interactive security services that compete with ADT. While the customer base of these companies is substantially smaller than ADT at the current time, this emerging trend could provide significant competition for ADT going forward. The penetration rate for cable and internet providers is significantly higher (60%-85% range) compared to traditional security providers (20% range). This gives cable and telecom companies a larger customer base from which to sell additional product offerings and/or bundle services at perhaps more competitive prices.
ADT is run by a well-seasoned management team led by Naren Gursahaney, who served as President of Tyco's ADT North American Residential business segment prior to the spin-off. ADT has other executives with extensive company and industry experience.
As part of the separation, ADT has entered into separation and distribution and other agreements with Tyco and Pentair Ltd. (formerly Flow Control). This will govern the relationship between the post-separation entities and provide for the allocation of various assets (including trademarks) and liabilities and obligations (related to asbestos, pension and tax-related matters).
ADT also entered into a Tax Sharing Agreement with Tyco and Pentair. This agreement will govern the rights, responsibilities and obligations of the three post-separation companies regarding certain tax matters. The Tax Sharing Agreement outlines each company's share of certain tax liabilities. Tyco will be responsible for the first $500 million of shared tax liabilities. ADT and Pentair will share 58% and 42%, respectively, of the next $225 million of shared tax liabilities. Finally, ADT, Tyco and Pentair will share 27.5%, 52.5% and 20%, respectively, of shared tax liabilities above $725 million.
Future ratings and Outlooks will be influenced by broad economic trends, as well as company-specific activity, particularly free cash flow trends and uses, debt levels and liquidity position. Positive rating actions are unlikely in the near to intermediate term as Fitch evaluates ADT's performance and management's financial strategy as a stand-alone company. On the other hand, Fitch may consider taking a negative rating action if there is meaningful deterioration in ADT's financial results or management undertakes a more aggressive financial policy, leading to diminished liquidity and higher debt levels. In particular, negative rating actions could occur if ADT's leverage is consistently above 2.5x.
Fitch has downgraded the following ratings for ADT:
-- IDR to 'BBB' from 'BBB+';
-- Revolving bank credit facility to 'BBB' from 'BBB+';
-- Senior unsecured debt to 'BBB' from 'BBB+'.
Fitch has also affirmed the following ratings for ADT:
--Short term IDR 'F2';
--Commercial Paper 'F2'.
Additional information is available at www.fitchratings.com'. Fitch has conducted a Rating Assessment Service for the ADT Corporation. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012)
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporates
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