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

Summary:
But private equity firm Apollo makes .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 .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 .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 .3 billion in long-term debt. Now, 18 months later,

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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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Wolf Richter
Founder, Wolf Street Corp. In his cynical, tongue-in-cheek manner, he muses on WOLF STREET about economic, business, and financial issues, Wall Street shenanigans, complex entanglements, and other things, debacles, and opportunities that catch his eye in the US, Europe, Japan, and occasionally China.

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