Description

ASCMA, a holding company with ties to Liberty Media that owns cash, real estate, and a residential alarm monitoring company, Monitronics, represents a compelling long-term investment to consider at today’s prices.

Pitch:

Our base case assumes ASCMA has ~30% upside using 2014 steady state free cash flow, but management’s goal is to put all of the cash + real estate at the holding company into levered acquisitions of other security monitoring companies, which could take the upside to 50% without stretching the assumptions. 

Furthermore, management has the ability to use the 150m revolver at Monitronics for accretive transactions, such as the recent Pinnacle deal that boosted subscribers by 13% with almost no impact to net debt multiples and creates an on-going dealer relationship that should prove beneficial.    

The residential security alarm market is highly fragmented with ~ 90 regional companies and many smaller, local competitors.  The ability to roll-up the industry at attractive returns, or execute large bulk account purchases with the revolver at Monitronics could persist for some period to come. New interactive services have the potential to drive higher ARPU of new and existing accounts and could be under-appreciated.  Please see disclosure statement at end of write-up.     

Key asset:

Monitronics is a defensive, highly recurring business with attractive returns on capital, good growth characteristics serving an underpenetrated market, and has one of the best management teams in the sector with a long history of successfully executing for more than a decade.  We believe these factors should allow Monitronics to compound value for a number of years going forward with low macro correlation.  Additional data can be found in the company’s Investor Road-show presentation including management’s view of the IRR per new account and historic EBITDA CAGRs. 

Misperception:

ASCMA has limited sell-side coverage and liquidity is only ~2m per day, which may explain the current valuation.   One also has to assume management will deliver on their M&A strategy, where timing and accretion are difficult to predict. 

Background / update:

ASCMA was written up by Jon64 on Aug 30, 2011 and the thesis seems unchanged.  Please refer to Jon64’s post for more background information on the security industry and Ascent’s unique model.  Four major changes since this post are:

 a) ASCMA completed their refinancing. Mar 12’

b) Telcos / Cable have entered the market in select geographies.  11’ & 12’

c) John Malone resigned from the board, but has been consistently buying stock in ASCMA.  Sep 12’

d) ASCMA completed a large account purchase from a competitor, Pinnacle.  Oct 12’

Refinancing

While the refinancing came in at higher rates than were expected, which impacts steady state free cash flow, management also gave guidance on how to think through steady state free cash flow for their model, which included a number of add backs to be considered due to their unique dealer based model and offset much of the increased interest expense.  Furthermore, management has argued the 400m unsecured 9.125% senior notes were sold to create flexibility in the capital structure at the revolver level, a point that until the recent Pinnacle transaction seemed like an excuse. 

Pinnacle:

However, we believe the Pinnacle transaction is transformational in that it highlights management’s ability and commitment to using leverage in a highly accretive fashion.  It also highlights that while the industry has become more competitive on purchase multiples and private equity participation has increased in the last two years, making it more difficult for management to acquire security businesses, it is still difficult to operate the model successfully and highlights why owning the best operator is important. 

Numerous articles on the Pinnacle transaction imply that the company grew too quickly over the last two years, acquired poorly, and needed to raise liquidity.  Throughout most of 2012 and late 2011 ASCMA had actually reduced their purchases of account rather notably and beefed up their internal account generation instead.  At the time management highlighted that multiples had gone up and participants were growing in a sloppy fashion, that they didn’t want to participate as aggressively in the purchase market, but that this would correct itself at some point and they would be ready to act.  Ascent was able to purchase the higher quality half of Pinnacle’s account base at attractive multiples entirely with leverage and form an ongoing partnership that should aid internal account growth.  For what it’s worth, the 150m revolver at Libor + 4.25% & 1.25% floor used to purchase the Pinnacle accounts was completely re-loaded post the acquisition; Lending credence to the 9.125% note issuance being an instrument to preserve deal flexibility. 

Valuation:

Price: $63

Shares: 14.5m

Mcap: 913m

Debt: 1125m (At Monitronics & Pro-forma Pinnacle)

Cash: 249m (Unrestricted at holding company)

Real estate: 30m

Given significant capital is required to grow the business, ASCMA does not generate free cash flow while growing.  In order to properly value the business management suggests using steady state free cash flow, an industry metric also used by ADT. 

 Using management metrics and assuming some growth, including one other medium sized bulk account purchase, 2014 SS FCF could be 55-60m at Monitronics.  Using a 7.5% yield this would equate to $53 per share in value. 

 Secondly, one can value the cash & real estate at the holding company at face value, which would imply $17 per share of value for the cash and $2 per share for the remaining real estate, or $19 in other assets.  $53 + $19 would imply $72, or 16% upside, but management has articulated they plan to take the cash + real estate to purchase other security alarm monitoring companies with leverage. 

 If one assumes they can put 150m of the cash to work at an ROE of 15% that would create 22.5m of additional SS FCF.  Using a 7.5% yield this would create ~ $20 of additional value per share and leave ~$9 of cash + real estate at the holding company.  $53 + $9 + $20 would suggest an $82 stock price, or ~30% upside.  

 With that said, management articulates they have somewhere between 750m to 1B of deal capacity with the current capital structure and are continually evaluating acquisition opportunities.  Assuming a 10% ROIC at 750m of invested capital would imply 75m of additional SS FCF.  Applying a 20% discount rate and increasing the target yield on SS FCF to 8.5% would suggest a $95 stock price, or ~50% upside. 

From here, the company should be able to grow attractively with FCF generated by the business, price increases, and increased penetration of interactive services. 

Another way to think about ASCMA is to take the cash + real estate and back it out of the stock price to value the steady SS FCF on the remaining equity.  This would result in a ~9% yield.  However, at ~800k accounts, there remains significant optionality to use these assets accretively to grow their base and it seems appropriate to value them as such.  ADT for reference has ~6.5m subscribers.

 Note SS FCF assumptions at Monitronics are:

11.75% churn rates (i.e expected to be lower than MRQ in SS mode), 34.5x purchase multiple, a normalized tax and rate of 35%.  It is important to use RMR multiples b/c ARPU on new accounts is higher than the installed base, so cap ex per account is flawed if one leaves out the higher ARPU and simply evaluates cap ex to gross adds. 

Cable / Telco Competition:

So far their entry has proved to be more bark than bite.  There are numerous periods in history where cable has tried to enter unsuccessfully.  The barriers to installation have reduced since this time due to cellular / wireless technology but there is no indication this is having an impact on a smaller player such as Ascent.  ADT, who is much larger, has also noted minimal impact.   

Risks:

Churn has been ticking up as the housing market improves.  Cable and Telco competition could increase.  An element to ASCMA’s success is finance related due to their dealer based asset-light model.  Higher interest rates would limit their ability to make accretive deals.   

Disclosure:

We and our affiliates are long Ascent Capital (ASCMA) and may long/buy additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of ASCMA. This is not a recommendation to buy or sell shares.  Our research should not be taken for certainty.  Please conduct your own research and reach your own conclusion.

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