Description

Summary Thesis

Investors have historically hated the home monitoring market. ADT has been a popular short. Skeptics point to the lack of moat, fierce competition, high customer acquisition costs, and leverage as the death knell for these standalone providers. Vivint Smart Home (VVNT) has and continues to face many of the same critiques. However, I believe that VVNT is on the cusp of a fundamental change in both thematic and financial orientation that could make it the rare breed of both value and cleantech darling stock. I believe such an outcome would support the stock at least doubling and potentially becoming a multi-bagger.

The nature of smart home monitoring is changing rapidly. More connected devices, combined with more home power production (e.g. solar, battery storage) is necessitating more “brainpower” in the home to synchronize and optimize appliance usage. With nearly two million subscribers, >10% organic growth, and a new CEO back from Vivint Solar (acquired by SunRun – RUN), I see scope for lower attrition and subsequently material value optimization of both existing and new subscribers as home monitoring begins to pivot to smart home / energy management. 

Vivint’s accounting is complicated and has proven an obstacle for both buy and sell-side analysts vis-à-vis valuation. Nevertheless, following a recent comprehensive debt refinancing ($50 mm annual interest savings), I look at the company’s free cash flow prospects and are astonished at how cheap VVNT is on even conservative FCF metrics. The stock is trading ~10x Consensus 2022 P/FCF. I believe VVNT ultimately compares to residential solar providers (NOVA and RUN) for whom customer NPV from home energy services is the defining valuation metric. Neither NOVA nor RUN generate any FCF (in fact, both burn ~$1 bn annually). Before factoring in prospective “cleantech” valuation premium, 20x 2022 Consensus FCF supports a $22 price target, similar to a 20-yr DCF at a 7% WACC with no terminal value. If I start using cleantech valuation metrics (e.g. ~30x 2023 P/FCF on average for cleantech companies with positive FCF), VVNT would be a >$45 stock.

Vivint is something of an orphan stock today. Sponsor overhang, stock liquidity, leverage, competition, subscriber attrition are all concerns. But the company’s recent attractive refinancing, bringing an experienced solar executive to lead Vivint forward into “cleantech,” and a change in the nature of home monitoring sets up a highly favorable risk/reward with the stock trading at a deep discount to no-growth peers like ADT and a laughable discount to “cleantech” peers.

Business Description

Vivint is a vertically-integrated smart home platform, providing hardware, software, installation, and ongoing support to its nearly two million subscribers. Founded in 1999 as APX Alarm Security Solutions, the Company rebranded as Vivint in 2011, launched Vivint Solar (later IPOed and acquired by RUN separately), and was subsequently acquired by Blackstone in 2012 (for $2 bn). Post initial Blackstone acquisition, Vivint developed cloud-based home automation solutions (2014) and began partnering with larger tech firms (e.g. Amazon and Google) to integrate the Vivint smart home suite with partner hardware (2016+). Vivint came public through a special purpose acquisition company (SPAC) in 1Q20 before SPACs were en vogue. Following the retirement of founder Todd Peterson in 2Q21, former COO David Bywater (previously CEO of Vivint Solar) has returned to take the helm.

Investment Highlights

Cleantech Transformation Imminent

As a cleantech/ESG investor, I see extraordinary efforts to greenwash company profiles. Most are not truly clean… not even close. Vivint occupies a unique niche in a rapidly evolving cleantech landscape. Home monitoring is not just cameras and sensors anymore. It is lights, thermostats, diverse appliances, all working together. And the proliferation of connected devices creates room for new adjacencies every day. And in the middle is a hub. We see something of a space race in cleantech to capture this hub. Enphase Energy (ENPH), Sunnova (NOVA), Sunrun (RUN), Generac (GNRC), among others, are all working to this end. But they are coming from outside-in. Vivint is already inside nearly two million households. Wrapping energy services on top of a growing list of other capabilities is a logical/obvious adjacency that 1) can add significant value to subscribers and 2) creates the potential to materially improve the resource efficiency of the home. In our view, that is the most impactful sphere of cleantech: energy efficiency.

This transformation (or I should say evolution) of Vivint is clearly underway. Having been on the periphery of cleantech for ~20 years, the path is now clear. I see two recent events that catalyze this view: 1) the return of David Bywater as CEO and 2) recently announced partnership with Freedom Forever. On the former, Mr. Bywater led Vivint Solar (VSLR) since it went public in 2016, leading the company through a challenging period for solar equities before seeing through an acquisition by Sunrun (RUN). Over his tenure, VSLR equity appreciated >1000%. I have met with Mr. Bywater on numerous occasions and believe he sees the critical nature of home energy management. Returning to VVNT as CEO, I believe he sees it as the right platform to capture this nascent area of focus (smart home energy management) for the smartest players in cleantech. I look forward to seeing him lay out this vision for the Company in the quarters ahead.

I see the recently announced partnership with Freedom Forever as “writing on the wall” of where Vivint is going. By wrapping Vivint smart home systems with solar installations from a significant mid-market solar developer, I see 1) a new growth outlet and 2) scope for significant adjacencies to VVNT smart home offerings. The margin and FCF implications are as yet undefined but based on our conversations with the Company, I would anticipate extremely healthy incremental margins on adjacencies (leaving aside prospective multiple expansion from a transformation of the story. I see more of these mid-market partnerships potentially forthcoming as larger developers are less likely to share economics with VVNT. By scaling through the mid-market, Mr. Bywater and team can scale and start to capture growing share of NPV for a growing pie of hugely recurring and cash flow generative subscribers. I expect to see the impact of this start to accelerate in 2022+. But again, the path from staid home monitoring to smart home/energy management cash juggernaut seems plain to see.

Powerful Organic Growth with Many Value/Cash Optimization Levers

An estimated >25 million households out of 160 mm in the US and Canada utilize professional home monitoring services. The market is massively underpenetrated and as connected devices gain share in every household, VVNT has a long runway for growth before even factoring in any of the cleantech aspects. VVNT has grown subscribers at ~10% or above every year since 2013 (with the exception of 2020). The Company has again guided to double-digit subscriber growth in 2021. Prevailing secular themes of “home as the sanctuary” and “work from home” provide an ongoing tailwind for interest in the product. Based on our conversations with the Company, I believe that bigger barriers to growth could be the availability of hardware. Although would note that management appeared confident that they had sufficiently pre-ordered equipment from suppliers to meet expectations for 2021.

Beyond the secular drivers of organic growth, I see adjacencies to drive both growth and margin beyond the cleantech sphere (and ahead of Consensus). Specifically, value-added features such as HVAC monitoring, insurance, water sensors, among others are not reflected in consensus expectations. So if our baseline is ~10% organic growth but the Company picks up a couple points from the aforementioned adjacencies (and potentially more from energy management offerings), I see potential for ~60% incremental margins in this new growth phase. I believe the associated FCF generation with this growth is fairly differentiated versus both other home monitoring peers as well as cleantech companies.

Cleaning up the Balance Sheet - Refinancing

With FCF weighed down by expensive debt with nearing maturities, Vivent finally addressed its balance sheet in a comprehensive refinancing in July 2021. I viewed this as a material positive as the Company termed out new senior notes and a first lien senior secured TL, replacing 2022 and 2023 maturities with 2028 and 2029 paper. This action also cut annual interest expense by ~$50 mm. As the Company is loss-making from a GAAP EBIT perspective and has no material tax payments, that $50 mm of savings flows directly to FCF. Following the refinancing, the Company should be well under 3x 2022 net debt to EBITDA.

A Word on Accounting and FCF

A fair amount of pushback around our long VVNT thesis (beyond home monitoring is a bad business) stems from convoluted accounting. Capitalizing contract and customer acquisition costs as well as change in revenue recognition to ASC 606 are barriers to entry for some. I do not entirely disagree. I also do not love big stock-based compensation. But ultimately, I look to cash. I look at VVNT compared to a cleantech peer group and the accounting and SBC is no less egregious. But because of the large recurring nature of the subscriber business, the FCF profile for VVNT is much, much more compelling. In the coming quarters, I will see how durable and sustainable the FCF generation is for VVNT. I am willing to look past the accounting noise so long as there is FCF to reinvest in the business and ultimately return to shareholders.

Cheapest Cleantech Growth Story on the Board

I see a lot of mental gymnastics to justify valuations for cleantech equities. The basis of value creation for these equities is predominately the underlying economic rent extracted by how households consume energy. If VVNT is providing a critical service that ultimately wraps around those areas of value creation, why shouldn’t it be considered in the same league as “cleantech” equities? Furthermore, very few cleantech stories have any FCF to speak of. And if they do, the stocks are astronomically expensive on FCF metrics (~30x 2023 P/FCF on average of the comp group I am using). If I postulate that VVNT is capturing similar value (or even greater given it’s margin structure) to what cleantech peers are from home energy consumption, I would argue that VVNT should trade closer to cleantech peers on FCF. But VVNT is trading at 11x our base case 2023 P/FCF and thus, in our view is the cheapest “cleantech” name on the board. 

Valuation

I hate DCFs but love FCF. Looking beyond accounting complexity (e.g. capitalized contract costs), FCF metrics should drive valuation for VVNT. The key drivers of our model are organic growth assumptions (>10%), margin expansion from high value services (e.g. water sensors, insurance, HVAC), and working capital needs. I see a range of 2023 FCF generation of ~$250 mm to $350 mm. And over a five-year period, see 20% FCF CAGR. On the low end, applying 20x P/FCF to $250 mm FCF gives us a base case of $22/sh. On the high end, if VVNT gets a cleantech re-rating and 30x the high end of our FCF range, I see ~$45/sh upside case. Our risk case of $9.50-10/sh assumes 1) VVNT does not deliver on growth initiatives, 2) faces higher attrition, leading to a 5-10% miss on EBITDA vs. consensus in 2022, and 3) trades at a discount to ADT’s EV/EBITDA multiple (7x). 

Catalysts

I see multiple paths to unlocking value for VVNT:

1. Partnerships with energy service providers demonstrating the smart home energy management (i.e. “cleantech”) aspect of VVNT’s story (e.g. partnership with Freedom Forever on integrated smart energy offering in 3Q21)

2. Exceeding expectations on earnings reports through 1) organic growth, 2) margins, 3) FCF, and 4) lower attrition

3. New service offerings to enhance customer NPV (e.g. insurance, HVAC, water, energy monitoring)

4. New sell-side coverage / ratings upgrades

Risks to Thesis

The primary risk to VVNT long position is sponsor overhang. Blackstone still owns 55% of the company. And Fortress owns 12% of the company. Both will undoubtedly sell down over time. But I see that as less of a risk at current prices. While I expect secondaries to temporarily weigh on the stock when then happen, sponsor sell-downs should ultimately improve stock liquidity, which is another barrier to more institutional ownership in VVNT. 

Another risk to the VVNT thesis is attrition. VVNT and the home monitoring business overall is no stranger to aggressive sales practices. VVNT needs to develop a sufficiently diverse and sophisticated offering to create a real moat in an industry where historically there has been little competitive advantage. Part of our long thesis is the expectation that VVNT can overcome this risk.

Legal wrangling between VVNT and ADT create noise and headline risk. ADT has sued VVNT for patent infringement and requested that the International Trade Commission (ITC) block imports of VVNT security monitoring and automation control panels. This comes after VVNT had sued ADT for patent infringement previously. While worth monitoring, I think most of these lawsuits have limited/no merit but create sporadic headline risk.

A final nearer-term risk is availability of critical hardware. VVNT relies on third-parties to provide the hardware, which it then installs for subscribers. VVNT largely orders its equipment well ahead of spring/summer selling season and have expressed confidence that they are in good shape for 2021. However, equipment availability may cap subscriber upside in the near-term as global electronic equipment supply chains remain constrained. I would note that this may also create some lumpier FCF depending on working capital flows.

Catalyst

1. Partnerships with energy service providers demonstrating the smart home energy management (i.e. “cleantech”) aspect of VVNT’s story (e.g. partnership with Freedom Forever on integrated smart energy offering in 3Q21)

2. Exceeding expectations on earnings reports through 1) organic growth, 2) margins, 3) FCF, and 4) lower attrition

3. New service offerings to enhance customer NPV (e.g. insurance, HVAC, water, energy monitoring)

4. New sell-side coverage / ratings upgrades