Home and commercial security company ADT (NYSE: ADT) is on our radar this week, as we cover additional factors behind the company's surprise loss (on an adjusted basis) in its first earnings report since its January IPO.
In this segment from Industry Focus, Vincent Shen and senior Motley Fool contributor Asit Sharma dive into ADT's assertion that the lines between its competitors and collaborators are blurring.
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A transcript follows the video.
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This video was recorded on April 3, 2018.
Vincent Shen: It's surprising to me, because I think it probably has to do with those high upfront installation costs the company has to bear. Usually, more so on the tech side, but sometimes in our consumer retail space, too, we look at these companies where they're able to generate this subscription, monthly recurring revenue that you can compare to a Netflix, for example, and some of the positives of that.
As you scale, you see a lot of benefits in terms of your profitability and things along those lines. I think that exists here, but there's the upfront costs that the company has to bear and also the attrition rate that they're trying to manage, and we know that as that improves, they see a direct positive in terms of how that bolsters their cash flow. But that's definitely something that investors have to monitor with this company as things go forward, also in terms of the debt reduction and the high balance that we often see with these kind of leveraged buyout deals when the companies go back onto the market.
We have a couple of minutes left here, and I do want to spend some time looking at the outlook for the company and also for some of its services and how that will change with some of the new technology, the do-it-yourself offerings that customers are adopting as well. For ADT, I think the biggest question, at least for the residential side of its business, is whether or not the company will be able to really compete as these do-it-yourself alternatives become more and more popular. You also have all these new smart home devices that can offer similar monitoring and protection services that could arguably make what ADT offers redundant. I'm curious what you think about the prospects for this company going forward in that regard.
Asit Sharma: Right. Interestingly enough, Ring is such a great example of a small do-it-yourself company, which Amazon just acquired. That was one of the announcements in the last few weeks that pushed ADT's stock down. I would look at it as a real competitive threat. But interestingly enough, ADT's executive team actually likes this whole progression because they have a lock on the traditional home security market. And what they see is, smaller companies or companies that may team up with an Amazon will develop younger millennials who are interested in the do-it-yourself technology. And on the company's earnings conference call last month, the CEO, Tim Whall, described how these are often renters. ADT sees this as a progression, where you do your own security yourself in your small apartment, but when you're ready to move into a home, you need a better system. And they see themselves as a company that can merge up and partner up with companies that grab these millennials. And it's a long-term benefit in ADT's eyes.
Now, I don't know if that's actually how this will all pan out. It's a really fast-growing market. Vince, you mentioned this digitally connected market, which is yet another subset of the home security industry, that is the so-called smart home powered by the Internet of Things. That subset is growing at a compounded annual growth rate of 17% a year, so it's doubling nearly every five years. And ADT is just a little bit late to the game. As you mentioned, it made some small acquisitions to play in this space. It's open yet to see whether they will eventually benefit by scooping up companies and/or partnering with them as customers buy these new technologies, or if they'll lose out, and with that high fixed cost space, if they are destined to a low single-digit growth rate and a high debt burden, which is still going to take some years to pay off.
Shen: Absolutely. As promising as it is, I think, to see ADT embracing some of these collaborations, some of these partnerships with both the big tech companies like Google and Amazon, I kind of question whether that competitive dynamic will prove to be a long-term tailwind in terms of attracting those younger consumers. I definitely think it's a possibility, and again, we'll have to see how things bear out. But the effort that's required for a renter, for example, to self-monitor a do-it-yourself system, the various motion detectors and sensors that you can install now in your own apartment or your home, they will send a pop-up notification through to your phone when something's detected, compared to the ADT system where they have the 24/7 monitoring, they have those 12 dedicated monitoring centers in North America. But that doesn't make up for the added cost of what is essentially a middleman here between the resident knowing that something might be wrong, in terms of a smoke detector going off or an intruder on their property, and then contacting emergency services.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Asit Sharma has no position in any of the stocks mentioned. Vincent Shen owns shares of Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Netflix. The Motley Fool has a disclosure policy.