TEXT-S&P summary: ADT Corp. (The)
Aug 28 -
Summary analysis -- ADT Corporation (The) ------------------------- 28-Aug-2012
CREDIT RATING: BBB/Stable/-- Country: United States
Primary SIC: Computer related
Mult. CUSIP6: 00101J
Credit Rating History:
Local currency Foreign currency
27-Jun-2012 BBB/-- BBB/--
The rating on The ADT Corp. reflects the company's "satisfactory" business risk profile (according to Standard & Poor's Ratings Services' criteria definitions), characterized by its leading market position and strong brand recognition. ADT's presence in the highly competitive U.S. security alarm monitoring industry with its high customer attrition rates somewhat offset these business strengths. The rating also reflects ADT's "intermediate" financial risk profile.
ADTCorp. is going to be spun off from Tyco International in September 2012. In connection with the spin-off, ADT issued $2.5 billion in senior unsecured notes to fund a payment to Tyco. Following the spin-off, we expect ADT to maintain consistent operating profitability. We also expect revenue increases in the low- to mid-single digits over the next one to two years due to growth in the subscriber base, price escalation, and sales of new premium-priced services.
ADT's EBITDA margins have benefited from the company's efforts to lower costs and the higher monthly revenues that new contracts are generating. We expect continuing improvement in EBITDA margins as the company sells more home automation systems.
We view the financial risk profile as intermediate. We expect the company to generate sufficient levels of operating cash flow to support projected growth through new customer account additions, as well as planned shareholder payouts, without the need for additional debt financing.
With Standard & Poor's adjustments, pro forma debt (including leases and pensions) to our 2012 EBITDA estimate is approximately 2.9x, on the high end of our expectation for the rating. Our adjusted EBITDA reflects the ongoing purchase of customer accounts necessary to offset attrition and is reduced by deferred costs related to customer account creation. Over time, however, we expect adjusted debt to adjusted EBITDA to average about 2.5x.
We view ADT's liquidity as "adequate." We expect ADT to generate sufficient operating cash flow in the near term to fund capital expenditures of about $1 billion annually, which includes dealer-generated customer accounts and subscriber system assets. We also expect near-term operating cash flow to cover the company's planned dividend payments, based on a target dividend payout ratio (dividends as a percentage of net income) of approximately 30%.
We expect liquidity to comprise approximately $300 million of cash on hand on the close of the transaction, reliable free cash flow generation, and availability under the $750 million revolving credit facility.
Other relevant aspects of ADT's liquidity, in our view, include the following:
-- We expect sources of cash to exceed uses by more than 2x for the near term.
-- Net sources are likely to be positive, even if EBITDA declines by 20%.
-- The current rating does not incorporate any material business acquisitions.
-- We believe ADT could absorb low-probability, high-impact shocks.
The stable outlook reflects ADT's clear market leadership position and our expectation that its recurring revenue model will result in solid free cash flow generation. We could lower the rating if the ratio of adjusted debt to adjusted EBITDA is likely to remain in the mid-3x area on a sustained basis because of weaker operations or incremental debt to support shareholder returns, acquisitions or accelerated growth plans.
A higher rating is unlikely for the foreseeable future based on current leverage and our expectation that ongoing investment in new accounts to offset attrition and provide growth will slow de-leveraging over this period. We likely wouldn't consider a higher rating until the company reduces its debt to EBITDA ratio to 1.5x-2x on a sustained basis.
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