By Nick Carey - Analysis
CHICAGO (Reuters) - It would be hard for many to imagine hedge funds buying stock in a U.S. company with the word “home” in its name in the worst housing downturn since the Great Depression — let alone speak admiringly of its solid cash flow and growth prospects.
But to a number of hedge funds, Brink’s Home Security Holdings Inc CFL.N is just such a company, benefiting from long-term solid cash flow and more security-conscious consumers who fear rising crime as the nation’s economic slump drags on.
“With its very predictable cash flow, this stock is the Rock of Gibraltar,” said a principal at a hedge fund that has owned Brink’s shares for years. He said he could not be quoted on the record, in part because the fund was considering raising its stake in the home-security system provider.
“Hedge funds are a suspicious bunch,” he said. “We don’t want to be out there talking about this stock while we’re thinking of buying more of it.”
He calculates that BHS, which is trading at around $21, is 75 percent undervalued.
Irving, Texas-based Brink’s Home Security is a spinoff from Richmond, Virginia-based security company Brink’s Co (BCO.N).
BHS provides home-security monitoring services, with 1.3 million subscribers across all 50 U.S. states and two Canadian provinces.
In what might come as a surprise to many, this relatively small company — with 2008 revenue of $532.3 million — was among the top 10 new positions taken by large hedge funds in the fourth quarter, according to Thomson Reuters Ownership data.
But it turns out that a couple of those hedge funds were also long-term shareholders before the spin-off and say they have no intention of unloading their shares. Hedge fund managers say BHS is often confused with being a housing stock and argue that it is a relatively recession-resistant, cash-flow rich bet.
“This company is not at all what people think it is,” said Jerome Lande, executive vice president of New York-based hedge fund Millbrook Capital Management Inc, which owns stock in the company. “This is a very strong, consistent vehicle for generating recurring revenue and cash flow.”
Millbrook has been a shareholder of Brink’s Co for years and received shares in BHS when the former unit was spun off last October.
Analysts and investors say the reason “smart money” has bought BHS’s stock is its long-term steady cash flow, customer retention and the fact it is debt free.
They say BHS is undervalued because its business model is misunderstood, as are its growth prospects in a recession when Anecdotal evidence suggests more people worry about security.
Timing also played a role.
“(BHS) went public under horrendous market conditions last October” when the markets nearly collapsed, said James Clement, an analyst at Sidoti & Co. “Can you think of a worse month?”
Clement added that the key to understanding BHS’s business model comes down to accounting.
When a new customer signs up for a BHS home-security system, the upfront cost to the company to install all the equipment — sensors, alarms and such — is anywhere up to $1,600, $300 of which is covered in an initial payment by the customer. Customers then pay around $35 per month for the service, which means that in less than four years, the full cost is repaid and customers become profitable for the company.
BHS has a loyal, carefully screened customer base. The company had an attrition rate of 7.5 percent last year — a low figure in the home-security industry, which means customers on average stay with them for up to 14 years — translating to almost guaranteed long-term revenue.
Sidoti’s Clement said many investors appear to focus on accounting standards that list the upfront cost to BHS, but fail to take into account its cash flow.
“A lot of people don’t understand the accounting or the value of the business,” he said.
Investors like Millbrook’s Lande said BHS’s recurring revenue model is so strong it could cut spending to invest merely in offsetting attrition — and still be a cash cow.
“Even if you took that draconian approach, it (BHS) is significantly undervalued,” Lande said.
BHS CEO Bob Allen said the company is continuing to spend on new business and expects its customer base to grow in 2009.
The company has little debt and its only major expense on the horizon is between $100 million and $150 million it has to spend on developing a new brand name to replace Brink’s.
Hedge fund managers say one significant issue for BHS is the tendency of investors to view it as closely linked to the blighted and beleaguered U.S. housing sector.
“Nothing could be further from the truth,” said a manager at a third hedge fund that owns BHS stock, who wished to remain unnamed because he is not permitted to talk about holdings withthe media.
Sidoti’s Clement said anecdotal evidence — unfortunately not backed up by hard data — suggests companies like BHS do well in recessions because homeowners fear rising crime and are more willing to pay $35 per month for a security system.
BHS’s Allen said this seemed to be true in this downturn.
“People do seem to be more attuned to security issues,” he said. “We found the market has been more responsive recently to our marketing efforts.”
Editing by Maureen Bavdek