Dec 12 -
Summary analysis -- Protection One Inc. --------------------------- 12-Dec-2012
CREDIT RATING: B/Stable/-- Country: United States
Primary SIC: Security systems
Mult. CUSIP6: 743665
Credit Rating History:
Local currency Foreign currency
07-Mar-2012 B/-- B/--
The rating on Protection One Inc. reflects the company’s “weak” business risk profile, characterized by its second-tier position in a highly fragmented market with low barriers to entry, as well as its “highly leveraged” financial risk profile. These factors are partly offset by the company’s highly recurring and growing revenue base.
Protection One provides electronic security alarm monitoring services, mainly to residential and commercial customers, but also to independent alarm dealers. It is one of the larger second-tier alarm monitoring companies, alongside Monitronics and Vivint, but its revenue base is approximately 9x smaller than industry leader ADT. The company mainly uses the internal generation/direct sales model to create its security accounts, which allows it to have lower customer creation costs and higher free cash flow than competitors who purchase accounts from dealers. Protection One benefits from a highly recurring revenue base of approximately 88%, as well as from multiyear contracts that support revenue visibility. It also has a diversified customer base of residential, commercial, and multifamily subscribers.
The company’s revenues for the last 12 months ended Sept. 30, 2012 were $364.4 million, an increase of 6.8% over the prior-year period. Revenues for the three months ended Sept. 30, 2012 were $94.4 million, a 9.6% year-over-year increase. Revenue growth was mainly related to higher revenues resulting from an increase in national accounts. We expect mid- to high-single-digit revenue growth in 2013, mainly reflecting continuing growth in national accounts.
Protection One maintains a highly leveraged financial risk profile, with adjusted leverage in the mid-7x area in the 12 months ended Sept. 30, 2012. Since our EBITDA is adjusted by deferred costs related to customer accounts creation and costs related to purchases of new accounts, we expect spikes in leverage as the company spends more to create customer accounts.
The company’s funds from operations (FFO) to debt was around 11% as of Sept. 30, 2012, and we expect it to remain stable over the outlook horizon.
Free cash flow is positive, but it has been decreasing recently, reflecting the higher growth rate achieved through ongoing investment in new accounts.
The company’s liquidity is “adequate.” Liquidity sources include a cash balance of about $5.2 million (as of Sept. 30, 2012), access to an undrawn $25 million revolving credit facility, and modest cash flows from operations.
We expect Protection One to generate sufficient operating cash flow to fund capital expenditures, which include new account creation costs and account purchases from dealers.
Other relevant factors in our assessment of Protection One’s liquidity profile include the following:
-- We expect sources of cash to exceed uses by more than 1.2x for the near term.
-- Net sources are likely to be positive, even if EBITDA declines by 15%.
-- Mandatory debt amortization is approximately $5 million.
The current rating does not incorporate any material business acquisitions or further shareholder payments that could stress liquidity.The company had around 30% cushion under its consolidated leverage ratio covenant as of Sept. 30, 2012.
The stable rating outlook incorporates our expectations that the company’s diversified customer base and revenue visibility will support consistent operating profitability. An upgrade in the near term is unlikely given the company’s highly leveraged financial profile and our expectations that it will use its cash flows to finance growth rather than repay debt. We may lower the rating if increased attrition rates or increased customer creation costs lead to a deterioration in cash flows such that FFO to debt decreases to the 7% area on a sustained basis.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Use Of CreditWatch And Outlooks, Sept. 14, 2009
-- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008