When Dennis Kozlowski became CEO of Tyco (TYC) in the early 1990s, he ignited a relentless M&A strategy, acquiring more than 1,000 companies. Wall Street loved it, and the stock price soared, making it easier and easier to do deals. But the house of cards fell apart in 2002 when Tyco got embroiled in an accounting scandal.Since then, Tyco has been fairly restrained in its deal-making. But this week, the company has returned to the M&A game, agreeing to pay nearly $2 billion for Broadview Security (CFL), which is a monitored home security business. Tyco plans to fold Broadview (formerly Brinks Home Security) into its ADT business unit.
No doubt Tyco has wanted to bolster ADT because of the attractive recurring revenues and hefty margins in the security business. And Broadview is a smart choice. Founded in 1983, the company has grown its business to 1.3 million subscribers in North America (across 250 markets) and generates a nice monthly recurring revenue stream of $43 million. Margins run 65% to 70%, which compares to the industry average of 50% to 55%.
Broadview also has a strong retention rate. Over the past decade, its disconnect rate has ranged from 6.5% to 7.5%. This is critically important since the cost of customer acquisition is about $1,200 (according to a recent investor presentation).
While the disconnect rate has ticked up over the past year because of the recession, it is still impressive. Then again, Broadview invests heavily in customer service, has a user-friendly installation process, and takes a metrics-driven approach to running its business.
The Biggest Player Gets Bigger
As for the deal, there are clear cost synergies. Tyco expects the transaction to boost earnings by $0.07 per share in the full-year after the closing (excluding transaction and integration costs). The forecast for the following year is $0.14 per share.
Interestingly enough, Tyco also announced that its fourth-quarter earnings will come in at $0.63 to $0.65 per share (after excluding one-time items) and the annual earnings at $2.30 to $2.50. The street consensus was for $0.51 and $2.47, according to Bloomberg.
Might there be antitrust problems with this deal? Industry leader ADT has a 29% market share, and while Broadview's stands at just 4%, that's still enough to make it the No. 2 company in the business. As with any acquisition among such significant firms, the Feds will strongly scrutinize the deal. But the fact remains that the residential security market is still fragmented. According to various research reports, about 40% of the market is controlled by the top five companies -- but the top 100 companies only control 60% (this is also in a Broadview presentation). So based on pure market-based analysis, it would probably be tough for the government to justify blocking the deal.
Why do investors make the decisions that they do?View Course »