What the ADT IPO Teaches Us About Making a Killing in the Markets

The ADT Inc. (NYSE: ADT) initial public offering (IPO) priced on Jan. 18, and the reception was lukewarm at best.

The ADT IPO offering was priced at $14 a share - below the expected range of $17 to $19. This values the equity of the company at about $10.6 billion. That's a nice premium from the slightly less than $7 billion that private equity giant Apollo Global and its partners paid for the company in what became the biggest leveraged buyout (LBO) of 2016.


However, when we dig deeper, Apollo's two-year return is a lot higher than it first appears.

And it's Apollo's larger-than-expected return that reinforces my stance that ADT shares are not worth my time...

There's More to ADT's LBO Than Meets the Eye

Just to quickly review, an LBO is when a company acquires another company using a high amount of debt or borrowed money. Using debt lets companies go on buying sprees without having to spend a lot of their own cash.

When Apollo snagged ADT two years ago, it only put up $4.5 billion for its stake in North America's leading home security company. The rest was borrowed or financed by a preferred stock placement.

Meanwhile, Apollo execs also paid themselves a special dividend of $750 million last year, bringing their net investment to just $3.75 billion.

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So in less than two years, Apollo has almost tripled the value of its investment in this deal!

Why did it make so much money so fast? To channel my inner Meghan Trainor, "it's all about that price."

Leon Black, the CEO of Apollo, talked about the ADT deal on his earnings call a few weeks after the deal closed in 2016. He told analysts, "it's something where we trade complexity and aggregation for a rate of return for purchase price."

He added later in the call, "I don't want to simplify, but when you're buying at six and the market is trading at 11, you make a decent amount of money on the buy, you just do. And then, when the companies perform, it starts to impact the valuation."

Buy low, sell high. It's something that everyone slavishly repeats when talking about buying stocks, but very few actually do it. But clearly it is the chief driver of return for private equity investors like Apollo.

On his most recent conference call, Mr. Black pointed out that their Fund VII, raised in 2008, was averaging an internal rate of return of 19% annually. He attributed that return to the purchase price of the companies in the fund, saying "the average creation multiple of Fund VII portfolio companies is nearly five multiple points below industry averages of approximately 10.5% enterprise value to EBITDA... there is a meaningful upside potential as these portfolio companies execute their business plan and are increasingly valued more in line with relevant market metrics."

I'd rather replicate that strategy instead of chasing lukewarm shares of a security giant...

Why I Won't Be Jumping into ADT Right Now

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I was asked several times about ADT's market debut - if I would buy shares in aftermarket hours.

Now, ADT is a fantastic business, and I do not think that people will be any less concerned about home security in the years ahead than they are today. They will most likely be even more concerned, which bodes well for the home security business.

However, I am every bit as price-sensitive as Leon Black is when investing my money. Taking out my pencil and working over the prospectus, the answer is that I would indeed buy the stock if I could do so with an enterprise multiple of less than seven. That works out to a stock price of around $9 a share, so I am not a buyer of ADT anytime soon.

My time is better spent doing precisely what Mr. Black and his team do every day. I spend my time looking for companies that I can buy at very low enterprise multiples that can be sold for much higher multiples a few years into the future.

The combination of a good business, low price, and time is very powerful and allows me to focus on opportunities to measure my return in multiples and not just percentages. Finding such bargains is not as easy today as it was a few years ago, but there are still some opportunities that appear to have enormous potential for enormous returns.

In fact, my screens this morning turned up several companies with this kind of potential...

A leading manufacturer of MRI machines that has come out with some breakthrough innovations on this core medical technology...

A company that has mobile cybersecurity solutions and boasts a portfolio of valuable, cybersecurity-related patents...

A building materials companies that will see strong sales and profits growth as homebuilding continues to improve...

A company involved in building and repairing the electrical grid in the United States...

A leading environmental consulting firm with operations around the world...

A company that makes implantable lenses to treat a host of eye conditions...

And a company that is a leader in drug testing products that will see huge improvements as we battle the growing opioid crisis.

The real key to making money in the stock market is not buying what someone as smart as the folks at Apollo are selling. It is not trying to guess day-to-day movement of the market averages.

The best investors over my lifetime are folks like Warren Buffett, Seth Klarman, and Carl Icahn, and they all do exactly what Apollo Management, KKR, and Blackstone do when they select investments for their private equity funds.

They simply buy earnings and assets at very low prices and hold them until market conditions allow them to sell at much more generous valuations.

Buy low, sell high, ignore the noise. Easy to say, harder to do, but it is the secret to long-term investing success.

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About the Author

Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of Peak Yield Investor.

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