CHICAGO--()--Fitch Ratings has assigned a 'BBB' rating to the ADT Corporation's (NYSE: ADT) proposed offering of senior unsecured notes. The new issue will be equal in right of payment with all other senior unsecured debt. Proceeds from the notes issuance will be used primarily for share repurchases. In November 2012, the company's board approved a $2 billion share repurchase program over a three-year period that will be funded by debt and free cash flow (FCF).
The Rating Outlook is Stable. A complete list of ratings follows at the end of this release.
ADT's ratings and Outlook reflect the company's strong brand recognition, its national footprint and leading market position, recurring revenue base, sustainable FCF generation and solid liquidity. Concerns include emerging competition from non-traditional security service providers, risk associated with operating as an independent public company, and contingent liabilities, particularly tax liabilities, related to its spin-off from Tyco International, Ltd. (Tyco).
The ratings also reflect management's willingness to undertake a more aggressive financial strategy soon after becoming an independent company. The recently announced $2 billion share repurchase program that will be funded by debt and FCF creates some uncertainty regarding management's financial policies beyond the near term. Fitch will continually evaluate how management balances demands from its shareholders while maintaining its commitment to an investment grade profile.
ADT expects to incur $650 million to $900 million of incremental debt in 2013 and return approximately $900 million to $1 billion to shareholders in the form of share repurchases and dividends this year. Based on the projected share repurchases and debt levels, Fitch projects ADT's leverage will increase from 1.6x during fiscal 2012 (ending Sept. 28, 2012) to about 2x for fiscals 2013 and 2014. Interest coverage is projected to range from 13x - 14.5x over the next two years.
The ratings incorporate ADT's strong competitive position as the largest residential security provider in the U.S. ADT currently has over six million customers and a roughly 25% market share based on company estimates.
ADT's subscriber-based business requires significant upfront costs to generate new customers. Capital expenditures, including dealer-generated accounts and bulk purchases and subscriber systems, totaled $1.09 billion and $902 million in 2012 and 2011, respectively. Capital expenditures for 2012 represent approximately 33% of annual revenues. Fitch expects capital expenditures to approximate 35% - 40% of annual revenues in the next few years. Fitch estimates that new customers yield an average cash payback of three years.
ADT has shown the ability to generate sustainable FCF in spite of the large capital expenditures that it incurs. ADT's subscriber-based business and recurring revenue stream contribute to steady income and cash flow. Revenues have been relatively stable as approximately 90% of its annual sales are recurring in nature. ADT had $406 million and $537 million of FCF during 2012 and 2011, respectively. Fitch expects ADT will generate annual FCF (FCF: Cash flow from operations less capital expenditures and dividends) of approximately $275 million - $350 million during the next few years.
Fitch expects ADT will maintain liquidity of about $1 billion, consisting of cash and availability under a $750 million revolving credit facility. ADT does not have any debt maturities until 2017, when $750 million of senior notes become due.
Fitch believes that ADT's competitive position will remain strong in the near-to-intermediate term. However, ADT faces competition from non-traditional security service providers. Several cable and telecom companies have introduced interactive security services that compete with ADT. These competitors have a larger customer base from which to sell additional product offerings and/or bundle services at perhaps more competitive prices.
As part of the separation, ADT has entered into separation and distribution and other agreements with Tyco and Pentair Ltd. (formerly Flow Control). ADT also entered into a Tax Sharing Agreement with Tyco and Pentair. This agreement will govern the rights, responsibilities and obligations of the three post-separation companies regarding certain tax matters. The Tax Sharing Agreement outlines each company's share of certain tax liabilities. Tyco will be responsible for the first $500 million of shared tax liabilities. ADT and Pentair will share 58% and 42%, respectively, of the next $225 million of shared tax liabilities. Finally, ADT, Tyco and Pentair will share 27.5%, 52.5% and 20%, respectively, of shared tax liabilities above $725 million.
Future ratings and Outlooks will be influenced by broad economic trends, as well as company-specific activity, particularly FCF trends and uses, debt levels and liquidity position. Positive rating actions are unlikely in the near-to-intermediate term, as Fitch evaluates ADT's performance and management's financial strategy as a stand-alone company. On the other hand, Fitch may consider taking a negative rating action if there is meaningful deterioration in ADT's financial results or management undertakes a more aggressive financial policy, leading to diminished liquidity and higher debt levels. In particular, negative rating actions could occur if ADT's leverage is consistently above 2.5x.
Fitch currently rates ADT as follows with a Stable Outlook:
--Issuer Default Rating 'BBB';
--Revolving bank credit facility 'BBB';
--Senior unsecured debt 'BBB';
--Short-term IDR 'F2';
--Commercial Paper 'F2'.
Additional information is available at www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012)
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 8, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporates