First Step

ADT's IPO Is No Quick Exit for Apollo

It may come as a surprise, but buyout firms are hanging on to investments longer.
Photographer: Michael Nagle/Bloomberg
APOLLO GLOBAL MANAGEMENT - A
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As of 12:44 PM EDT
31.64 USD
ADT INC
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As of 12:59 PM EDT
8.80 USD

Would you look at that? ADT Inc. is back on the New York Stock Exchange less than 19 months after it was taken private by Apollo Global Management LLC. But to describe the deal as a swift private equity exit would be a misconception. 

Apollo was able to pull off the $12.3 billion buyout because it essentially acted as a strategic buyer, an increasingly common industry practice. The transaction hinged on combining ADT with two smaller rival companies, Protection 1 and Alarm Security Group LLC that Apollo had purchased in July 2015. For those keeping count, that's when the holding-period clock started on the investment. 

In Thursday's initial public offering, Apollo didn't sell any shares, so it isn't considered an exit. That happens when a firm completely sells down its stake, according to Hamilton Lane, which advises private equity investors. (On Friday, the stock opened more than 10 percent lower after pricing below an initially targeted range.) 

Theoretically, Apollo could sell all or part of its 84.9 percent stake when the lockup expires 180 days from now -- July 18 -- which would take its exit timeline beyond three years. That's in line with the majority of private equity exits lately. In fact, exit timelines have lengthened on the whole since the early 2000s, when eight in 10 transactions were "quick flips", or sales in less than three years. 

Pump the Brakes

Even though sky-high valuations are making it a seller's market, private equity firms have been holding on to companies for longer

Source: Hamilton Lane 2017 Market Overview

*Hamilton Lane only records an exit when a firm has fully exited its position

Private equity investors have become accustomed to holding on to investments way past their lockup so as to ensure they benefit from any improvements they've made to a company. In the case of ADT, Apollo's changes involved some $250 million of cost-cutting, replacing its management team and improving overall customer experience so as to improve retention, which have led to improved earnings before interest, taxes, depreciation and amortization margins. The prospect of stronger profits as ADT's evolution continues will likely be enough to keep Apollo in the stock for a while. 

Stickier Business

Under Apollo's ownership, ADT has reduced customer churn, which saves the company from having to fork out generous upfront promotions to lure new customers

Source: Prospectus

*Deal closed in May 2016 **The company estimates that every one percentage point improvement in attrition frees up more than $100 million in free cash flow needed to replace lost customers.

The increasing patience of private equity firms -- many of which are setting up longer-term funds -- has the potential to be a boon for their investor base, largely made up of pension funds and sovereign wealth funds. By waiting longer to sell and allowing more time for a company's earnings to improve, private equity firms can shoot for a higher multiple on invested capital, or MOIC. Depending on how long they wait, it could also lead to a higher internal rate of return, which is another closely-watched metric. Plus, if things go to plan, executives -- who share in a percentage of the deal's profits through so-called carried interest -- get even richer. 

No Hurry

Private equity firms haven't rushed to completely cash out of companies that they've take public

Source: Bloomberg

*Total return since IPO date, includes dividends reinvested where appropriate

Of course, sometimes firms are forced to hold on to companies far longer than expected if situations get hairy (Toys R Us and iHeartMedia both spring to mind). The same applies to publicly traded investments: If companies aren't performing, it's logical for private equity backers to hold out until things turn around.

Hanging On

Private equity investors are more likely to take their time exiting if a stock has performed poorly

Source: Bloomberg

*Total return since IPO date, includes dividends reinvested where appropriate

As for ADT's IPO, the stock's miserable opening day may peeve Apollo. But even at the security company's lower valuation, Apollo is still poised to at least double its money. And other private equity firms observing from the sidelines needn't be spooked. After all, an IPO is simply the first step down the path. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Gillian Tan in New York at gtan129@bloomberg.net

    To contact the editor responsible for this story:
    Beth Williams at bewilliams@bloomberg.net

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