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Bear of the Day: ADT inc (ADT)

David Borun

Most great business have built some kind of moat around themselves. As an economic concept, it’s known as “barriers to entry” – meaning that competitors can’t easily enter the market.

Sometimes those barriers are natural. The most obvious example is the utility business - where the initial investment in infrastructure is generally so insurmountable that state and local governments generally regulate pricing behavior to ensure that citizens have access to gas and electricity at reasonable rates.

More often, the barriers are created by the business themselves. Pharmaceutical companies spend a great deal of time and money applying for and litigating the infringement of patent protection on their intellectual property. They’ve developed unique compounds and/or processes which the government then grants them the exclusive right to sell in the market, and they use that exclusive right to command a premium price for a set amount of time.

The barriers could also reside in the minds of consumers themselves. Companies develop products and services that customers get used to, come to trust and continue to buy even in the face of lower-priced competition. It’s most commonly called “branding.”

Branding is the most tenuous type of barrier because customers can be very fickle. Also, as new generations become the next wave of consumers, not only do they tend not to respect the brands of the past, they often actively shun them as old news.

This is exactly the predicament in which security firm ADT Inc (ADT) currently finds itself.

Security – especially home security – used to be a gravy train for a handful of household-name companies. Because the equipment had to be installed by a professional and then connected to a monitoring system (usually through phone lines), ADT was able to sell the equipment and then sign the customer up for monitoring services manned by humans for a monthly fee. It was a great business model – money up front and then annuity-like cash flows.

The internet has put a serious dent in that model.

You can now purchase an entire security system online, have it shipped to your home, install it yourself and monitor it (including live and recorded video) through a variety of means, including on a smartphone. You can also subscribe to professional monitoring services if you so desire.

This model is much more appealing to the millennial generation who tend to be tech savvy and also leery of subscription plans. They also like that you can pick up the equipment and take it with you when you move.

In fact, Alphabet (GOOG) bought Nest  five years ago and turned the maker of smart thermostats into a total home-automation company, selling a system which includes easily configurable, high-tech security solutions as part of the Google Home automation suite.

This is bad news for old-school security providers like ADT. Not only are there few barriers to entry in the home security business, advanced competition is actively destroying the old model.

It shows in ADT’s results. The last year has been disastrous, with the company posting net losses in each of the past four quarters, badly missing the Zacks Consensus Estimate each time.

ADT shares actually haven’t been pummeled quite as badly as they might have been, given the hugely disappointing results, though they have lagged the industry and the markets as a whole by a wide margin so far in 2019.

The home security industry is becoming a crowded place and ADT isn’t well positioned with the next generation of homeowners.  In the security and Safety Service industry, investors would be better off taking a look at Axon Enterprise (AAXN) or NAPCO Security Technologies (NSSC), both Zacks Rank #2 (Buy).

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