Initiation of Research Coverage: The ADT Corporation; Resumption of Research Coverage: Tyco International, Ltd.

Thursday, January 10, 2013

William Blair & Company analyst Nicholas Heymann initiated research coverage of The ADT Corporation (ADT $46.66), the largest pure-play residential and small-business security company in North America, with an Outperform rating, Established Growth company profile, and 12-month price target of $57.00. Heymann also resumed coverage of Tyco International Ltd. (TYC $29.82), the market leader in global fire and security product offerings, with a Market Perform Rating, Established Growth company profile, and 12-month price target of $30.00.

“Despite being a well-known part of Tyco International before it was spun out as a separate company in late September 2012, ADT is a unique company with performance metrics and growth and value creation drivers,” Heymann said. “Perhaps most crucial for assessing the fair value of ADT is the company’s rapidly expanding avenues of growth. Historically, these have been relatively one-dimensional, consisting of macroeconomic and served market variables, such as GDP growth, new housing starts, housing resales, and market share gains. Today, these factors—plus the introduction of ADT’s digital remote home management system—are projected to enable ADT to continue to grow at a faster rate than the North American security industry. From 2012 to 2016, ADT projects that the North American home security market will grow 2%-3% annually, or about 50% more than the 1%-2% averaged from 2008 to 2012. ADT’s organic revenue growth rate from 2012 to 2016 is expected to average 5%-7%, or about 70% faster than the roughly 3.5% averaged during the 2008-2012 period (excluding the acquisition of Broadview). While part of this higher growth reflects a recovery in North American new home sales, a larger factor is the advent of digital remote home automation and, to a lesser extent, the emergence of new distribution partners, such as utilities and telecommunication and cable companies.”

Heymann continued, “Tyco’s emergence following the spinout of ADT and the sale of the flow control business put the company in a unique predicament: accurately presenting its potential and financial condition yet ensuring its independence. We believe Tyco management decided the best means of remaining independent was to present the full potential of internal upside improvement through mid-decade, particularly given the company’s respectable free cash flow and modest 10% net debt to total capital. As a result, the company’s original outlook for its operating margin through 2015 is expected to increase a fairly substantial 30%-40% over the next three years; it is targeting an operating margin of 15%-16% by 2015, versus the adjusted 12.7% in the company’s just-completed fiscal 2012. While the potential for a substantial increase in margin is not unusual, the message from management was clear: if another party wants to acquire Tyco, it should expect to pay for the potential internal improvement anticipated over the next few years, not the company’s currently anticipated fiscal 2013 performance. These lofty targets are part of the reason we maintain our Market Perform rating on the stock.”

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William Blair & Company, L.L.C. receives or seeks to receive compensation for investment banking services from companies covered in this research report. Investors should consider this report as a single factor in making an investment decision.

William Blair & Company, L.L.C. is a market maker in the securities of The ADT Corporation and TYC International Ltd. and may have a long or short position.

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Current Ratings Distribution (as of 12/31/12)

Coverage Universe
Outperform (Buy): 62%
Market Perform (Hold): 33%
Underperform (Sell): 1%

Inv. Banking Relationships*
Outperform (Buy): 9%
Market Perform (Hold): 2%
Underperform (Sell): 0%

* Percentage of companies in each rating category that are investment banking clients, defined as companies for which William Blair has received compensation for investment banking services within the past 12 months.

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