Description

Trading at under 7x 2007E EV/EBITDA, worth $80 Sum-of-the-Parts, 25%+ upside. The Brink’s Company provides premier security services worldwide and maintains two operating segments: Brink’s, Inc. and Brink’s Home Security.   Brink’s Inc. is a provider of armored car transportation, security services, ATM servicing, currency and coin processing and other services to banks, retailers, and commercial and governmental agencies worldwide.  Brink’s Home Security markets, sells, installs, monitors, and services electronic security systems in residential and commercial properties.  The company was founded in 1838 and is headquartered in Richmond, Virginia.

INVESTMENT CONCLUSION:
The recent sale of BAX Global for $1.1BN was greater than expected and provided the opportunity to invest in a “pure play” security company with premium assets and significant growth prospects both domestically and abroad.  The sale of BAX enabled Brink’s to fund $225MM to the VEBA, pay down $185MM in debt, and buy back over 10MM shares through a Dutch tender offer.  Despite the proceeds from the sale of BAX and the growing strength of the balance sheet, BCO remains an undervalued and underleveraged security company.  BCO is trading at 6.7x projected 2007E EV/EBITDA whereas the industry average is approximately 8x.  Because BCO continues to trade at a significant and unjustified discount to the industry, Pirate Capital has urged management to retain an investment bank to explore broader strategic alternatives including a large Dutch tender and/or the sale of the company.  Pirate Capital recently announced that BCO has avoided a proxy contest by granting Pirate a Board seat and a position on the Board's strategy and pension and finance committees.  This could provide a near term catalyst in which Pirate urges the company to retain an investment bank from the inside.  A sum-of-the-parts valuation suggests that BCO is worth $80 per share based on an 8.5x-9x 2007E EV/EBITDA multiple.  This valuation is supported by a detailed presentation by MMI Investments which supports Pirate’s initiatives.  The presentation can be found at http://www.sec.gov/Archives/edgar/data/78890/000095013706013786/c10849a4exv99w3.htm.
 
SUMMARY: BCO operates two premium global security businesses that continue to experience robust growth Brink’s continues to benefit from the increased outsourcing of cash processing, expansion into emerging economies, stronger economies in Europe and Latin America, and increased cash circulation worldwide.  Brink’s Home Security is the 2nd largest alarm company in North America, and has steadily grown its subscriber base to approximately 1.1 million throughout 250 metro areas with operating margins of more than 22%.  BHS serves to benefit from under-penetrated residential markets and its new commercial security business.

Sale of BAX Global:
The Brink’s Company completed the sale of BAX Global Inc to Deutsche Bahn AG for $1.1 billion in cash in 2006.  This value was substantially higher than the expected, creating a pretax gain of approximately $585 million ($374 million after tax).  The company used these proceeds to contribute to their Voluntary Employees’ Beneficiary Association Trust (VEBA) to pay retiree medical obligations to former coal operators.  The company also used the proceeds to pay down $46 million in short term debt.  A large portion of the cash funded a Dutch auction share repurchase.  The auction process closed on April 6, 2006 and the company bought back over 10.3MM shares with a tender offer of $51.20 for a total value just over $530 million in cash.

Capital Structure:
After the sale of BAX Global, the allocation of cash to VEBA, the Dutch tender offer in the beginning of the year, and the recent $100 million share repurchase, Brink’s has just over $155 million in cash and marketable securities remaining on its balance sheet.  BCO currently maintains net property, plant, and equipment worth $941.9 million, and carries long term debt valued at $144.7 million.  This lack of leverage on the company’s balance sheet makes the company very attractive to potential buyers, both financial and strategic, and provides an opportunity for the company to return significant value to shareholders through another Dutch tender offer for its stock.

Health Benefit Act and Black Lung Liabilities:
Brink’s is subject to fund disability and medical payments for workers in the company’s former coal mines.  The Health Benefit Act of 1992 stipulates that benefits be paid to members of the United Mine Workers of America’s (UMWA) combined fund.  These benefits are paid over the next 60-70 years, but since the company is no longer involved in coal related operations, the required funding is expected to decline as the beneficiary group ages.

VEBA:
The company established a Voluntary Employees’ Beneficiary Association trust (VEBA) to pay benefits associated with coal related benefit plans.  After the sale of BAX Global, the company contributed $225 million to the VEBA resulting in a balance which exceeded the liability previously recorded.  The $100.7MM balance is now listed under “prepaid postretirement benefits other than pensions” under non-current assets on the company’s balance sheet.  The funding of the VEBA and the elimination of much of the legacy liabilities makes BCO an attractive acquisition candidate for potential buyers.

Legacy Liabilities:
The company is subject to legacy liabilities related to current business segments including pension and non-pension expenses.  These liabilities are currently valued at $181.7 million and $210.5 million respectively.  The liabilities are estimates, and can vary significantly from the actual values.  For example, the medical inflation rate and the Medicare subsidy value will directly affect the relative value of the company’s estimated non-pension liabilities.  Just as with any other pension plan, the company’s funding requirements are directly linked to employee retirement age as well as average life expectancy.  Any material change in either could result in a funding shortage.

Deferred Tax Asset:
As the company funds its legacy liabilities, each dollar used to fund these obligations is deducted from the company’s tax payments.  This $146MM “deferred tax asset” generates tax deductions on the company’s future earnings.  BCO is expected to produce enough taxable income to fully absorb the tax deductions.

Robust Multiples Paid for Competitor:
On December 14, 2006 HSM Electronic Protection Services, Inc (HSM) was purchased for $545mm in cash by Stanley Works (SWK).  This deal closed at 60x recurring monthly revenue (RMR), 2.7x annual total revenues, and 12x EBITDA.  Although BCO and HSM are not perfect competitors since HSM is focused on the commercial monitoring market, BCO should trade at similar multiples since the residential security market exhibits similar characteristics as the commercial security markets.  Currently the 60x RMR multiple of the HSM deal is significantly higher than the implied BHS multiple of approximately 45-50x.  This indicates that BHS is trading at a discounted RMR multiple.  This discount is entirely unwarranted.  Both HSM and BHS are considered best-of-breed businesses and both maintain comparable growth rates of around 13%.  However, BHS maintains EBITDA margins of 44% whereas HSM’s EBITDA margins are only 37%, suggesting that BHS should at least trade in-line with HSM multiples.  Applying a 10.5x 2007E multiple to BHS, which is conservative and below the 12x multiple of the HSM deal, results in a sum-of-the-parts valuation of over $80 per share in 2007.

Fourth Quarter Earnings:
Brink’s recently reported fourth quarter earnings of $0.71 a share, $0.09 above consensus estimates.  The company exhibits strong signs of growth in its armored car services in the Americas, and operating profit for Brink’s Inc. exceeded management’s year end guidance of 7%.  The Brink’s Home Security division also showed strong growth in the fourth quarter, and management achieved its full year guidance of a triple double – 10% growth in full year revenue, profit, and subscriber growth.  The company has put forth the same guidance (of 7% operating profit for Brink’s Inc, and another triple double for BHS) for 2007, thus confirming management’s confidence in its ability to growth the business organically.

VALUATION:
Including the effects of the share repurchase, the company is currently trading at 6.7x 2007E EV/EBITDA based on current capitalization and 2007E EBITDA of $463 which is consistent with current sell-side estimates.  Despite BCO’s recent sale of BAX Global and significant growth prospects both domestically and abroad, the company continues to trade at an unwarranted discount.  Other pure security stocks, like Securitas, are attracting multiples closer to 8.0x 2007 EBITDA.  With a more secure business model, and a higher level of service and brand recognition, Brink’s should trade inline or above multiples of competitors.  Applying an 8.0x multiple to Brink’s 2007E EBITDA estimate values the stock at $70 a share, and applying an 8.5x multiple yields a $75 share price.  BCO remains an undervalued and underleveraged company.  As a result, Pirate Capital has urged the company to retain an investment bank to explore strategic alternatives such as a large second Dutch tender and the sale of the company.  Pirate has recently been granted a Board seat at BCO.  Pirate’s continued push for the company to explore strategic alternatives could provide a near term catalyst for the company’s shares.

($mm except share data)
2007E EBITDA            455  
Stock Price                   63.8  
Shares Out                    47.9
Market Cap                  3,058.6
Net Debt                       42.7
Enterprise Value            3,101.3
EV Multiple                  6.7x  

2007 Implied Valuation Range
Multiple                     2007E EBITDA ($MM)
                         450                  460                  470

8.0x                  $68.75            $70.40             $72.05
8.5x                  73.39               75.14              76.89
9.0x                  78.02               79.88              81.74
9.5x                  82.66               84.62              86.58

Comps:

Now that BCO has parted ways with BAX Global, it may be valued as a pure security services company.  Although there are no perfect comps for Brink’s, other public pure play security companies are compelling higher multiples.  BCO is currently trading at a sizeable and unjustified discount to the industry average.

Company                       Market Cap              Net Debt           2007E EBITDA                2007E EV/EBITDA
Group4Securicor            3,743                       1,338                 705                                   7.2x
Securitas                        6,775                       1,890                 1,055                                8.2x
Brink’s Co                     2,687                       27.5                   463                                   6.7x   

Price to Earnings:
Brink’s current trailing price to earnings ratio is high in comparison to non-alarm based competitors, in part because of the cost of growth associated with the business.   In 2006, BHS is produced over 10% revenue growth, 10% subscriber growth, and 22% operating income growth; this growth requires high levels of investment in new subscribers.  BHS spent $164 million in capital expenditures in 2006, and although the CAPEX will not show up directly on the income statement, it will be amortized and expensed as subscriber acquisition costs.  The company amortizes the expense of gaining each additional subscriber over a fifteen year period.  When a customer disconnects service, the remaining portion of the subscriber acquisition cost is immediately expensed.  Subscriber acquisition costs also exist, such as equipment installation in newly built homes.   These enormous growth-promoting investments have not fully matured and have yet to reach the full pay-back period.  Thus, at this point, the subscriber acquisition costs outweigh the new subscriber revenue.  While this is hindering earnings power in the near term, it allows for longer term revenue streams once the pay-back period is reached.

Growth Capital at BHS:
In 2006, Brink’s management expects to spend approximately $165 million on capital expenditures at the Brink’s Home Security division.  Of these expenditures, approximately $8 million will go to technology upgrades while the remaining CAPEX will be spent to replace customer disconnects and to grow the subscriber base.  Management’s estimated breakdown of expenses are displayed in the chart below:

2006 BHS CAPEX ($mm)
Total CAPEX                        164
Technology Upgrades             8
Disconnect Replacement         63
Subscriber Growth                 93

If BHS sought only to replace customers that disconnected each year, the company could save $93 million a year in capital expenditures.  As shown in the chart above, subscriber growth is by far the largest portion of the estimated capital expenditures for 2006.  Operating the business as a steady state business, replacing only disconnects, would increase free cash flow by $93 million a year.  This “growth capital” is the bulk of the new subscriber acquisition costs highlighted in the previous section.  Eliminating this growth spending would improve both cash flow and near-term earnings, but would also limit expansion in the long run. 

Sum of the Parts Valuation:
Our sum-of-the-parts valuation for BCO suggests a break-up value of $80 per share based on 2007E estimates.  The 7.5x multiple for Brink’s Inc is based on the expected multiple that Loomis Fargo (a division of Securitas) will be spun off as in the first half of 2007.  Because Brink’s maintains higher margins, it is safe to say that this segment of the company should at least trade in line, if not at a premium, to the Loomis Fargo shares.  Therefore, if Loomis Fargo trades at 7-7.5x when it is spun off, it is safe to say that this is a conservative multiple for Brink’s Inc.  The 10.5x multiple for BHS is based on the 12x multiple that was paid by Stanley Works for BHS’s competitor HSM Electronic.  This 10.5 multiple is clearly conservative, and BHS could certainly achieve an 11-12x multiple similar to HSM.

Brink’s Inc:               2007E                         BHS:                         2007E
EBITDA                   255                             EBITDA                   208
Multiple                    7.5x                             Multiple                    10.5x
Value                       1,861.5                        Value                        2,184.0

Sum of the Parts:                    2007E
Net Debt (Cash)                    (45)
Legacy Cost                          330
Def. Tax Asset                      133
Equity Value                          3,894
Shares Out                            48.5
Share Value                          $80.28

Investment Conclusion:
Brink’s remains an undervalued security company that has solid growth prospects both domestically and abroad.  The recent sale of BAX Global created the opportunity for investors to invest in a pure play security company with premium assets.  The sale enabled Brink’s to fund the VEBA, pay down debt, and invest in its other operating segments.  BAX was sold for more than expected, which significantly helped to clean up the balance sheet.

Brink’s management takes a consistent approach to the business, attempting to control growth to ensure that service does not begin to lag.  If the company can successfully put cash to work and lever the balance sheet, there could be significant increases in shareholder value.  Management has stated publicly that they are looking into acquisitions to expand into the corporate security business, ensuring investors that they will take their time and will not overpay for the business.

Another interesting possibility for Brink’s is the prospect for the company to be taken private.  If BHS were run as a steady state business, only replacing subscribers who disconnect each period, CAPEX would fall by $93 million.  The currently under-levered balance sheet also makes the company an attractive acquisition candidate for both financial and strategic buyers who may want to purchase BCO and lever the balance sheet, therefore limiting the cash investment.

Catalyst

1. Activist investor elected to the Board and given a position on the strategy committee. 2. The Company retains an investment bank to explore strategic alternatives including the sale of the company and an additional Dutch tender offer for the company’s shares. 3. Strong growth opportunities and continued free cash generation including margin recovery of the European cash collection business, and further subscriber growth in the home security business.