As I have mentioned before in Market Musings, buying into IPOs is not really my game. I was trained in a dealing room, where one of the many things that aspiring dealers learn is to stay away from trades where the counterparty knows more about what is going on than you do, and that is always the case when you buy an initial offering. Of course, if you have access to IPOs at the actual offering price you can often sell on the first day to make a quick profit, but for longer term investors, the pattern of early gains followed by a sharp retracement is a well-known one, and not one that often leads to good decisions.
That is hardly surprising; investment bankers are smart people with access to all of the information they need to price and promote an IPO in order to achieve exactly that result. Occasionally, though, along comes an IPO that shows relative stability in early trading and, once the dust has settled, represents a long term buy with great potential. The recent Nasdaq listing Alarm.com Holdings (ALRM) is just that.
When I first looked at Alarm.com and found that they were involved in “the internet of things” I was put off. I can’t stand jargon, especially meaningless jargon. If you want to say that a company is about practical applications of internet technology, say that. You don’t need a confusing catch phrase to describe it. Anyway, rant aside, the practical application of internet technology is what Alarm.com is about. They are the market leaders in the “connected home”; the idea that data from your home can be uploaded to a remote server (“the cloud”), analyzed and then used to optimize performance of everything from your alarm system to your air conditioning.
The buzzword-filled explanation of what they do is a bit off-putting but remotely monitoring alarm systems and conserving energy by turning down heat and AC systems and turning off lights when the house is empty has a kind of “Jetsons” futuristic appeal. More importantly, it makes economic sense for most people. It should come as no surprise, then, that Alarm.com was already profitable before they went public. That is a welcome thing, as the increase in the overall number of IPOs in the first half of this year has led to an increase in the number of “pre-positive cash flow” offerings. We are not at 1999 levels yet, but that is a worrying trend.
As I said, though, it is not one that should worry investors in Alarm.com. They made an after tax profit of $13.5 million last year and, given their revenue model, profits are set to increase rapidly over the next few years. They currently have 2.3 million subscribers who are locked into multi-year contracts and an impressive retention rate of over 90 percent. There is plenty of room to grow as well; there are over 125 million households in the U.S.
The price action since last week’s IPO has been typical, but much less exaggerated than we have become accustomed to. The stock was priced at $14 for the offering, traded higher on the first day and then gave back some of those early gains. ALRM closed yesterday at $15.62, representing a roughly 10 percent premium to the offering price which, given the potential, the likelihood even, of rapid profit growth looks like a bargain, even to my somewhat jaded eyes.