AlarmForce (TSX:AF) – Why did 3G Buy and Sell AlarmForce? And why didn't we buy it?

Whenever you can, you should check your original investing thesis and see how things turn out.

In November of 2017 BCE Inc. (Bell) (TSX:BCE.TO) (NYSE:BCE) announced was going to acquire AlarmForce Industries Inc. (TSX:AF.TO), Canada’s lone public home security and monitoring services company, for approximately $166 million ($16/share).

We took a look at this company in November of 2016 (a year before almost exactly to the day). At that time it was trading at ~$10/share. The Company had a new management team, was in the middle of a brand and product refresh, and started outstourcing product development. Our conclusion was “wait and see” in the sense that we liked what the Company was doing but things were just too unclear for us to buy – effectively it was execution risk. Full details here:

Interestingly, Pavel Begun, Managing Partner at 3G Capital Management, recently spoke at Ivey Business School and covered why they bought the business originally:

3G owned AlarmForce for just about a decade before you sold it at the end of last year [2017]. Would you be able to walk us through your original thesis as well as why you sold?

The original thesis was that you had this business that had a significant competitive advantage within an industry where everybody else did things in a highly inefficient manner. So more specifically if you look at the home alarm industry what you see is that pretty much all the players distribute their services through a network of dealers. Unlike everybody else AlarmForce distributes its products and services direct to consumers, so they take out a huge layer of cost, and as a result they were able to sell their product and service cheaper than everybody else. And yet they still enjoy a significant margin advantage. So, when I looked at AlarmForce and the structure of the industry it reminded me of GEICO back in the day because GEICO had a very similar industry structure and a very similar advantage. And with AlarmForce I thought well look, you are going to be in this large and growing industry, you have probably 1/10th of 1% of the market share, you have a significant cost advantage versus everybody else, and you have the industry structure that restricts adaptation because if you sell through dealers it’s very hard for you to say well I’m just going start selling direct because that’s going to, I guess this, piss off your network and they might leave.

So that was the theory and it was working well early on for the first maybe four or five years and then things got off track a bit. There was a significant technology change within the industry, there were changes to marketing channels, and there were changes to the product suite as well. And those were tough challenges, but they were not insurmountable, so I think you could have overcome those challenges. But management struggled to do it, so the company did not grow as much as I originally expected.

But in in the right hands that business was still worth a lot of money because at the core they still retained their low-cost advantage and the industry structure was still such that existing players could not adapt their marketing strategies to sell direct. And that was not lost on potential buyers and in November of last year Bell decided to make an offer for AlarmForce at a 65 or 75 percent premium and so we ended up selling. So, we really didn’t have a choice but at the end of the day we still earned a good IRR depending on the time of purchase and the price of purchase, because we purchased AlarmForce at a number of different times at different prices. We earned anywhere between 14 to 23 percent IRR on that investment.

Lesson learned: Keep checking your thesis, and make sure you didn’t miss anything that you could have foreseen.

3G’s initial thesis was good. The world changes and in this case unforeseen technology changes eroded some of AlarmForce’s business and advantage, but the core thesis that they had a structural competitive advantage – by not having to rely on a network of dealers – remained sound.

And us? We missed out on a 60% upside in one year, sure, and on the day of the announcement we definitely had FOMO. But after reviewing the situation, it was not foreseeable that they were going to be bought at this time (although it is a logical outcome). There was still a lot of execution/management risk (something that 3G would have had much more insight into as a large long-term shareholder and they also had a Board seat) and 3G also benefited from a lower cost base vs where the shares were trading when we reviewed the Company.

2008 Globe and Mail Article on 3G's purchase/thesis

2017 Bell Acquisition Announcement