Abstract

Anna Amphlett, a financial analyst with Southern Cross Capital LLC, spent the first days in her new job gathering information about ADT Corporation, a company whose shares Southern Cross was considering acquiring for its Business Services portfolio. Amphlett graduated with an MBA in accounting and finance, and had spent a summer as an intern with Southern Cross specializing in the service sector before joining the company. On September 28, 2012, ADT became an independent publicly traded company listed on the New York Stock Exchange, after Tyco (TYC) split itself into three independent companies. ADT generated revenues by charging customers monthly subscription fees for commercial and home security services. Southern Cross’s portfolio manager had asked Amphlett to pay close attention to the company’s accounting methods, and particularly to its policy of capitalizing and amortizing cash outlays on sales commissions, instead of expensing them immediately. Southern Cross had become wary of companies such as Pre-Paid Legal Services, PolyMedica, and Excel Communications, which experienced significant stock price declines after popular press articles discussed their policy of boosting earnings by capitalizing and amortizing indirect costs. Such companies also experienced significant stock price declines when it was disclosed they were under investigation by the U.S. Securities & Exchange Commission (SEC).

Teaching
To understand how a company generates revenue, its business strategy for achieving this, and the implications for the company’s financial performance.
To analyze a company’s growth, its ability to generate cash flows, and its recent financial performance.
To evaluate a company’s accounting methods and their impact on a company’s financial performance.
To develop a communication and disclosure strategy for dealing with critics of the company’s accounting policies.
To evaluate the investment returns from a company’s customer acquisition and retention strategy.
To evaluate the intrinsic value of a company’s equity security relative to its current stock price.
Specifically, students are asked to consider several issues in the case. First, students are asked to explain ADT’s business model, to evaluate business strategy, and to evaluate how successful execution of this strategy is likely to be observable from the company’s financial performance. Second, students are asked to analyze the company’s cash flow situation and recent financial performance, including its profitability, asset management, and leverage. Third, students are asked to consider the impact on the company’s financial statements of its revenue and expense recognition policy and whether they are consistent with GAAP. Fourth, students are asked to evaluate whether the company’s investments in customer acquisition and retention are profitable. Fifth, students are asked to consider the communication and disclosure issues the company faces in responding to analyst criticism of its accounting methods. Finally, students are asked whether ADT’s shares are worth the target price of $45 per share.



The case has been used successfully in MBA programs to cover corporate financial reporting issues, and in bank training programs focused on credit analysis and quality of earnings issues.
Case number:
A01-14-0010
Case Series Author(s):
Graeme Rankine
Subject:
Accounting and Control
Year:
Setting:
U.S.
Length:
12 pages
Source:
Published material