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Strategic Buys Drive Acquisitions Growth but the Major Security Companies and VC's Keep Their Powder Dry
By Allan McHale, Director, Memoori 2010/11/8

It was always difficult to follow on from last month, when the industry posted the biggest monthly acquisition spend on record and it has failed to keep up this pace. However, consolidation continues at a high rate and has thrown up some interesting trends that are taking place and lessons to be learnt. The consolidation process in the security industry ran out of steam in August 2008 coinciding with the financial meltdown and it reignited some 15 months later in the last quarter of 2009. This coincided with the return of confidence that the security business had turned the corner, trading conditions were more stable and most major players had built up their cash reserves. In the meantime the general economic gloom has not fully lifted but as we show later companies at the high-tech end of the market are growing at more than 20 percent and profitably. It was always difficult to follow on from last month, when the industry posted the biggest monthly acquisition spend on record and it has failed to keep up this pace. However, consolidation continues at a high rate and has thrown up some interesting trends that are taking place and lessons to be learnt.

The consolidation process in the security industry ran out of steam in August 2008 coinciding with the financial meltdown and it reignited some 15 months later in the last quarter of 2009. This coincided with the return of confidence that the security business had turned the corner, trading conditions were more stable and most major players had built up their cash reserves. In the meantime the general economic gloom has not fully lifted but as we show later companies at the high-tech end of the market are growing at more than 20 percent and profitably.

For some time, it has been expecting that the venture capital (VC) companies would take some of their investments to the Initial Public Offering (IPO) stage and this would add further momentum to the pace of consolidation. However it is interesting to note that in May Hikvision was the first IPO that we had recorded for more than a year and no major IPOs have come to market since. So the long-standing process of private-equity companies selling off their more mature investments has yet to happen. In fact in some sectors such as alarm monitoring services VC's are active buyers rather than sellers at this time.

Strategic Buys Drive Acquisitions
HID Global acquired ActiveIdentity for US$162 million. This strategic buy provides the foundation for HID's security offerings with capabilities focused on the convergence of physical and logical access control. This acquisition will play a vital role in developing HID's converged physical and logical security business so long the privilege of the IT integrators. Combining their expertise should produce a more standard off-the-shelf solution and reduce the design and engineering costs. However the IT-based competitors will fight their corner aggressively. The enterprise value of the transaction is approximately $84.6 million. Trailing twelve month (TTM) revenues were $57.3 million, meaning that the transaction was valued at 1.48-time annual revenue. This seems a low multiple for a high-tech business, but ActivIdentity's revenues have been flat over the last three to four years. At the same time, Earnings and EBITDA have been nonexistent and cash burn in the TTM was about $1.5 million. As a standalone operation this looks an expensive buy but this is a strategic move that will long-term prove to be a very shrewd acquisition.

Expect others in the security and IT business to make similar moves although the majority will go for technical and marketing alliances as the preliminary stage of their courtship. ActiveIdentity was on the list of the top 50 acquisition targets as indeed was Vumii, also acquired this month.

The sale of L-1 Identity Solutions's biometric and enterprise access businesses to Safran, 3M's announcement of an agreement to buy Cogent and the biggest single deal, HP's buy of security software company ArcSight for $1.5 billion. All of these deals are intended to build platforms that will facilitate the convergence of some aspect of security with the business enterprise.

These three major acquisitions tell us more about how the shape of our market will develop. HP/ArcSight and their IT competitors could influence and or be major buyers of physical electronic security systems. The influence of IP and the network in the security business showed that the IT enterprise and communications channel was being courted by both security manufacturers and their clients to get involved in providing holistic solutions. This together with Cisco and IBM's activity in the market confirms this trend and we should expect this to extend to more acquisitions of security companies by IT and communications companies in the future.

Nice Systems must be a serious acquisition target because it holds strong positions in both video surveillance and business enterprise solutions that extract insight to impact business performance. Nice have experienced a surge in sales and profitability. It will require a company with deep pockets to acquire Nice which should be worth more than $2 billion.

Other acquisitions that we detailed this month included Lockheed's sale of the EIG operation to Veritas Capital for $815 million in cash, Trimble's purchase of ThinkMagic, Securitas's acquisition of Reliance Security, Assa Abloy's purchase of 32.95 percent of Agta Record stock, Opgal's deal for Vumii, the Kratos purchase of Henry Bros and ManTech International's acquisition of QinetiQ North America's Security and Intelligence Solution business.

Sitting on a Powder Keg
The number of transactions in October was unchanged on the same period in 2009, which was one of the most active months in that year. The value of transactions this month is well down on last month but this is hardly surprising given that September was the highest ever recorded for a single month with two purchases more than one billion dollars. Consolidation activity for the first ten months of this year exceeds the same period in 2009. We could be sitting on a powder keg that's about to ignite for 2010 looks like setting a new record, because most of the majors including Honeywell Security, Schneider, Siemens Building Technologies, Johnson Controls, Bosch Security Systems and UTC Fire & Security have yet to seal a deal this year and the VC must soon sell some of their investments in the security business.

Confidence despite the Gloom
The third-quarter financial announcements show a continuing trend of steady but solid results that appear to defy the general economic gloom and threatening double dip in GDP growth. The star performers are Nice Systems and Mobotix. Both recorded revenue growth of more than 20 percent and on improved margins. They are forecasting continued growth in 2011.

Revenue from Flir's Commercial Systems division, excluding Raymarine, increased 8 percent from the third quarter of 2009 to $132.4 million. Within the Commercial Systems division, revenue from Commercial Vision Systems increased 17 percent from the third quarter of last year to $61.4 million.

China Security & Surveillance third-quarter revenues were up by 15 percent but this was approximately half the average growth for the last few years, which is because of the change in mix of business. They are concentrating on large-scale government projects which are delivering increased margins up by 10 percent on the same period of last year. They are forecasting a 26- to 29-growth in revenues for 2011.

Honeywell and Johnson have not separated out their security business but both reported increased revenues in their controls businesses for the third quarter. UTC increased third-quarter revenues by almost 20 percent on the previous year, while the sales for the nine months are up by 17 percent on the previous year.

However these figures include the sales of GE Security & Safety business acquired in November 2009. GE sales should have added on at least $300 million this quarter and this would have accounted for an additional 22 percent, making organic growth zero.

Stanley security sales increased by 6 percent while Ingersoll Rand fell 4 percent in the last quarter. The trend we have witnessed over the last year where specialist high-tech companies have substantially increased their financial performance, while the majors have fallen behind continues.

For more information, visit Memoori.

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