Security Consolidation Shows No Abatement for 2009-2015

Security Consolidation Shows No Abatement for 2009-2015

Allan McHale, Director of Memoori, assesses the impact of the global recession on M&A activity for 2009 through 2015.

In two previous articles on mergers and acquisitions in security, Memoori reviewed consolidation from 2000 to 2008 and benchmarked the value of companies purchased against high technology and growth. In the January issue, we reviewed entrepreneurship in the IP video sector, by company, age and country of origin. For this article, we assess the impact of the credit crunch and global recession on the consolidation process. In light of recent events, we forecast merger and acquisition activity in 2009 through to 2015.

Figure 1 shows the volume of deals increased threefold from 2000 to 2007. Activity fell off in 2002, coinciding with a short recession in the economy. For 2006, the figure is distorted by two previous years of frenzied activity by the major companies.

While the value of deals fell 30 percent in 2008, the last quarter was down 50 percent compared to the same period in 2007. The reason for the fall in activity is the credit squeeze, which became apparent in August 2007. There is general consensus that the current recession will not be short or shallow.

It is noticeable that acquisitions by the major companies fell off in 2008 before the worst of the economic mire was realized. UTC Fire & Security spent US$5 billion on purchases in the previous five years, while Schneider Electric spent $2.3 billion. Stanley, Honeywell Security and Bosch Security Systems were active in 2008, but no mega deal was completed. Could these companies be building up their cash reserves for major buys at lower exit prices in the next two years?

Mirroring Market Trends
The situation of the security industry mirrors the global merger business, which dropped about a third in 2008 and ended five years of deal growth. A lack of available credit, plunging stock markets and a worldwide financial crisis undermined companies' ability to make acquisitions.

With regard to the security industry, our database on mergers and acquisitions only has macro data for the last eight months of 2008. However, we have tracked the major suppliers since 2000 and a cursory appraisal suggests the reduction in deals was hardly noticeable until the last three months. Virtually all the 56 deals recorded since April 2008 have been cash purchases. But with the lack of finance available to the industry — particularly from equity partners — this suggests the nadir of cash acquisitions for the next few years. Finance from venture capitalists will be strained and although it is not the right time to go public, some may be forced to cash in their chips.

Driven by the need to continue high levels of investment in product development, most providers will be obliged to merge with a suitable peer company. The December 2008 announcement of the Panasonic-Sanyo deal, along with the proposed merging of SCM Microsystems and Hirsch Electronics, lends support to our forecast for more mergers in 2009 and beyond.

Consolidation in this fragmented business has a vital part to play. It requires companies to be over the minimum size to make a contribution for a stable future, and too many are well below it. However, as present economic conditions show in Figure 2, we expect deal activity to fall another 30 percent in 2009 and remain atthat level for 2010, before returning to growth. For that scenario, deal activity will reach its 2007 peak by 2014. We forecast deal activity will grow about 20 percent for the next few years, based on the value of deals. However, we have entered uncharted waters, as the number of mergers and acquisitions over the next five years could significantly increase. The chart forecasts that the importance of cash deals — constituting up to 90 percent of business in the past seven years — will fall to less than 50 percent in 2009 to 2010, as mergers become the main driver of consolidation.

We invited three companies to give their views on how they see the consolidation process developing over the next few years. The first is John Monti, VP of Marketing at Pixim, a young dynamic U.S. IP video supplier. Next is Israel Livnat, President of Nice Security, a well-established supplier of access control and video surveillance systems. Finally, Bosch Security Systems offers insight as one of the major players in the security industry.

Due to global economic conditions, Monti expects M&A activity to affect a number of smaller companies with no or modest revenue. These companies will not be able to secure external funding, and thus will have to look for acquisition. Two recent examples are Mobilygen (bought by Maxim) and W&W Communications (bought by Cavium).

While Pixim does not plan to acquire, there is the possibility it could pick up small technology providers to complement its base image capture and processing technology. Monti said it was unlikely that Pixim would be acquired.

Memoori expects the credit crunch to have a significant impact on acquisitions with the major companies, which will seize the opportunity to acquire valuable assets at bargain prices. Small companies with minimal revenue may have no other choice, given the lack of external financing, but to seek refuge.

Monti said the downturn in demand will have a particularly adverse effect on specialized startups. In some cases, it may oblige startup investors to bring about an early exit. Private equity capital is much scarcer than a year ago. Venture firms are choosing winners and losers in their portfolios, so only the top 25 to 33 percent of companies can expect continued funding.

"These economic times are unprecedented," Monti said. "The companies that adapt quickly will have the best chance of success."

Nice Systems
Israel Livnat, President of the Nice Security Group, Nice Systems, said, "Over the years, Nice's growth and strategy have been combination of both organic and external growth, supported by acquisitions."

Nice feels it has what it takes to survive the credit crunch. "We believe that the company's very solid financial standing of more than $500 million in cash and equivalents as of the end of December 2008 will enable Nice to seize new and exciting opportunities and emerge as an even stronger company," Livnat said. "2008 was a successful year for Nice. Our strong performance in both the enterprise and security sectors, coupled with the company's strong financial position, demonstrates our growing market share."

Bosch Security Systems
Bosch investigates possible M&A opportunities on an ongoing basis. It confirmed "our preferential focus is not based on current market prices but rather on our fundamental strategic approach, which is to selectively expand our portfolio in 2009 to acquire a technological know-how complementary to ours rather than to increase sales." Bosch expects the amount of acquisitions in 2009 to be lower than 2008, due to the current economic situation.

Over the last four months, Memoori has identified a growing trend of alliances formed between smaller players to create end-to-end solutions and share the cost of developing vertical markets and overseas markets. This will continue in 2009 and has extended to medium-sized players. The industry will be incumbent on alliances and mergers to fight off the worst of the financial crisis and ride out the storm.

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