Much has been written about how security dealers, with their profit-rich recurring monthly revenue (RMR), are valued in the marketplace, but the factors that go into valuating systems integration companies has been covered to a lesser extent. RMR â€” if any exists in the integrator business â€” certainly plays a role in determining value, but a distinction is made between RMR from monitoring and RMR from service. There are other similarities in how the two types of businesses are valued, such as service efficiencies and the composition of customer contracts. Differences exist in the type of technology the integrator offers and the vertical markets that comprise the client base.
According to Bill Polk, managing director, CapitalSource, Chevy Chase, Md., the primary driver of valuations is the liquidity of capital markets. While the current economy has restrained the flow of capital to a degree, Polk believes low default rates characteristic of the security industry have and will continue to lead to rising valuations.
“We’re in an environment where debt markets have come back,” Polk says. “The high-yield bond market has been extremely active over last 12 months and this is driving up value. Falling default rates, more competition and generally favorable economic reports are driving pricing down, which is making it cheaper to borrow.”
Polk adds that in such a market, “the security industry has proven over the last 24 months a safe port in a storm.” Still, the availability of capital varies greatly for systems integrators ranging from the small local companies to the large multinationals. “The very largest companies have the ability to reach capital markets and find the lowest cost capital today while local retail players have a more limited ability to do so,” Polk notes.
One key element which facilitates finding that capital is a high percentage of recurring monthly revenue (RMR). Polk identified there is a group of lenders who clearly see the value of those contracts and seek out those companies with steady RMR streams and service contracts. RMR gives even smaller companies an edge in their ability to raise capital and makes them more attractive to larger integrators looking to acquire businesses.
“Systems integrators without RMR are valued on the trailing 12 months cash flow. The value applied to cash flow is three to four times on the low range and eight to nine times on the high range.” Polk adds that, “As it costs the same to buy a $5 million business in terms of legal fees as a $50 million business, it is more efficient to buy larger business.” Also, because cash flow will be measured only within that trailing 12- to 24-month period at most, any significant fluctuation in performance during that time will cause some concern.
“RMR is an indicator of future cash flow performance,” Polk says. Volatility indicators such as attrition rates or whether that RMR comes in month-to-month or on a long-term contractual basis all directly affect the value and dependability of those contracts and consequently, the valuation of a company. At the same time, how those contracts are spread out geographically and whether they are monitoring or servicing contracts gives prospective buyers and lenders insight into profit margins. For example, servicing a concentrated group of contracts is generally less expensive than servicing larger areas. In addition, it costs more for an integrator to maintain service contracts than it does to maintain monitoring contracts .
The specific type of contracts also translates into lower or higher company values. “Intrusion and fire have been around for a long time and are very established,” Polk says. “There are many buyers and competition for that is intense. Classes [of product and service] such as managed access control and remote video monitoring are newer in the market and perhaps not as highly valued as intrusion and fire, but are becoming more and more common.”
As security solutions evolve and those established systems transition, companies that are too committed to one genre of technology can be vulnerable, Polk believes, saying, “Markets evolve and technology evolves and you have to be able to adapt quickly.” The ability to prove technology-agnostic is key in maximizing a company’s current value and viability in the future.
“Another important thing that people who are trying to assess value look at is the nature of a company’s customer base,” Polk comments, adding that government, education and healthcare are hot vertical markets and that integrators who establish themselves in these markets will have an advantage. As an example, Polk notes that the critical infrastructure market is growing and so are opportunities for installations in stadiums, hospitals, etc. “If integrators are able to crack that market… government contracts can provide revenue that’s easier to underwrite because government contracts have visibility going forward.”