Despite a bumpy economy, the security industry has been operating in top gear throughout 2013. An unprecedented number of buyers, lenders and new investors are courting dealers and systems integrators. The activity is being fueled by a combination of low interest rates, the security industry’s ability to weather the recent U.S. recession like a champ, and plenty of available capital. The result is a plethora of options for security dealers who are looking to either cash out or take their businesses to the next level.
Security industry mergers and acquisitions (M&A) and financing experts report that they are handling a dizzying number of requests to buy both businesses and contracts. Sales are correspondingly brisk and multiples are the highest they have ever been — in the 40× recurring monthly revenue (RMR) range.
“This is an excellent time to sell,” says Michael Barnes, founding partner of Barnes Associates, St. Louis. “There are plenty of buyers seeking to do deals and they are supported by aggressive capital markets.”
As with any market nearing, or at, its peak, people realize that peaks do not last forever. Nevertheless, the experts acknowledge that a post-peak market would probably be a relatively good one for well-run businesses.
In the meantime, the vigorous M&A cycle has not had a negative impact on the number of independent dealers.
“Look at the SDM Top 10. They all got where they are through acquisitions, and there are still plenty of independents,” says Ron Stennes, owner of Sierra Consulting, Bonney Lake, Wash. “For every company we sell, two or three more open up the next day.”
The current low interest rates are having a positive impact on the market in terms of the number of deals taking place. They also mean that buyers can pay dealers more for their business or book of business, says Rory Russell, owner of Acquisition & Funding Services, Kattskill Bay, N.Y. “There are a lot of people interested in the security business that want to lend money to the right people,” Russell says.
Some have more to lend than others do. While they agree that the security industry is a great investment, banks and private investors do not agree about soaring multiples of up to 40× RMR. Always conservative — yet favorable to the industry — the banks’ multiples are staying between 22× and 26× RMR depending on the clients and their relationships with them. The lower multiples keep the banks well protected, and in a place where they can get a full return on their investments, explains Amy Kothari, CEO of Alarm Capital Alliance, Newtown Square, Pa.
“The acquisition market has been really ‘frothy’ since we exited the last recession,” Kothari says. “Mom & Pop businesses have always been between 33× and 35× RMR. Now those deals are being done between 37× and 40× RMR.”
The banks may move a little higher, but they are “never going to lend at what you are buying at,” and people are not getting all their money from the banks, she adds.
Indeed, strategic buyers, private equity investors and private equity groups are flush with cash and ready to invest it in proven, resilient markets. These investors also are keen on high-tech industries, so the security industry’s latest trend towards developing business offerings in home automation, video and managed services makes the security sector even more appealing to new investors, says Tom Pagnani, managing director at Capital One, McLean, Va.
“There used to be only a handful of private equity investors interested in this space,” he says. “With the advent of technology, the bubble of people interested in it today is not confined to just the people that know about the alarm space.”
In addition to increasing the number of M&A and financing options, new investors’ interest in, and increasingly mainstream views towards, the security industry enable dealers and systems integrators to create their own niches, he says. This is because there will be more buyers looking at their particular business models when they ultimately choose to sell.
Several large security businesses used a novel means of raising funds in 2013. Interface Security Systems Holdings Inc., a managed services security firm based in Earth City, Mo., completed a “meaningfully sized high-yield bond offering,” as did Vivint, Provo, Utah; Monitronics Int’l, Dallas; Protection 1, Chicago; and Securitas Direct, Malmö, Sweden, Pagnani describes.
Because high-yield bonds are rated below investment-grade bonds, they are perceived as a higher risk, he explains. Therefore, the bonds pay higher yields to make them attractive to investors.
“The fact that Interface and other prominent security companies with top-notch management teams successfully accessed the bond market provides further evidence of how far the security industry has come, as well as market receptivity to the space in general,” he adds.
In addition, M&A activities and restructuring of large companies have put a new emphasis on the residential market. This, in turn, will have a significant impact on the buying and selling of businesses and accounts throughout 2014, Pagnani says. Some of those activities include Boca Raton, Fla.-based ADT’s spin out of its residential and small business markets from Tyco Int’l, and its subsequent purchase of Devcon Security, Hollywood, Fla.; the recapitalization of residential giants Vivint and Monitronics; and the entry of cable and telecom companies into the security space, Pagnani details.
“All of those companies have a strong appetite to buy accounts,” he claims.
Variations on Valuations
Valuations are hitting unprecedented thresholds industry wide, but this is especially true for mid-sized companies with RMR of $75,000 to $250,000, says William Schmidt, managing director of security lending for CapitalSource, Los Angeles.
Nevertheless, most dealers that want to get the best price for their business or contracts work with advisors. This helps them exhaust the pool of potential buyers, sort out details they may not have considered themselves, and present their business professionally to the buyers, he emphasizes. To attract buyers that are likely to pay their preferred purchase price, dealers must offer up a high-quality, low-risk acquisition.
“Anything a seller can do to reduce risk to the buyer will command a better purchase price,” Schmidt thinks.
In addition, with so many buyers and fewer sellers, it is increasingly common for buyers to pay fees associated with a sale. Therefore, sellers need to choose their advisors wisely and focus on more than just their RMR when they decide to sell and determine their valuation.
“If the seller focuses solely on price or their multiple of RMR they almost always come up short,” says Jim Stewart, founding partner of Legacy Security Acquisitions & Consulting, Bend, Ore. “Value can be lost or gained in the fine print of a contract’s terms and conditions.”
Advisors are busier than ever, and unqualified buyers can turn what looks like a good deal into a lengthy, costly process. However, with so many options available to sellers, there is no need for any unnecessary suffering. “Every time I sign up a new client, there are five to 10 potential buyers I can take them to,” Stewart says.
The best buyers are qualified buyers, meaning they provide good service, are proven closers (30 to 60 days), are funded, and are prepared to pay a fair multiple, Stewart outlines. The best advisors are people that are trustworthy, responsive and have a good understanding of the business, Schmidt adds.
To Sell or Not to Sell
While today’s market is ripe for M&As, it also is a great time for dealers to expand or improve their businesses. Thanks to competition from the communications industry, residential customers are becoming increasingly interested in new services such as home automation, Voice over Internet Protocol, water leak detection, carbon monoxide monitoring and more. (See related article, “Not Your Father’s RMR” to the left.) While some dealers see this as a good reason to stay in business, others do not.
“Consumer penetration is moving out of the low 20s and home automation is rising above the sub-1 percent range, Kothari states. “Business hasn’t been this good in 30 years. People may want to ride the wave a little bit before they sell, but, who knows what the multiples will be by then?”
Many dealers would rather not test the water, Barnes thinks.
“There is no question that unprecedented changes are occurring in the industry with all of the new players, new products and services, and new models for chasing market opportunity,” Barnes describes. “However, not everyone wants to re-up their investment and commitment to the industry. For many players, these changes represent another level of risk. We are seeing more companies contemplating a sale.”
Barnes forecasts that 2014 will be an even busier year for sales of security businesses. “This is an unprecedented time to sell a business, and we think many players will pull the trigger next year,” he adds.
Indeed, many dealers are retiring and cashing out now to get top dollar for their businesses. Others would like to exit, but realize they may live a lot longer, Russell notes. They are cashing out, but staying in business by selling or leveraging their contracts for cash and a lighter workload.
Dealers located in areas where customers are being negatively impacted by the economy may suffer attrition rates and accompanying cash flow problems. Rather than sell their businesses, they can sell their accounts to a partner that can alleviate their cash flow problem immediately and help them grow their businesses going forward, says Greg Westhoff, president of Alarm Funding Associates, West Chester, Pa.
Meanwhile, some dealers are exiting their businesses because they see higher tax rates on the horizon. This outlook creates a strong incentive to sell sooner rather than later for those who are predisposed to sell, Pagnani says.
Some dealers would like to sell, but discover that they have to work on their businesses first. Many dealers do not think about what is involved in selling their businesses until they decide to sell, says Bill Larrabee, president of Larrabee Ventures Inc., Sherman Oaks, Calif.
“Preparing to sell a security dealership isn’t like what you do when you sell your house — painting over nicks and washing rugs. It’s structural, in most cases,” Larrabee describes.
For example, dealers often need to better leverage the core competencies of the owner and employees by acquiring the expertise they lack, he advises. If they are good installers, they may need help with sales, or vice versa. Other problems include poor record-keeping, non-standard contracts and phone lines that are difficult to port to the new owner’s central station. Buyers are looking to purchase businesses that will be easy to acquire, transfer accounts into their name and generate positive cash flow.
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Not Your Father’s RMR
Security dealers that got their start 20 years ago wisely got into a business that generates recurring monthly revenue (RMR) just by signing up new subscribers. Dealers who are in the business today, however, are well advised to take advantage of the opportunities they have to beef up their RMR by offering customers new or managed services.
“Greater awareness and continued adoption of home automation services will continue to grow the pie for the entire industry,” says William Schmidt, managing director of security lending for CapitalSource, Los Angeles.
Fortunately, dealers that want to expand have abundant financing options. Banks, private equity investors, and invisible or branded partners are eager to help them fund and make those improvements.
“Partners can introduce dealers to vendors that can help them with pricing or product, or show them how a service is working for other dealers they are helping,” says Greg Westhoff of Alarm Funding Associates.
Systems integrators also are well-situated to leverage consumers’ growing interest in new services, especially integrators that embrace a managed services model, says Schmidt. Managed services will create better margins and recurring revenue streams, as opposed to their traditional business models.
Systems integrators that want to get to market faster with managed services, yet keep their costs low, can outsource or partner with companies that provide video, perimeter and access control capabilities and more, Schmidt says.
“They can offer customers turnkey solutions with the hardware, human capital and cloud/IT components baked in,” says Schmidt. “It’s better to have a system with embedded services and a monthly service charge. A lot of times these are very sticky revenue streams, so people are moving in that direction and there is financing available to help businesses grow.”
Thanks to their expanding cash flows in recent years, new investors are taking a keen interest in the systems integrators’ space, Pagnani says. For example, private equity group Pamlico Capital, Charlotte, N.C., recently acquired Carrollton, Texas-based systems integrator Securadyne Systems.
3 Simple Steps
Three things that business owners can do to improve their businesses are:
- Understand that details and follow-through really matter.
- Sell more. This can be done by making more calls instead of rearranging their desk or reviewing their bank statement for a third time. Just a few more sales each week can significantly increase valuation.
- Always run your business as if you are going to keep forever, and sell it tomorrow. But keep your options open and realize you have choices.