Security Market - With Brian Ruttenbur from Imperial Capital

4:01PM May 11, 2023

Speakers:

Brian Karas

Brian Ruttenbur

Keywords:

acquisitions

companies

market

valuations

integrator

industry

security

brian

profitability

exit

deals

paid

years

boundaries

transactions

pretty

negatives

manufacturer

ai

good

Afternoon, everyone for for signing up and joining and for joining the session. There's there's some q&a So we're gonna probably try to pack load the questions, but feel free if you have any questions or commentary on Barnes and Noble free to pop into the questions box. We'll either answer them in line as we're going or Save All right how timely they are

yeah

all right. So we'll officially get

he's the managing director of the Institutional Research Group, and certainly has a lot of experience and exposure particularly in the security industry segment as a capital investment markets Thanks, Brian for for joining us today.

Industry and I'll turn it over. You start with this slide. Right.

So 17 companies right now.

As an equity research analyst, I've been an equity research analyst for close to 30 years that had a number of firms on the market that Imperial for about two and a half years in investment banking prior to this, so always on the security industry, so I've never primarily physical security. We have an annual conference in New York every year. Most of you guys attend or know about Si Si and been around the security industry for a while. Some of the subjects that I'm going to avoid during this. And I know Brian's you don't get to flip through but I'm going to talk about public company performance. I'm going to talk about some of the m&a deals, larger ones, some of the deal dynamics and trends but this is my coverage universe a primer primarily as well as test Monix guys to be service providers with a year or so right market, right. So in terms of it's pretty interesting, and I'm gonna look down a bunch of notes on where things were two years ago, in terms of in terms of stock. Let's start off with that before in 2021 degree of coverage companies was up about 14% in 2022, was down about 27%. And so far in 2023 We're kind of flattish to slightly. Losers, the winners, biggest loser for 2020 is at about 45% of the biggest winner OSI systems so there's a variety of winners and losers in there so far. Generally.

We're at 2.63.

So, overall we've seen some contraction of public multiples, which we'll probably talk about that probably means a somewhat of a contraction on the private side. And generally the security industry performs in line with the Russell 2000 overall within a point to three points. Next slide. Cool.

So here we've got we've got a selection of some recent m&a transactions that have occurred in the security industry. I'll go over a few of these. Then Brian go over a few. I think the summaries takeaways here. You start to add these up. I think we all we all kind of hear about these in line as they happen. But you look there's been about $10 billion in acquisition activity in the industry over the course of last year. I mean this this I you know, Brian, I've always curious for your feelings, but I feel like this is a pretty big number and a number that you know, not that long ago would have seemed just like, like a total moonshot expectation to see security industry, m&a transactions. Rolling up to that, that size of activity.

Yes, it was big transactions that happened in 2022. It was that big chunks. 2021 was the middle market lower middle market. was super high. So 2022 was the big guys and I'll talk about those in a second. I'll let you lead on some of those transactions, but 20.2 was all about.

So, at the top of the list here, you know there's a handful of kind of what I sort of classify some weaker players are ones that didn't quite grow into the expectations that have been looking out for more quantity at the top there. The solid state LIDAR company remember Siemens Isus. I want to say around 2016 in a row, really launching into this space and I think the concept of solid state Lidar and a lot of money interested in progress and costs like never quite met market expectations for what it could deal with deliver. They had gone public for a spec reached the same valuation then sold for was was 1.2 million but it was effectively was small downloads especially compared to what they raised and what they were once valued at. co star who had bought air con vision. They were recently acquired by hiatus I think not a great all things considered another spectacular exit for Coast Guard. Probably good deal for is my personal opinion. cleitus has really been trying to push into the global markets for for a number of years trying to increase their exposure increase their product range, they've got the they've got the r&d and manufacturing facilities to I think takes on what what they picked up with co star and run with that a bit so not a great exit for co star necessarily with probably a nice win for itis and I think we could probably say the same thing about venture the AI company. Full disclosure I was at interferring hearing in 2020 which obviously was a super crazy year for trying to launch a new company and technology in this in this space they they were developing a server GPU based AI platform that was recently acquired by alarmed F calm the press release put out classified as an asset acquisition which is usually a little bit of a dog whistle for we just bought some parts and pieces it's not an indicator of a strong exit for the company has been been no details released on the specifics of that but you know all the whispers and rumors definitely point to low valuation. But But again, there may be an opportunity. What we've heard is that alarm.com I want to hand this over to open AI and have open AI incorporate the venture AI technology into their platform. And I think I think if that happens as as planned or as advertised it'll be you know that this will this could turn out to potentially be maybe one of alarm that comes best acquisitions in an ROI perspective. I think what they paid for vintra If they can roll that into open AI and make that a very unified offering the way say like a vigilant has with their analytics that there'll be a huge win for us tonight. And we'll do mostly on that adventure acquisition. I think these next few started with the Eve eclipse the Motorola ones are yours Brian so I'm gonna turn it over you to give your your summary of those.

Yeah. So what I really want to focus in on the bottom three, not that the other ones aren't interesting. It's just the bottom three are earth shattering because they really change the industry. People look at StateFarm putting 1,000,000,005 into ADT as an investment and cash and being that you know, exclusive insurance you know, primarily on the water and fire but it's really about water. You know, that's a big investment. They're going to recede out of it. There marketing in four states right now with State Farm ATT is going to roll out another tree next month to roll this out to the entire ADT system. Excuse me, the entire state farm system. And that's really interesting. And everybody that you talk to you from talking to alarm.com to brains to smart rent to anybody who's talking about insurance. So that's an interesting that kind of shakes up the next one that shaken things is finally the DOJ I think on the sixth may 6, maybe off the day is signed off on the long awaited an acquisition ahi or two brands that gets some Yale there's divestitures involved. There's a lot of moving parts 4.3 million. Still trying to figure out exactly what kind of multiples they're actually paying what they're keeping, because there's all these moving parts going on. But that's going to shake things up for not just awesome, but for Legion. And dormakaba And everybody else's lock industry. Having such a dominant player with with Austin Austin was already the center pound gorilla. It's now 1000 pound gorilla and maybe even heavier. So that's and that moves forward and expected to close in June. The last one is another one is like at State Farm. It's like you got Devon and NRG you have a you know oil and gas play energy play if you will, buying a home automation company and paying your 14.2 times even 3.2 times revenue 5.2 million enterprise value. So they paid a hefty sum to get into that pilot. So lots of moving parts here and those are the significant ones

that I

think movers in the industry that kind of reshaped.

Cool, real quick

question or comment kind of related as the ritualism was asking about health insurer as it relates or overlaps with object video, that IP portfolio that alarm.com wired a couple years back and I think the biggest difference there is that the venture product is more real. That there there is there was a real product is active development team. Barcelona, led by addreality was a really strong development team really good technology. So I think it's gonna get something that's up and running. Great, whereas I think most of what they picked up from object video was more of a patent portfolio that can be used defensively or for licensing purposes or or fundamental.

Was really wasn't pleased a bunch of

academic technology has been pretty good. Take this one here, Brian. Yeah, sure. So

prior to this on this webinar, I went out through from clients to to our banking team and asked, you know, what kind of deals have been closed so far this year. And there's kind of 20 sizeable ones, that were were trapped that we closed as a kind of the beginning of May but one thing that we are definitely hearing more and more about

is the bank notes impacting the

timing of your closing. And it's about getting that that debt financed having cash, your private equity has deep deep pockets. They have billions of dollars and there's a lot of private equity trying to throw money out. I'm not going to explain private equity here one on one, but it's all about the leverage. That's how you get your returns and when you're paid don't have access to leverage or which is worse news or be your cost of capital radically increases because interest rates going up and Silicon Valley Bank was kind of go to on the lower middle market for transactions that were taking place in your deals, and maybe charge a little bit less than others. And that's gone away. And then you have an issue in terms of transactions. Like obviously there's still a lot of transactions to get done and multiples what we're hearing at least. Now I'm not privy to everything because I'm on the ivory tower of equity research. But what I'm hearing is that multiples are generally stable.

Yeah, yeah. We'll talk a little bit about that in the next slides as it relates to integrator acquisitions, but on your your third bullet point at ISC West, I had a few meetings with some PPS and some private investors and I think just kind of like the mental note I had is that I had about what represent about $5 billion worth of active capital, folks that came to me kind of describing some of what they're looking for in the industry, whether, you know, what we would traditionally call manufacturer startups, or integrators and things like that, but there's definitely a lot of money looking for a home in the industry. We're gonna talk about that a little later, too, and what specifically they're looking for what's making those deals most attractive to them. So, a little bit more on that thread. You know, we've covered a lot of the, again, kind of manufacturer or supplier large, large acquisitions, there's, there's been a consistent trend in integrator acquisitions over the last few years. And again, I think some things maybe those don't always percolate up to mainstream news. But there's a good market for well run integrator makes it again, I think maybe you've been in the time I've been paying attention, you know, in this industry last decade or so. With this might be maybe the best market I've seen for exits for you know, for the well run integrators. Valuations are are commonly above 10x EBITDA, convergent, you know, few logos. There's a few big brands convergent sage security one to one, you know, they're all putting out press releases about acquisitions, they're doing a handful of PE firms and I've also had some, what I would call like, large regionals or other players that have, you know, they've built up a bank account or they've got access to some funds. They're looking to make some acquisitions regionally, or expand nationally and, and invest in in buying some well run integrators. I've heard from this. Unconfirmed source told me that convergence done about 54 deals between six to eight times EBIT a secure tasks suppose the paid 17x For for Stanley, I've heard it but you don't get a lot of others coming in that, that 10 to 12x range. So I think back to your comment, Brian valuations are remaining pretty strong. I'm seeing and hearing more and more about ARR vn which works with optimal valuations that was in the past, you know that the cloud services and manage access cybersecurity monitoring things that were maybe viewed again in the past as as nice to haves or like an extra little thing that kind of over the top I think there's a lot more attention being paid to and another one of these companies that's that's just acquisitions, they look really strong cultural fit and corporate fit, making sure that they're not just looking to evaluate the territory or market are making sure that they can fully integrate this into their existing business. And when you check those boxes, these deals, they tend to move pretty quickly. I think maybe sometimes, you know, unlike some of the other ones we talked about, it's rare, if ever for these to really get hung up at like the SEC level and be waiting on a lot a lot of approvals and things like that. So they can go pretty quickly. And many times, especially when you've got like I said, like like the logos here, all run by executives that really know the industry. They can come into an integrator firm. Take a look at it. Get down to evaluation pretty quickly determined pretty quickly whether or not it's something that they want to buy that would complement their portfolio and when that happens, it's a tends to be I think, a pretty fast track deal doesn't get hung up by by too many things. And so, you know, for for integrators that have built up a good you know, good business profitable business sometimes well run looking for an exit you know, what are we We're mid May by the end of summer, you could you know, potentially be on your new boat at your beach house and, and be out of your integration business if you're if you're looking for an exit this time. So I think it's a it's a good market there. key trends you hit on some of these I think this is affecting the the industry in general. I think for people that are you know, for equity events happening or even just for the general business, I think the things you highlight here, Brian are kind of end to end we're seeing in the business there's a lot a lot a lot of demand a lot a lot of backlogs, new offerings to supply chain stuff. We've definitely heard more and more about that those things. Easy enough and handful and negatives but I kind of feel like the negatives are are I think the positives, more than offset the negatives that we're seeing in the industry and just a lot of positive outlook.

Okay, so let me just jump in there. You know, on top of the commercial demand being strong backlogs still at record levels, companies were just finishing up first quarter earnings. You know, this week, I had three last night. And so everybody's talking about their backlogs bookings, you know, new offerings are all coming out. Supply chain pressures are definitely easing. We're starting to see on the positive side, that's not written down. Here. And that's why I wanted to highlight is there's a changing geographic focus. I'm seeing a lot of reshoring nearshoring a pivot to the southern United States. There's all this stuff happening. That's going to you know, II supply chain pressures in the future. One thing on the negative side so on the negative is you know, consumer retail demand is down. public company performance is obviously weak slowing up new hiring many of the companies are, you know, cutting are announced cuts at year end, and margins definitely haven't fully recovered. When I look at the big guys from a lead gen on, you know, for manufacturers and things like that they're down from pre COVID levels. So those haven't fully recovered yet. But for the smaller guys on the negative is there's a stretching and working capital. One thing that we recently had a manufacturing conference that I spoke at, and one of the things that came up repeatedly is the smaller guys are looked at as banks and there's a stretching of working capital by you know, the customers so just highlighting the positives and negatives and I I tend to agree with the with Brian on this that definitely the positives outweigh the negatives. But there are some negative headwinds out there.

And this one here one of your slides I think this is I think this is interesting and maybe this this boundary creeper boundary elimination that you highlight here is something that again, isn't jumping in front of everyone isn't isn't patently obvious, but I think when we step back and look at some of these deals and some of these trends, it's very interesting to see where how the edges are moving here.

Yeah, so the elimination of boundaries and I spoke with SIA and OIC at ISC West about this. You know, this is one of the top trends. And I spoke at securing new ground on this also. It's it's kind of two things happening on the the boundary elimination. One is all these organizations different industries are coming into security or security is going into those organizations. So you got the insurance, you got energy. You just looked down through their Google and so yeah, technology, you got solar. You got all this other stuff that a couple years ago, it was security and then other things, it was silos, okay? Now, there's this melding kind of elimination of boundaries, if you will, there's no motor more of these boundaries. But there's a second part of this on the elimination of boundaries. You know, when you say access control to somebody, somebody comes up and goes, well, that's locks. No is that he pads is that an HIV card is that video is that and all this stuff is starting to meld together have used to have silos of video of different areas. That you could identify and go those are clean. There's no longer this, this very clean boundary and then to take that one more step further, is that cybersecurity was its own silo two years ago. Very clear, clearly. And physical security were the guys in the basement and the ex police officers down there running the physical security for a C Corp. And those two guys didn't talk to each other. Now there's this cross pollination and elimination of boundaries from that angle. So there's multiple tiers of available elimination of boundaries that are happening in the industry, kind of three different ways if you want to look at it, but there's a lot of things happening in the security industry. Yeah,

most definitely.

Okay, so just taking that trend a step further. And just highlighting a couple things that I've already mentioned. The Google investment with ADT, the State Farm, we've already mentioned NRG Vivint, and then the sunpro ADT transaction so you know, we're talking about billions and billions of dollars, just from that getting thrown at this industry and we're not even talking about any of the other things that are happening out there and including OSes, you know, transaction and, and a variety of other things going on, but that's just some of the things that are happening where there's this boundaries are shifting, right there.

Yep. And another question that came in from Jennifer, I think is pretty good. That might be good for you to field here. She was asking how are valuations being impacted from 2021 to now with the Fed increase of 5% since February 20, trying to increase in labor cross compression of margins due to inflationary price increases? I think that has a major change to ROI of buyers. What are you seeing in the in the ones you're involved in in that regard, Brian?

Okay. So again, I'm on the equity research side, ivory tower. I know public multiples, okay. Public multiples are haven't decreased at all, and the 14.3 times and RG pay for vivan. You've got a big multiple still being paid for the big transactions. What I'm hearing on the smaller side, as you are Brian, is that multiples are relatively stable on EBIT, da basis. Evey enterprise value to EBIT da Yeah, we're still talking

and I'm going to loop back because I think it's on the next slide or the one after that, but so for companies looking to raise capital, you know, startups, early stage companies doing you know, seeds A's B's, I originally had a little more content here, a little more, a few more bullet points. But I think these two kinds of summarize it, particularly were a few years ago, these would have been inverted or frankly, the profitability one might not have even been your top three or top five bullet point. I think I think we went through this era that is now kind of more or less ended where everyone's like, we'll worry about profitability later. You know, I mean, we certainly saw that in the in the call it namebrand Silicon Valley markets, you know, the Ubers and the lifts and DoorDash and all these, all these services that were basically subsidized by Vc capital and, and many other things that entered the market with huge valuations with no revenue model. But But even in the security market, I think I think we had this period where there was really a lot of interest in you know, IoT, and AI and other things where investors looked at it as like, this seems like something that could grow to a big market. And if it does, we'll figure out the profitability when when we get there it was it to questions during the pitch sessions and during the due diligence sessions. Were more about the people and the technology and the grills and all those kinds of things. Now, I really feel like this, this has has inverted in and profitability, or if you're very early stage, you know, seed wise path to profitability, how you're going to get there, how you're going to fit in with your competitors, and you know, obviously tied into that margins and everything is it's a top line part of the discussion and bit of a gating factor to, you know, deeper level discussions past those, you know, introductory 30 minute pitch sessions and a lot of cases. So, if you're, if you're one of these companies that's looking to, you know, to raise capital, I think that I think that you know, back to the previous points, the valuations are still good when when you can get there, but I think the talk paths and the pitch decks are starting to shift a little bit towards leading with profitability, maybe over you know, over anything else. I think that kind of hits a question Jerry asked, as well about new new software startups and things like that and valuations of IP and patented technology, I think, I think, you know, patent portfolios and intellectual property is always important in these, you know, in seed stage and early stage they, before that you've had a chance to carve out the market, or prove yourself on the market, it's important to know what you're going to be able to patent what your what your blockers are going to be there. So that always comes up and then exits and again, I'm addressing this slide kind of what I call more from my end of the market, the things that are going to happen in the in the $50 million and under sector. And earlier we kind of said that, like for integrator acquisitions, they're on kind of an accelerated path, if you will, a lot of times other things, you know, manufacturer style acquisition supply requisitions thing things are taking a little bit longer some of that due diligence into the profitability and margins and what can we do about that? I see a lot more scrutiny there. Some of the deals I've personally been involved in recently seem to seem like they move a little, little slower and a little more precisely, maybe than they had in the fat in the past. strategic fit and integration, you know, assuming that the exit is is an acquisition, it's an exit say from a small PE firm to to a big firm, but it's a company that's been acquired. I heard this from integrators buying companies, I heard this from, you know, manufacturers looking to buy companies or do consolidations that again, they pay a lot of tension upfront the strategic fit and integration. Versus again, some things that I had been involved in in the past it was kind of a, you know, buy it now integrate it later. Approach and things weren't always weren't always thought of upfront about what exactly this melded organization was going to look like. for lots of reasons we see more attention being paid to that now. And then kind of back to our previous comments, and you know, Jennifer's question and so on. The valuations are good, and they're still strong and I think they're still positive but with all this in mind, you know, I think they need to be one more than they were in the past there's there are still some bidding wars that we hear about especially with integrator acquisitions. But a lot of times those bidding wars are are a lot less like drunken spending and a lot more like strategic considerations. And, you know, integrators or manufacturers looking to exit I think it's still getting really strong valuations in the market today. But you're having to really spend a lot of time you know, you're filling up data rooms, you're doing a lot of due diligence, you're really proving that valuation is valid and earned and not just kind of hanging a number out there, and, you know, waiting for the offer letters to come in.

And let me just add something to that real quick on that talking to several large public company CEOs. The comments have been pretty consistent and in when we're talking valuation, is that these these small companies have not changed their valuation. You know, they want to still get x no matter what's going on in the market. They still have these founders still have a number in mind, and public company CEOs. Realize the cost of capital has gone up. And you haven't seen as much m&a happening out of the group. I think as a result, I think there is a valuation differential out there. So maybe that shows itself more in 2024. But, and maybe there'll be a contraction. I don't know right now. I agree with you. multiples are up are stable, excuse me, and profitability is key.

Cool, thanks. So I think I think that's the content that we had. If there's any last minute questions from anyone feel free to throw it in the chat. And we'll try to address those if we can. There's one that we didn't get to. Steve was asking about thoughts on the carrier sale of their fire and security businesses predictions on who might make a play. You have any any speculation there? Oh, yeah.

API, or Yeah, I mean, that would be my bet. They buy everything. They bought Chubb. They're moving forward with that integration. I follow them on you know, they're a consolidator. They have the balance sheet, they have the cash flow. So that would be my number one choice if I had to pick somebody

got it. Yeah, I don't I don't really I don't personally have a lot of speculation on that, especially in the fire stuff. I haven't been as involved in those but yeah, there do seem to be a pretty short list of potentials there. So be interesting to see what happens. Brian's contact information is here as is mine. So you know, we're we both try to be pretty reachable and addressable and sociable. So feel free to reach out if you have any, any questions for either of us or any follow up stuff. quick plug. I'm also going to be doing a AI webinar June 1 at 11am. So if you're on this one, you'll see the invites for that if you're on my email list, you'll see that we're gonna be talking a little bit just about the AI trends of the industry, some of the exits, things like GPT, four and Dali and all this stuff that people are sometimes speculating is going to, you know, change the world or melt things down or not. So I think we could spend a good bit of time just on those topics. So we're gonna do that June 1, and hopefully some of you folks here today will will be able to join us there. Thanks, everyone. Thank you