Will Schmidt is managing director of CapitalSource’s Security Lending Group, based in Los Angeles. In keeping with this month’s Business Issue theme, we sought Schmidt’s projections for 2012 as well his insights on current financing trends and challenges.
Are you bullish on the industry’s prospects for 2012? Where do see real business opportunity?
The companies we speak to seem to have done very well through the recession by controlling costs and right-sizing overhead in their business. It helps that many of the businesses have a large component of RMR, which anchored their business through those difficult times. But we are seeing many businesses already talk about an uptick in installation revenue and a thawing in the markets generally.
I am optimistic that 2012 will be an improving year with growth on the top line from an installation perspective for many of the participants in the industry. I’ve been in the industry for 14 years and I would say now is as an exciting time as I have ever seen.
The combination of pervasive, inexpensive broadband and wireless connectivity is really enabling a whole new suite of services to residential and commercial customers that are creating perhaps an unprecedented opportunity for alarm companies to command greater RMR for these services. Examples would include remote video monitoring, interactive residential services, energy monitoring, remote video in the home, managed access control on the commercial side. A bunch of these services are finally getting to the sweet spot where broad adoption is occurring.
Financing has been very tight or even nonexistent for all but the most successful companies. Will that ease in 2012?
The credit markets will continue to improve. [Installing security firms] with large recurring bases will absolutely continue to have plenty of interest from the banks and finance companies that participate in the security industry. On the integration side, companies that borrow on the basis of the earnings of their business — a multiple of EBTDA — did see more challenges to obtain those sorts of loans through the recession period. That is starting to ease up and I would expect that to continue improve in 2012.
What financial factors determine the well-being of an alarm company?
The No. 1 indicator of a company’s health is the attrition rate they are experiencing. There are so many factors that go into that. To name a few: How a customer is sold; how good the company is doing servicing the customer after they are sold; the competitive environment of their particular market. The second thing is the cost to create the customer. That would be the dollars spent to install a new alarm customer minus the amount that the customer would pay divided by the amount of RMR that is created. Being able to create accounts at a rational cost is critical because that is where the value is created in the business and doing so efficiently is important. The last factor is the margin that the company has on monitoring and servicing their customers and making sure they are doing so efficiently and they are getting as much a profit from their existing account base as possible.
So those are the top three factors, but there is another element which is incredibly important for any company: To have good, sound reporting and be able to demonstrate those numbers. Having a good accounting system and the ability to track the amount of RMR put on and canceled in a month, and have sound attrition reporting with backup for all these reports that can be audited, is incredibly helpful. It is good not just for when you want to raise capital with a debt provider, but it is also helpful if you ever want to sell your business or do any sort of any other capital market transaction. It’s also incredibly helpful to know all these metrics and be able to manage those metrics. I would encourage anyone, whether they need financing or not, to make sure they have sound internal reporting and make the investment in personnel and systems. Make sure you are tracking what is probably the most valuable asset in your company — the RMR base.
Can you offer some advice on how to streamline the cost to create a customer?
The creation cost is very dealer-model specific. Commercial alarm companies will create at lower multiples because they receive higher dollars upfront from the customer. Other companies that are doing higher volume sales on the residential side will have higher creation costs because they have to pay higher sales commissions and they typically get a lower install amount. It is important to look at that not as an absolute number but also within the other factors. You want to make sure all these things work together, so you might have a higher cost to create the accounts but perhaps you have a lower attrition rate or a higher margin and all three of these factors need to work together.
One example would be a commercial account. You may be able to create it at a lower expense, but you might not make quite as much of a margin on monitoring because typically commercial accounts are higher touch accounts with greater monitoring as it relates to open and closes, false alarms and things of that nature that make it a higher touch on the monitoring side. It’s important that all three of these factors all work together and you have an overall profitable mix.
To what extent is private equity money driving the electronic security market?
Whereas 10 years ago there were only a handful of [installing security] companies among the top 25 that had private equity backing them, I would say now it is certainly more than a third of them have private equity backing them. It has grown significantly. It is good on a couple levels. It is a true testament to financial players understanding the value of the recurring revenue model. Many of them have become more interested recently because of some of the dynamics where there are new services and the increased adoption rate of these new services, and the ability to get greater share of wallet or increase monthly average of revenue per client. Those opportunities are tremendous.
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