Security Investors Ride Rally Into 2013
Publically traded security firms experienced a mostly tumultuous 2012 before staging a strong stock recovery, closing the year well positioned relative to major U.S. indexes. Industry participants remain hopeful the market can hold onto its Q4 gains.
In 2012, security industry stocks experienced something of a rollercoaster ride similar to most other markets. The sector started off well, followed by weak Q2 and Q3 performances reminiscent of 2011, leading into a strong Q4 rally. As compared against major benchmark indices, the industry finished second only to the NASDAQ (+14%); SecDef Industry Index, a customized security/defense stock index (+12%); S&P 500 (+11%); and the Dow Jones Industrial Average (+6%). If the year had ended on Sept. 30, SecDef would have been the worst performer.
Last year was punctuated with numerous events that adversely impacted both the sector and the broader markets: mass shootings in the United States, the attack on the American diplomatic mission in Benghazi, Department of Defense (DoD) sequestration, the “fiscal cliff” fiasco, the European debt crisis, and more. Despite it all, as the year wore on it appeared investors’ demand for sector stocks gained momentum, thereby buoying valuations.
While not a huge year for mergers and acquisitions (M&A), the sector was dynamic and some players made meaningful strategic purchases. The overall industry stock performance facilitated multiples expansion, with revenue multiples rising an average of 13% and EBITDA (earnings before interest, taxes, depreciation and amortization) multiples rising an average of 18%. Industry revenues and profit margins were relatively stable as compared year over year. Multiples improvements appear to be largely due to increases in stock price, shares outstanding and additions to debt.
SECURITY SALES & INTEGRATION’s annual industry financial analysis and stocks report examines the performance of the security industry (as well as related sectors) for the year just ended and offers perspective on what may occur during 2013.
In keeping with the previous two years, bigger was usually better in 2012. When analyzing the market, stocks with market capitalizations greater than $2.5 billion performed better than smaller industry players. In addition to turning in superior equity price gains, this group of companies also experienced lower earnings and valuation volatilities.
Micro capitalization companies with total enterprise values, or TEV (equals total equity value, plus total debt less total cash), of less than $500 million finished the year with their stocks averaging 75% of the year high price. Small caps ($500 million to $2 billion) finished at 88% while midcaps ($2 billion to $10 billion) closed at 90%. Large caps (>$10 billion) closed the year at 93% of yearly high prices.
During uncertain environments, there is often an investor “flight to quality”; frequently investors associate large scale and an ability to withstand adverse conditions with larger companies. These large caps also generally enjoy superior access to capital, a critical variable in recent years. Supporting this view, most large caps issued shares and/or debt during 2012.
Industry Segments Detailed
The “2012 Security Sector Performance” table on page 45 shows relative performance for nine key industry segments, comparing the opening and closing valuation metrics by segment. Whereas in 2011 most segments showed annual declines, almost all segments turned in strong valuation improvements in 2012.
The Alarm Equipment/Physical Access companies experienced strong equity value expansion; median equity values rose approximately 19%. Segment EBITDA margins increased an average of 35%, which was seen as a major driver of equity value increases. ASSA ABLOY was a big winner with a 48% increase in equity value with sales up 15% and margins improving 17%. The company traded at significantly greater multiples than the overall segment. In part, this was attributable to being the only large cap in the segment and therefore perceived as the segment leader. There were many small M&A deals as well as debt capital raising, given the unusually attractive borrowing rates. Segment stock prices finished the year averaging 82% of the 52-week highs, a 15% improvement compared to the previous year.
Asset Tracking/Intelligent Traffic did not finish the year as strongly, closing at 80% of stocks’ 52-week highs. Still, that was a 22% improvement compared to the previous year’s finish. While median multiples finished the year mixed, averages delivered a strong 5% revenue multiple gain and the segment’s EBITDA multiple finished up an average of 21%. As in previous years, Trimble was a dominant segment winner capturing more than a 40% increase in equity value. Outperforming Trimble were Intermec, NEDAP and Init. In the case of Intermec, activist initiatives led to the company’s sale. Downward pressure on segment multiples came from Kapsch (margins declined more than 80%) and others, where anemic sales growth and margin erosion drove an overall average 1% decline.
C4ISR/Threat Detection continues to be one of the higher valued segments, experiencing generally low- to mid-teen valuation multiples gains, marking a huge shift from 2011’s average 17% multiple contraction. That said, segment margins remain pressured and fell by approximately 2%. Smiths, Qinetiq, OSI and Kratos Defense & Security Solutions all had equity value gains exceeding 34%, in part driven by sales and margin improvements (e.g. Kratos had a 30% sales gain and 13% margin increase). Contrasting these gains, Cephid, Analogic, AS&E and others experienced significant margin decreases ranging from down 23% to 50%. Multiples rose, perhaps in part to keep valuations stable, but shake-out within the segment will likely continue.
In Corrections/Guarding, CCA, GEO and Prosegur grabbed the lead performances. CCA and GEO delivered top segment equity gains (75% and 65%, respectively) while Prosegur experienced a segment-leading sales increase of 22%. Overall, segment margins averaged a decline, but that was largely driven by Command and AlarmForce (the two smallest segment players posting 40% and 35% declines). Across the segment, stock prices finished the year better than 2011 and gained an average of approximately 22%.
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