SPECIAL REPORT – Security Stocks Tick Up

Led by surging micro and small capital stocks, the security industry again outpaced the general market indices for 2004.

With a post-election to year-end spurt, the S&P 500 registered a modest 8.9-percent gain for the year, the NASDAQ Composite rose by 8.6 percent and the Dow Jones inched up 3.1 percent. The strength of the micro caps was reflected by the more robust gains of the Russell 2000, which jumped 17 percent for the year.

The Mallon Global Security Stock Index rose 41.9 percent for 2004. The index consists of 185 separate public companies or firms with significant security subsidiaries or divisions on stock exchanges around the world. A breakout of the stock performances in 18 separate security sectors appears on pages 40-46 of the February issue of Security Sales & Integration.

But the real story for 2004 was in the micro caps. Three emerging companies actually recorded four digit gains — as in 1,000-plus percent — for the year.

Nonlethal Weapon Manufacturers See Biggest Growth in 2004
The three mega winners for 2004 were MDM Group (OTC PK/ MDM), a manufacturer of nonlethal ammunition, Law Enforcement Associates (NASDAQ/ LENF.OB), a manufacturer of audio and video surveillance equipment, and Universal Guardian Holdings (NASDAQ/ UGHO.OB), a provider of a diverse range of security goods including nonlethal defense products.

Aside from the anti-terrorism connection, these top performers were all engaged in the development or distribution of nonlethal guns and ammunition — and investors were obviously looking for another Taser Int’l (NASDAQ/ TASR), the stun gun manufacturer, which led the stock market in the prior year with a whopping 1,953-percent appreciation.

Despite some negative publicity about fatalities allegedly caused by its weapons, Taser managed to register an impressive stock gain of 361 percent in 2004 and rank in the top 10 for the year.

Last year’s top 10 consisted of a more diverse collection of security companies. In the past, emerging computer and network security firms dominated the list of leading companies, but in 2004, only one from that sector — Network-1 Security Solutions — made the cut.

The extraordinary gains for many of the security industry high-flyers — most with market caps below $100 million — have been taking place below the radar screens of the big institutional investors.

NAPCO Has Top Stock Surge Among Alarm Equipment Makers
NAPCO Security Systems (NASDAQ/NSSC) led the electronic security-specific companies on this year’s list. The well-established manufacturer of security alarm products and electronic locking devices, came in ninth in the rankings of companies on the Global Security Stock Index with a gain of 259 percent.

With its stock surging 25 percent the last week of the year, NAPCO finished 2004 at $13.23 a share — up from $3.69 at the start of the year.

For its year ended June 30, the Long Island, N.Y.-based company, which has been around for more than 30 years, reported net income of $3.3 million. That was up from $1 million in 2003 on sales of $58.1 million (up from $57.3 million).

As a whole, the stock value of alarm equipment manufacturers in the index rose 52 percent. Among the manufacturers besides NAPCO, GE, at 18 percent, and Honeywell, at 6 percent, also saw gains in their stock prices, while International Electronics (8-percent loss) and Richardson Electronics (13-percent loss) took a loss in 2004.

Alarm contractor Guardian Int’l, which mostly installs systems in Florida and New York City, saw the largest percentage increase — 75 percent — in its stock among companies that install burglar and fire alarm systems. However, its 35-cent stock price at the end of the year tied for the lowest among alarm companies in the index.

Among the higher-profile alarm companies, Brink’s saw the largest 2004 stock gain (73 percent) with FirstService (56 percent), Group 4 Securicor (50 percent), Tyco Int’l (34 percent) and Prosegur (12 percent) among the other companies with double-digit gains.

Microtec Enterprises (27-percent loss) and Integrated Alarm Services (36-percent loss) were the only alarm companies in the index to see a drop in their stock price last year.

Overall, alarm companies in the index had a 21-percent hike in their stock price in 2004.

Mergers and Acquisitions Continue to Spur Security Company Growth
The global mergers and acquisition market is heating up and major security companies are joining in.

For 2004, GE (NYSE/ HON) and Honeywell (NYSE/ HON) continued their battle for supremacy in the security product sector with both making significant acquisitions. Another major trend for 2004 is the proliferation of cross-border transactions and, again, security companies are participating in a big way.

Having jumped into the security pool with its acquisition of Interlogix in 2002, GE made a move to boost its security product sales beyond the billion-dollar mark by announcing its intent to acquire explosives detection manufacturer InVision Technologies in March for approximately $900 million.

However, the transaction got stymied in the subsequent due diligence when InVision disclosed that it may have made illegal payments in connection with some of its foreign sales. Regulators moved in and the deal was put on hold. However, by year’s end the issues were resolved and the transaction was completed.

GE further demonstrated its commitment to the security industry by offering $1.4 billion to buy Edwards Systems Technology, the fire and security unit of the embattled SPX.

Meanwhile, Honeywell, which had been the 800-pound gorilla in the security product sector through its 1999 acquisition of Pittway, indicated it was not going to give ground in that growing sector. Through its sale of its alarm operations to the private equity Quadrangle Partners, Honeywell signaled it was bowing out of security services — but not security products. In December, it jumped across the Atlantic to offer $1.7 billion for the U.K.’s Novar plc, which manufacturers a variety of security, fire and safety products.

Another major newcomer to security, the defense contractor United Technologies Corp. (UTX), also decided to go abroad to expand its security business to acquire the U.K.’s Kidde plc, a major manufacturer of fire and safety equipment. Kidde was once affiliated with Chubb Security, which UTX picked up in 2003. The price tag for Kidde was approximately $2.8 billion.

Other significant security industry moves for 2004 include Stanley Works’ purchases of integrators Frisco Bay and ISR Security Solutions, as well as Diebold’s acquisition of Antar-Com, a New York-based security systems integrator.

Investors Bet on Potential of Electric Charge Ammo-Maker MDM
The stock of the Santa Clara, Calif.-based MDM skyrocketed in March when its price surged from 5 cents a share to a high of $4. The volatile stock has since been drifting downward and finished the year at $1.50 for a still phenomenal gain of 2,900 percent (to qualify for the top performers’ list, a company’s year-end stock price must exceed a minimum of $1 dollar a share).

MDM is a development stage, advanced technologies research company focused on the security industry. It is devel
oping ShockRounds™ technology — which introduces a nonlethal electric charge to traditional ammunition.

With the company showing nominal sales numbers, this is obviously a very speculative play, with investors placing a high premium on future success in the highly visible anti-terrorism environment.

Police Security Product Supplier Light on Sales, High on Hope

Another stock with light sales but great expectations was Law Enforcement Associates, which started the year at 28 cents a share and finished at $5.15 – a mega gain of 1,739 percent.

For the nine months ended Sept. 30, the company’s sales rose 24 percent to $4.5 million. Its net loss was $280,000 – up from $49,000 for the prior year’s comparable period.

Based in Youngstown, N.C., the company distributes its products to law enforcement, the military and security communities.

Contractor Breathes in New Role as Product/Service Provider

The third 1,000-plus-percent stock performer for 2004 was Universal Guardian Holdings, whose stock surged from 11 cents on Jan. 1, 2004 and closed out the year at $1.38 for a nose-bleeding 1,155-percent appreciation.

The Newport Beach, Calif.-based company had taken a nosedive after the termination of a subcontract it had for the installation and service of security systems at four U.S. Navy harbors. It reinvented itself in 2004 as a full service provider of security products and services and introduced its new Cobra StunLightTM.

For the nine months ended Sept. 30, 2004, its revenues fell 48 percent to $2 million. Net losses for the period totaled $3 million.

The remaining top 10 performers – most from the micro cap world – all registered triple-digit gains for the year. Many of these high-flyers will likely grow and continue their upward spiral, while others will undoubtedly plunge back to earth and into oblivion.

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