Analyzing Security M&A Activity in 2022

Investment bank Houlihan Lokey’s Michael Morabito goes over key trends in security M&A, provides a public markets overview and more.

Mergers and acquisitions is always a hot topic on SSI. In fact, M&A stories made up three of the top 10 stories of 2022. But what is the state of M&A?

Following a record-shattering year in 2021, M&A activity remained elevated by historical standards during the early part of 2022. However, M&A activity has decelerated in recent months, and it remains unclear whether intensifying geopolitical and macroeconomic headwinds will continue to dampen transaction momentum going forward.

To get a handle on the security and safety solutions sector, SSI recently spoke with Houlihan Lokey’s Michael Morabito to detail key trends, a public markets overview and select deal coverage.

Houlihan Lokey is a global investment bank with expertise in mergers and acquisitions, capital markets, financial restructuring, and financial and valuation advisory. Morabito serves as managing director in the company’s Industrials Group and leads the firm’s Security & Safety Solutions practice.

After you are up to speed on the industry’s M&A trends, be sure to check out the major acquisitions of 2022.

SSI: What were the main drivers of M&A activity in the security sector for 2022?

Michael Morabito: Following a record-shattering year in 2021, overall U.S. M&A activity remained elevated by historical standards during the early part/1H 2022. However, M&A activity decelerated in recent months/2H 2022, and it remains unclear whether the intensifying geopolitical and macroeconomic headwinds will continue to dampen transaction momentum in 2023.

Global and domestic M&A activity decreased substantially through the YTD period ending September 2022 relative to the same period last year, with transaction values declining by ~32% and the number of transaction declining by ~15% on a year-over-year basis.

In general, there are many factors that can influence M&A activity in any sector, including the security sector. These factors can include economic conditions, regulatory changes, technological developments, and the strategic goals of the companies involved.

Increased investment and M&A activity was driven by a continued pace of consolidation, technology and product acquisitions, and the growing demand for a more integrated approach to security solutions. Additionally, 2022 also saw the shift towards recurring revenue and managed services models as end-users/customers have a growing preference for one-stop shop solutions to solve a number of security needs. Strategic acquirers are actively seeking to add subscription-based/SaaS-like recurring revenue to create more top-line consistency and achieve margin expansion.

Will trading volumes in 2023 exceed that of 2022? If so or not, why?

With 2021 being a hard act to follow, both the NYSE and the NASDAQ have shed gains this year with the sell-off disproportionately impacting growth and technology stocks. Through the end of Q3 2022, the NYSE and NASDAQ indices were down ~22% and ~32%, respectively on a year-to-date basis.

Equity market volatility was a core theme throughout 2022. Geopolitical and macroeconomic concerns sent the VIX up to 36.5 in March 2022, reflecting the highest reading in more than a year. Market volatility remained elevated throughout Q2 2022 before cooling down towards the start of Q3. However, volatility levels increased yet again in September through the remainder of the year with a monthly average ~4 points above the historical three year average of 23.9. Additionally, U.S. corporate and high yield spreads widened in 2022 amid several announced rate hikes by the Fed.

The M&A market is influenced by a wide range of factors, including economic conditions, industry trends, and company performance, among others. There are several trends and developments that could potentially impact M&A activity in 2023 including continued investment into the sector from the private equity community and strategic acquisitions from established players looking to advance their technology and service portfolio (such as Motorola Solutions) or new entrants into the space (such as Hexagon AB’s acquisition of situational awareness and video provider Qognify).

What is the current level of sponsor interest for this sector?

The competition to deploy capital among private equity firms/sponsors remains as strong as ever and is to some extent bracing valuations across the broader market, as the “private equity put” has been buffeted but remains in place. Q3 2022 LBO dollar value and deal count fell materially from Q2 highs reflecting in part current market difficulties from obtaining committed financing from the traditional “money center” banks.

Sponsors are however, “picking their spots” (more than in recent years) around industries, transaction types, and business models they either know best or where they think their competitive advantages are strongest, leading to a “thinning of the field” among buyers and within sale processes. In response to continued market volatility, risk of a U.S. recession in 2023 and travails of the debt market, some sellers are taking a “wait-and-see” approach to launching deals today.

With that said, the security and public safety sector(s) remain highly attractive areas of investment from the private equity community as increasing demand for security products and services in a variety of settings, but more so in the attractive commercial, and industrial end-markets drives demand and the sector continues to be counter-cyclical and insulated from macro-economic trends as shown by its resilient performance during the COVID-19 pandemic.

What subsectors within the industry do you expect to outperform against others?

The most attractive sectors for 2023 and beyond include areas that are well positioned to facilitate the paradigm shift and acceleration of Cloud technology adoption and business model transition within the industry. This includes the access control and video surveillance sectors that are both migrating towards Cloud-based models (ACaaS and VSaaS) as well as recurring revenue and managed services models/sectors such as remote video guarding/monitoring and commercial security integration and monitoring sectors that remain highly-fragmented in nature.

How should private companies prepare now, in order to position themselves for public monetization opportunities in the future?

There are several steps that private companies can take to position themselves for future public monetization opportunities:

Focus on financial discipline: One of the key factors that investors consider when evaluating companies for public offerings is their financial performance. Companies should focus on building a strong financial foundation by maintaining disciplined financial management practices.

Develop a robust business plan: A clear, well-thought-out business plan can help to attract investors and demonstrate a company’s potential for growth. Companies should focus on developing a strong value proposition, identifying target markets, and outlining strategies for achieving growth and profitability.

Build a strong management team: Investors will want to see that a company has a talented, experienced management team in place to execute its business plan. Companies should focus on building a strong leadership team with a track record of success.

Prepare for increased scrutiny: Going public means subjecting your company to increased scrutiny, including financial disclosure requirements and greater regulatory oversight. Companies should ensure that they have strong internal controls and compliance systems in place to meet these requirements.

Build a strong corporate culture: Companies that have a strong corporate culture, with a clear mission and values, are often more attractive to investors. Companies should focus on building a positive company culture that is aligned with their business goals and values.

Overall, preparing for public monetization involves building a strong foundation for long-term success, including financial discipline, a clear business plan, a talented management team and a strong corporate culture. By focusing on these areas, private companies can position themselves to be attractive to investors and ready to take advantage of public monetization opportunities when they arise.

What are the factors that led to the current volatile market conditions for IPOs — and when might those conditions be more favorable?

New equity issuance/IPO activity remained at relatively depressed levels throughout most of 2022 as SPACs have fallen out of favor with investors and market volatility persists.

There are a number of factors that contributed to volatile market conditions for initial public offerings. Some of the most common factors include:

Economic conditions: A weak or uncertain economic environment can make it difficult for companies to go public, as investors may be more cautious about putting their money into new ventures.

Market demand: The demand for IPO shares can fluctuate based on a variety of factors, including investor sentiment and the overall state of the stock market.

Company performance: Companies that are not performing well financially may have a harder time going public, as investors may be less willing to take on the risk of investing in a company with uncertain prospects.

It is difficult to predict when market conditions for IPOs will be more favorable, as they are influenced by a wide range of factors that can change rapidly. However, in general, strong economic conditions, high investor confidence, and strong company performance tend to be associated with more favorable market conditions for IPOs. Many believe that there will be a resurgence in IPO and public offerings in 2023 but weighted towards the back-half of the calendar year.

It is important for companies considering going public to carefully assess market conditions and consider their own financial performance and industry trends before making a decision. They should also work with financial advisors/investment bankers and legal counsel to understand the risks and benefits of going public, and to develop a strategy that aligns with their business goals.

What major trends do you expect to see in 2023?

There are a number of security industry trends that could potentially emerge in 2023. Some of the trends that might be worth keeping an eye on include:

Cybersecurity: With the increasing reliance on digital technologies and the growing threat of cyber-attacks, cybersecurity is likely to remain a major focus for businesses and organizations in the coming years.

Artificial intelligence (AI): AI and machine learning technologies have the potential to revolutionize many aspects of the security industry, from surveillance and perimeter protection to threat detection and response.

Internet of Things (IoT) security: As the number of connected devices continues to grow, securing the IoT will become an increasingly important challenge.

Physical security: As the threat of terrorism and other forms of violence continue to evolve, the importance of physical security measures such as perimeter protection, access control and emergency response systems is likely to remain high.

Privacy and data protection: With increasing concerns about the collection and use of personal data, businesses and organizations are likely to focus more on protecting the privacy of their customers and employees.

Cloud security: As more businesses adopt Cloud-based services, protecting data and systems in the Cloud will become an increasingly important consideration.

Supply chain security: Ensuring the security of the supply chain is likely to remain a major concern for businesses, as disruptions to the supply chain can have significant impacts on operations and profitability.

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