Corrections, Guarding & Investigations companies had increased sales but also modest margin contractions. Unlike many other sectors, this group’s larger players were able to shore up equity capital losses via borrowing. Again, share repurchases contributed to noise in the numbers with Corrections Corporation of America (CCA) repurchasing almost 10% of its outstanding shares. The sector surprise was The GEO Group Inc., which delivered in excess of 30% sales and EBITDA growth, although its stock fell more than 30%.

Pureplay guarding companies Brink’s and Alarmforce were the only equity value gainers highlighting a market bias against government-driven revenues.

Credentialing/ID Solutions saw sales rise driving valuations and equity values to increase despite modest shrinkage in margins. This was the only sector to have no stock repurchases. Authentec was the big winner with a value gain exceeding 50%; sales rose almost 50% and negative EBITDA was cut by more than 50%. SafeTic appears to have been wrongly punished givens its attractive recovery and growth prospects.

Large Cap/Defense Primes experienced increasing sector sales and margins, and they similarly held onto equity values. Overall sector equity value shrank due to 50% of participants effecting share repurchases, with almost 15% of these firms repurchasing more than 10% of outstanding shares. Goodrich was the positive outlier, trading high off its merger announcement value of $16.4 billion. On the downside, SAIC’s margin contraction of 24% drove an almost 25% decline in equity value (also contributing was SAIC’s repurchase of more than 8% of its outstanding shares).

Safety/ Protection companies saw sector sales shrink by more than 5%, but margins held and expanded for some firms. Overall, sector equity values contracted a punitive 20%. As an example, OshKosh’s valuation was off 39% as a result of the 15% drop in revenues and an almost 50% fall in EBITDA margin. Mine Safety delivered the best performance with a 7% gain in equity value due to 40% margin gains and an 18% revenue gain.

The Security/Defense Integrators sector’s average margins dip
ped below 10% (the lowest average in the industry) and sales rose only modestly, putting pressure on equity values. Sector equity values were down by an industry-leading average of 30%. Computer sciences suffered the most with a drop of 52%, in part the result of a more than a 15% drop in margins. New competitive pressures (from defense and IT companies) hurt all sector stocks. CACI, which delivered 10% revenue gains and an almost 25% increase in EBITDA, was the best performer with a 5% price increase. (CACI’s equity value still declined due to the repurchase of more than 13% of its outstanding shares.)

Technology Will Drive Growth

Whether looking back at company successes and high-valued M&As or looking forward to where opportunities will present themselves, technology differentiation is key. Continuing from 2010, the “cloud” is a market reality and driving change. Related to that is the exploding cyber-security sector. Additional areas of distinct growth will include: wireless devices; communications platforms; integrated/converged services; and security as a service (SaaS)/managed services models in areas like video surveillance and physical security information management (PSIM).

In 2011, cyber-security deals represented more than $15 billion in transactional value. PricewaterhouseCoopers (PwC) indicates “cyber-security [deals] are expected to continue to grow given the fragmentation of the market and the attractive growth outlook.” Further, PwC suggests that cyber-security spending was to reach $60 billion globally by 2011 and is expected to grow at 10% annually during the next three to five years.

This year will also see growth in the wireless and communications domains. Wireless is ubiquitous and large firms that have product holes are filling them via acquisitions of smaller technology providers. Many new wireless technologies are incubated by venture capitalists (VCs) and/or Department of Defense (DoD) Small Business Innovation Research (SBIR) grant platforms. Both the VC and SBIR funds have increased and dollars are again aggressively flowing into continued technology evolutions.

Specific to communications platforms, the military is gradually migrating to commercial-off-the-self (COTS) platforms as the base for personal communications devices. This will drive a new round of growth in handheld devices and likely prompt security markets to re-evaluate outdated proprietary architectures relating to communications.

As the industry fights to protect its revenues, models like managed services for video surveillance, data analytics, security management and PSIM are increasingly attractive. Customers can “push” expertise requirements, system upgrades, etc., to the services provider and the providers are accepting this model in order to preserve revenue streams. As long as margin compression is not problematic this will be an effective model. But once margins begin to erode there will be pain points at the service provider level.

If you enjoyed this article and want to receive more valuable industry content like this, click here to sign up for our FREE digital newsletters!

Related Content