Inside Look: Why Security Companies Saw Stocks Drop in 2015
Publicly-traded electronic security companies had mostly dreary returns during 2015, ending a six-year run of outperforming the S&P 500.
LACKLUSTER. That fairly sums up the performance of the S&P 500 and Dow Jones industrial averages in 2015, which both ended lower for the year, marking their worst since 2008.
The S&P 500 ended the year down .73% after three straight years of double-digit gains. The index’s last major negative year was in 2008, when the S&P lost 38.49%. The Dow Jones was off 2.23%, its first negative year since 2008 when the index lost more than 30%. Conversely, the NASDAQ composite closed up more than 5.5% for the year, helped by outperformance in biotech stocks and major tech names.
Caught up in the market volatility were publicly-traded companies that are home to the physical and logical security markets. These manufacturers, systems integrators, alarm monitoring companies and related firms essentially mirrored the S&P 500. The Physical and ID Security group of 45 securities tracked by Imperial Capital was down .9% for the year, despite outperforming the S&P 500 by 15% at midyear. In August, however, the entire stock market tumbled with falling oil prices, wiping out the group’s overall gains – thus ending a six-year run of outperforming the S&P 500.
Based on in-depth interviews with Imperial Capital Managing Director Jeff Kessler, one of the industry’s foremost experts, Security Sales & Integration’s annual industry financial analysis examines just some of the trends that impacted the performance of various security sectors in 2015. Also included is a snapshot of some of the more significant M&A activity during the year, as well as a summary of company stock performance in the custom electronics space.
Attrition Rates Rule in Alarm Sector
Alarm industry bellwether ADT Corp. (NYSE: ADT) decreased about 3% in 2015, essentially ending the year where it began despite posting improved metrics. In fact, the valuation of most companies in the space edged downward over the course of the year.
Some of the negative effects can be attributed to the white hot marketing spotlight shining on home automation, do-it-yourself (DIY) and monitor-it-yourself (MIY) systems, as well as the onslaught of new competing entrants. Investors are awash in confusion over which companies will win big – or lose big – over the next 10 years.
The industry is also contending with multiple cross currents operationally, namely its ability to improve average revenue per unit (ARPU) and customer stickiness with more digital wireless interactive systems. It’s also contending with the lack of penetration relative to expectations by some of the cableco and telco firms that still have very high attrition rates. Margins are also under pressure to a degree with the cost of installing and servicing new interactive systems.
In ADT’s case, Imperial Capital is optimistic the company will remain a competitive force in the market. At press time the company had not reported its final year-end numbers, although expectations were favorable for continued improvement on all key metrics.
Yet another factor dragging on the alarm sector was a significant decline in the stock price of Ascent Capital Group (NASDAQ: ASCMA), whose primary subsidiary is Monitronics Int’l. Ascent’s decline was related mostly to investor impatience with Monitronics’ continued elevated attrition rate and less than expected production from its dealer base. By the time it reported third-quarter results in November – posting a loss of $24.3 million – Ascent shares had declined 57% since the beginning of 2015. And while the company did grow about 3% during the year, investors expected 4% to 4.5%. Combined with the higher than anticipated attrition rate, Ascent’s valuation took a hit.
Why the elevated attrition rate? Look no further than the roughly 93,000 subscriber accounts Ascent purchased from Pinnacle Security for $131 million in 2012. Many of the Pinnacle accounts came to end of contract in 2014 and continue to do so because a portion of them are five-year subscriptions. The attrition rate ticked upward following the acquisition, just as the company said it would; however, the rate has stubbornly remained above the company’s historical range of 11.5% to 12% longer than expected by about 120 basis points (1.2%).
By comparison, Vivint, which has public debt, reports attrition rates similar to Ascent but it is growing at 15% to 20% per year. While Vivint does have the highest average RMR per subscriber, it also has some of the highest customer acquisition costs per subscriber, which hopefully will lead to higher paying, more sticky customers. ADT’s attrition rate came down to 12% from 13.5%. The attrition rate of Securitas Direct hovers around 8.5% to 9% and is the gold standard for the largest companies in the industry.
Monitronics is actively maneuvering to reduce attrition as well as improve dealer production, predicative analytics for the subscriber base, and efforts that include marketing new types of remote home automation and smart home technology systems. As a result, Imperial Capital projects the company will begin to see marked improvement in 2017.
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