Financial Analysis: Security Solutions M&As Stable Amid Evolving Economic Backdrop

The security solutions merger and acquisition (M&A) market held strong through late November 2023, outperforming the prior-year period.

Fragmentation across the sector — and in the systems integrator (security and fire/life safety) segment in particular —spurred a frenzy of consolidation activity from private equity-backed buyers. Buyers also showed continued interest in residential end-market participants, which saw top-line growth supported by strong demand from homeowners.

Across the commercial end market, increasing construction value spurred acquirer appetite for targets with strong industrial surveillance capabilities. Robust equity market returns in recent months also offered an optimistic acquisition outlook for strategic buyers this year.

Despite an unpredictable macroeconomic environment, the sector’s M&A market for the year ahead is anticipated to build on the sustained growth experienced in 2023.

Inflation has cooled in recent months. The core personal consumption expenditures (PCE) index rose 3.5% year over year (YOY) in October, a decline from 3.7% in September and approaching the U.S. Federal Reserve’s goal of 2%, according to the Bureau of Economic Analysis.¹

Equity markets have subsequently benefited from the disinflation trend. As of Dec. 13, 2023, total return for the S&P 500 was 20.9%; meanwhile, total return for the Nasdaq Composite and Dow Jones Industrial Average indices were 38.7% and 10.4%, respectively.

In turn, security solutions sector participants experienced favorable growth during 2023. Allegion (NYSE:ALLE), a leading provider in the access control segment, reported a 36.2% increase YOY in net earnings per share (EPS) to $1.77, according to its Q3 2023 earnings transcript.²

According to the earnings call, the company is expected to build on its robust financial performance and pursue a structured acquisition strategy focused on access technology and Software-as-a-Service (SaaS) businesses.

Construction Spending Supports Industrial Surveillance Demand

Continued spending on private non-residential construction is expected to be a boon for sector participants in the commercial end market. The value of private non-residential construction rose 22.4% YOY in October 2023 to $694.8 billion, according to the U.S. Census Bureau.³

Amid the increasing value of nonresidential construction projects, construction businesses have needed to fortify jobsite security to mitigate expensive delays. In particular, equipment theft has become a costly and disruptive challenge for commercial construction projects. This has supported the increased need for sector services.

Every year, approximately $400 million in heavy equipment machinery is stolen, with mobile loaders making up 18%, according to the National Equipment Registry.⁴

As of this writing, providers offering construction jobsite security products and services have found healthy acquirer appetite.

Notably, ASSA ABLOY (OM:ASSA B), an active buyer in the access control space, acquired CrewSight last March for an undisclosed sum.

CrewSight is a construction technology business supporting both worksite and access control security solutions managed through a mobile application. The company offers security software, cameras and analytics in partnership with Sensera Systems to provide an accessible platform for jobsite surveillance.

Package Theft Drives Demand for Surveillance Products

Residential demand for accessible security solutions has led to increased adoption of video surveillance products, driving revenue for leading segment players. In a recent survey, 17% of people in the U.S. reported having a package stolen within the past three months.

What’s more, 44% of people in the U.S. have had a package stolen at some point in their life, according to Security.org.⁵ The pervasiveness of package theft has expanded the market for smart home surveillance and Internet of Things (IoT)-integrated products.

The size of the global smart home security camera market was valued at $7.4 billion in 2022, and it’s estimated to reach $30.1 billion by 2030 through an annual growth rate of 19.2%, according to Research and Markets.⁶

To capitalize on elevated demand, smart home security providers have begun to offer all-in-one services that include package detection, alarm detection, motion-based notifications, emergency response and 24/7 professional monitoring.

Bundled services have offered sector players recurring revenue opportunities through subscription-based business models. Notably, Arlo Technologies (NYSE:ARLO) used its subscription-based security service to achieve 59% YOY growth in annual recurring revenue (ARR), according to its Q3 2023 investor presentation.⁷

Arlo’s all-in-one security service also accounted for 42% of its revenue mix in 2022, according to the investor presentation. Leading players in the smart home security space are expected to continue prioritizing investments in the consumer end market.

Security Solutions M&A Outperforms Prior-Year Period

The security solutions sector has seen healthy M&A activity in recent years, and 2023 was no exception. As of this writing, there have been 175 transactions announced or completed in the space, as compared to 167 transactions during the same period last year — a 4.8% increase YOY.

The security solutions sector has outpaced the broader market, as M&A transactions decreased 25.2% YOY through Q3, according to Capstone’s Q3 2023 Capital Markets Update.

Although financial buyers accounted for the majority (53.1%) of transactions through late 2023, private equity platform transactions have only accounted for 5.1% of total deals.

An elevated interest rate environment weakened private equity appetite for buyouts across all markets through late 2023. However, sponsors were sitting on over $1.5 trillion in dry powder as of Q3 2023, according to PitchBook.⁸

Limited partners (LPs) will eventually expect this capital to be put to work, while private equity firms had already increased their equity contributions for platform deals by 2.6% YOY to 52.6% through Q3 2023, according to GF Data.⁹

Although vast amounts of dry powder might provide a more favorable environment for platform acquisitions going forward, sponsors are likely to continue pursuing add-ons in the coming year.

Fragmentation in the fire and life safety segment has made the space ripe for consolidation by private equity-backed companies.

Buyers have targeted the fire and life safety segment at a high rate (38.9% of total transactions), with many private equity-backed businesses in the segment pursuing tuck-in acquisitions to enhance their market share.

Private equity add-on acquisitions represented 48.0% of all deals in the broader sector to date and 90.3% of all acquisitions by financial buyers. Of note, Pye-Barker Fire & Safety, a portfolio company of Atlas Partners, completed 13 tuck-in acquisitions as of late 2023 in the fire and life safety segment alone.

The company completed 23 tuck-in acquisitions in the broader security solutions sector through the same time period — nine more M&As than it had completed in full-year 2022.

Additionally, HGGC-backed Marmic Fire & Safety completed six tuck-in acquisitions in 2023 as of this writing, the second most in the fire and life safety segment.

Valuation Outlook for Security Solutions M&A Looks Bright

Valuations in the sector remained robust YOY, despite there being a lull in the broader M&A market. Purchase multiples in the security solutions sector averaged 13.0x EV/EBITDA through late 2023, an improvement from the YTD 2022 average of 8.1x EV/EBITDA.

Comparatively, EBITDA multiples averaged 8.2x in the lower middle market ($10 to $100 million), 12.3x in the core middle market ($100-$250 million) and 10.6x in the upper middle market ($250 to $500 million) across all industries through YTD Q3 2023, according to Capstone’s Q3 2023 Capital Markets Update.

The median disclosed enterprise value for M&A deals in the sector was $53.0 million, a 76.7% YOY increase from $30.0 million for YTD 2022. Additionally, valuations through late 2023 outperformed the median enterprise value in full year 2021, a year that saw a high-valuation environment across the majority of M&A markets.

Valuations for security solutions transactions in the middle market also remained robust through late 2023, averaging $70.3 million, as compared to $50.1 million in YTD 2022. As the macroeconomic environment strengthens and valuations continue to increase, 2024 may prove to be a banner year for M&A in the security solutions sector.

Analyzing Security Industry Stocks

Public market performance in 2023 among companies in the security industry provides an optimistic outlook for growth in 2024. Public companies in the cybersecurity sector garnered especially healthy returns.

Total return for the Hack ETF amounted to +33.6% through mid-December, as compared to +20.9% for the S&P 500. Capstone’s Physical Security index underperformed the S&P 500.

However, individual stocks among companies in the physical security space experienced robust growth. Below, we highlight select equities in the physical security and cybersecurity verticals.

Top Performers: Physical Security

• Arlo Technologies (NYSE:ARLO) – Home security system developer Arlo Technologies saw its stock price improve 168.4%, to $9.42 per share, as of December 12, 2023. The company improved its stock price by 27.2% from May 11 to May 12, to $8.97 per share, following its Q1 2023 earnings release. Arlo reported $111 million in revenue for Q1, which was above the high end of the company’s guidance, according to an earnings transcript.¹³
• Alarm.com (Nasdaq:ALRM) – Alarm monitoring service provider Alarm.com experienced an 18.7% increase in its stock price through Dec. 12, 2023, to $57.93 per share. The company increased its last-twelve-month (LTM) revenue by 4.1%. It reported strong Q2 2023 earnings, including a 46.3% YOY increase in net income for the quarter to $15.8 million, according to an earnings call.¹⁴ Following the release on Aug. 9, Alarm.com improved its stock price by 24.1%, rising to $61.05 per share on Aug. 10.

Laggards: Physical Security

• SoundThinking (Nasdaq:SSTI) – Public safety solutions provider SoundThinking saw its stock price decrease by 26.5% (to $24.88 per share) as of Dec. 12, 2023. The company experienced turbulence in 2023 due to its controversial contract with the city of Chicago. Criticism of the company’s gunshot detection software sent its stock price down 22.3%, to $29.41 per share, on April 5, 2023. Additionally, SoundThinking reported $15.2 million in operating expenses in Q3 2023, according to an earnings release.¹⁵ This accounted for 64% of revenue in the quarter, as compared to 33% in the prior-year period.
• ADT (NYSE:ADT) – The stock price for home security provider ADT decreased 29.1% through Dec. 12, 2023. The stock dropped 14.3%, to $5.71 per share, following the release of the company’s Q1 2023 earnings on May 2. ADT reported an adjusted EBITDA loss of $11 million in its solar segment in Q1, while additionally incurring a non-cash goodwill charge of $193 million associated with the solar segment, according to an earnings release.¹⁶ The company also reported interest rate pressures as a barrier to growth throughout 2023.

Top Performers: Cybersecurity

• Crowdstrike (Nasdaq:CRWD) – Crowdstrike, a cloud-delivered endpoint protection provider, increased its stock price by 137.3% through Dec. 12, 2023. According to an earnings release, total revenue for the company grew 35% YOY, to $786 million, in its fiscal Q3 2024.¹⁷ Crowdstrike’s adjusted net income also doubled YOY to a record $199.2 million, according to its fiscal Q3 2024 earnings.
• Rapid7 (Nasdaq:RPD) – Cybersecurity solutions provider Rapid7 increased its stock price by 67.5% through Dec. 12, 2023. The company finished Q3 2023 with $777 million in AAR, an increase of 14% compared to the prior year period, according to an earnings release.¹⁸ The company also expanded its customer base by 6% YOY, according to its Q3 earnings. Following the release of its Q3 earnings on Nov. 1, 2023, Rapid7’s stock price rose 11.8%, to $51.35 per share, on Nov. 3, 2023.

Laggards: Cybersecurity

• Everbridge (Nasdaq:EVBG) – Software security manager Everbridge experienced a 24.6% decrease in its stock price through Dec. 12, 2023. In particular, the company reported a $15.1 million net loss in Q1, which sent the stock price down 21.8% between Aug. 8 and 10, according to an earnings release.¹⁹ The stock continued to drop, reaching a 2023 low of $19.34 per share on Nov. 13.
• Tenable (Nasdaq:TENB) – Despite seeing its stock increase 11.7% through Dec. 12, 2023, Tenable underperformed the cybersecurity market. Cybersecurity businesses with similar market capitalizations as Tenable ($4.8 billion), such as Varonis Systems (Nasdaq:VRNS) ($4.8 billion) and Rapid7 ($3.5 billion), experienced returns of 2% and 66.2%, respectively, through late 2023.

To discuss key trends driving top-line growth for sector players, to get an update on your business, or to learn about Capstone’s wide range of advisory services and security solutions M&A knowledge, please contact me. I am reachable at [email protected].

Analyst Joe Collins was the lead market intelligence contributor to this article.

Endnotes

1. S. Bureau of Economic Analysis, “Personal Consumption Expenditures Price Index, Excluding Food and Energy,” https://www.bea.gov/data/personal-consumption-expenditures-price-index-excluding-food-and-energy, accessed December 5, 2023.
2. Allegion, “Q3 2023 Earnings Call,” https://investor.allegion.com/~/media/Files/A/Allegion-IR/reports-and-presentations/allegion-q3-2023-earnings-call-presentation.pdf, accessed December 5, 2023.
3. S. Census Bureau, “Value of Private Nonresidential Construction Put in Place – Seasonally Adjusted Annual Rate,” https://www.census.gov/construction/c30/pdf/nonresidentialsa.pdf, accessed December 5, 2023.
4. National Equipment Register, “Equipment Theft Report,” https://www.ner.net/wp-content/uploads/2017/10/Annual-Theft-Report-2016.pdf, accessed December 5, 2023.
5. org, “2023 Package Theft Annual Statistics and Trends,” https://www.security.org/package-theft/annual-report/, accessed December 5, 2023.
6. Research and Markets, “Smart Home Security Camera Market Size,” https://www.researchandmarkets.com/reports/5786689/smart-home-security-camera-market-size-share-and#src-pos-3, accessed December 5, 2023.
7. Arlo, “Q3 2023 Investor Presentation,” https://s22.q4cdn.com/363130056/files/doc_financials/2023/q3/Arlo-Investor-Deck-Q3-2023-Final.pdf, accessed December 5, 2023.
8. PitchBook, “Q3 2023 Global Private Market Fundraising Report,” https://files.pitchbook.com/website/files/pdf/Q3_2023_Global_Private_Market_Fundraising_Report.pdf, accessed December 5, 2023.
9. GF Data, “GF Data Third Quarter 2023 Leverage Report,” https://gfdata.com/, accessed December 11, 2023.
10. Ai, “BigBear.Ai to Acquire Pangiam, combining facial recognition and advanced biometrics with BigBear.Ai’s computer vision capabilities to spearhead the Vision Ai industry,” https://bigbear.ai/newsroom/bigbear-ai-to-acquire-pangiam-combining-facial-recognition-and-advanced-biometrics-with-bigbear-ais-computer-vision-capabilities-to-spearhead-the-vision-ai-industry/, accessed December 11, 2023.
11. PRNewswire, “WELL Health’s Cycura Announces Two Tuck-In Acquisitions to Enhance Patient Data Protection and Appoints New Management,” https://www.prnewswire.com/news-releases/well-healths-cycura-announces-two-tuck-in-acquisitions-to-enhance-patient-data-protection-and-appoints-new-management-301968419.html, accessed December 11, 2023.
12. GlobeNewswire, “SoundThinking Acquired Intelligent Weapons Detection Provider, SafePointe,” https://www.globenewswire.com/en/news-release/2023/08/22/2729506/0/en/SoundThinking-Acquires-Intelligent-Weapons-Detection-Provider-SafePointe.html, accessed December 11, 2023.
13. Arlo Technologies, “Arlo Technologies First Quarter 2023 Earnings,” https://events.q4inc.com/attendee/360315514, accessed December 12, 2023.
14. com, “Alarm.com Reports Second Quarter 2023 Results,” https://s24.q4cdn.com/652723797/files/doc_financials/2023/q2/Alarm-com-Q2-2023-Press-Release-FINAL.pdf, accessed December 12, 2023.
15. SoundThinking, “SoundThinking, Inc. Reports Third Quarter 2023 Financial Results,” https://ir.soundthinking.com/news-events/press-releases/detail/275/soundthinking-inc-reports-third-quarter-2023-financial, accessed December 12, 2023.
16. ADT, “ADT Reports First Quarter 2023 Results,” https://investor.adt.com/News–Events/news/news-details/2023/ADT-Reports-First-Quarter-2023-Results/default.aspx, accessed December 12, 2023.
17. Crowdstrike, “Crowdstrike Reports Third Quarter Fiscal Year 2024 Financial Results,” https://ir.crowdstrike.com/news-releases/news-release-details/crowdstrike-reports-third-quarter-fiscal-year-2024-financial, accessed December 12, 2023.
18. Rapid7, “Rapid7 Announces Third Quarter 2023 Financial Results,” https://s29.q4cdn.com/157304370/files/doc_financials/2023/q3/Q3-2023-Earnings-Release-Final-110123.pdf, accessed December 12, 2023.
19. Everbridge, “Everbridge Announces First Quarter 2023 Financial Results,” https://ir.everbridge.com/news-releases/news-release-details/everbridge-announces-first-quarter-2023-financial-results, accessed December 12, 2023.
20. Tenable, “Tenable Announces First Quarter 2023 Financial Results,” https://investors.tenable.com/news-releases/news-release-details/tenable-announces-first-quarter-2023-financial-results, accessed December 12, 2023.

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