Imperial Capital’s John Mack Details State of M&A
As one of the industry’s foremost banking and investment experts, Mack is uniquely situated to explain the state of M&A in the midst of COVID-19.
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With all financial stars aligned heading into the New Year, 2020 was projected to be a banner year for mergers & acquisitions. And then COVID-19 happened. SSI recently conducted an in-depth interview with John Mack, executive vice president and co-head of investment banking at Imperial Capital, to discuss the M&A landscape in this time of historic economic upheaval.
A video of the interview can be viewed here. In the transcript below, Mack and SSI Senior Editor Rodney Bosch delve into topics and issues specific to alarm dealers, systems integrators, wholesale monitoring and much more.
Mack and his team were busy this week (Dec. 2-3) presenting the 17th annual Imperial Capital Security Industry Conference, which was held virtually for the first time due to the pandemic. Don’t miss the accompanying image gallery, which features M&A insights from Mack’s conference presentation.
How would you describe the impact the pandemic has had on M&A within the security industry?
Not surprisingly M&A activity globally, and certainly for the U.S., is off dramatically. It started to tail off in the second half of the first quarter. It fell off very dramatically in the second quarter and only started to come back modestly in the beginning of the third quarter. M&A is down 30% to 40% over similar run rates for 2019 for the first half of 2020.
What we’re starting to see, globally, is a pretty strong resurgence of M&A that’s coming on strong coming out of the third quarter, with people looking to try and get transactions done before the end of the year. There’s some pent up demand. There are some potential concerns about capital gains tax and other things that are driving that, so we’re seeing a recovery in a pretty dramatic fashion coming up for the fourth quarter right now.
Specific to security it’s hard to make generalizations across the industry because there are sectors of the industry that are doing quite well and there sectors that are having challenges. Those sectors that have more recurring revenue are clearly more resilient for this kind of circumstance. Some of the bigger alarm companies have fared well because their recurring revenue gives them a constant revenue stream; whereas it’s tougher for companies that have to find new installation revenue every month to make up the majority of their revenue.
Video surveillance businesses in the manufacturing side have done well with increased applications for video. Access control companies have done well. So where you see positive trends for the applications within security, you’re certainly going to see positive implications for M&A. So that’s the broader point.
What are the most significant finance issues facing alarm dealers?
An alarm company will have upward of 70% to 80% or more of its revenue coming from RMR from its existing customers. What we’ve seen in the pandemic is the customers haven’t been inclined to cancel their alarm service. In fact, they’ve been more inclined to keep the service given concerns about unrest and another issues relative to the crime profile in communities. That means that revenue stream has stayed incredibly constant.
For a period of time, certainly in the height of the second quarter of lock downs, it was hard to do any kind of installation work, so even for the alarm company that needed to install new customers, that activity was pretty significantly curtailed. That had a more dramatic impact for security integrators; of course, a more significant portion of a security integrator’s revenue is going to be new installation work or work that requires them to go to the customer’s premise.
What then has been the impact on integrators, specifically?
Most security integrators will have 20% or 30% of their revenue from some form of recurring revenue. But in many cases even that recurring revenue requires you to visit the customer’s premise. So that was more challenging. And then you have to kind of dive in more specifically within the security integrator community — companies serving, for example, the government market were doing quite well because government facilities needed to be protected. Most integrators had a much bigger challenge on their hands because the revenue was cut back pretty significantly in the second quarter and the beginning of the third quarter.
From anecdotal conversations I’m having with integrators, I’m hearing a pretty strong resurgence. There is some pent up demand for business that wasn’t completed in the second quarter in the beginning of the third quarter, so let’s hope that holds up. But I still think we’re net down from run rate levels we would have had had this been a normal year coming out of September and October.
Prior to the pandemic the industry witnessed a lot of consolidation among integrators. What is your near-term view for further consolidation in the midst of ongoing turmoil caused by COVID-19?
As we go into 2021 and ’22 it will provide more impetus for smaller integrators to consider transactions with larger acquirers. We know we have a healthy group of larger companies interested in doing acquisitions in the security integration sector. You have Allied Universal. You have Guarda more recently coming in. You certainly have Securitas and Convergint and ADT. So, you have a healthy group and there are others that want to do acquisitions.
If you’re a smaller company and you had a particularly tough experience in the second quarter and third quarter of this year, I think it’s going to give you more motivation to consider your options. Maybe in a particularly good economy, you might not have been as inclined to want to consider a sale of your business. I think it is going to provide some further impetus for M&A activity in that context.
What are the most significant financial issues driving M&A in the wholesale monitoring sector?
There aren’t enough of these companies that are actively in the market seeking financing [to get a clear picture] of the data bank information about what the market looks like.
We had a recent transaction where BV Investment Partner made a an acquisition of Becklar, which is the owner of AvantGuard Monitoring Centers and Freeus, at apparently a reasonably attractive valuation. So there’s one data point.
The wholesale monitoring businesses have been much more immune to some of the challenges that [security dealers] have faced, so their access to financing is probably better for the largest players in that sector. For the smaller players in the sector it is probably harder to come by financing because the issues associated with what’s happening in the residential market probably have some knock-on effect on those smaller players.
But again, it’s not a sector that has a lot of data points for us to look at because once you get outside of the big four or five guys in that sector, you have pretty small companies that aren’t accessing larger debt capital markets.
What are some of the key trends that monitoring center owners and operators need to be aware of right now?
On the residential side of the business there are a whole host of things that I think you have to be thinking about. We are facing a 3G-4G transition, so you’re worried about making sure your customers during the course of 2021 are going to be transitioned to a platform for communications from the system into monitoring center.
You’re going to be increasingly focused on verification both in the residential and the commercial side of the business, because we’ve got initiatives underway to move to systems that score the alarm signal coming into the PSAP to the 911 center in order to figure out if you have a real alarm or something that justifies being dispatched and the technology that allows you to have your customers system be verified and validated. That is going to be increasingly important, so I think you’re going to be looking carefully at the opportunity to evolve your customer base to that capability and make sure you’re monitoring center has the technology to be able to support that capability.
You’re going to be looking at newer technologies on the commercial side. Certainly much more active use of video and audio and other Internet-enabled sensor technologies so that when the signal comes in from that system, you’re getting more than just basic alarm data from motion detector or a door contact; you’re now getting video and audio and information about the whereabouts of the customer in the premise and related technology.
We are also moving into an era where I think artificial intelligence — which is the buzzword, really a glorified version of enhanced analytics — is going to be applied to monitoring technology in a way that allows for the ability to hopefully reduce false alarms and more accurately figure out when a real emergency is taking place. Indicative of that is the Google investment in ADT. I think a significant part of what motivated that was looking at the Big Data capabilities that Google could bring to bear.
So there are lots of things. There is more to be thinking about in the next several years in the monitoring side of our industry than there has been in the last 30 years, given the evolution of technology, financing and another trends.
What do you find especially interesting about Google’s investment in ADT and tech behemoths entering the industry in general?
Google making the investment in ADT and announcing the partnership is a big deal. Certainly it was very good for ADT stock, which went up substantially after that announcement.
What I think is nice about it is there’s been some presumption that somehow these big technology players can come in and just take over this industry with some magic technology that’s going to do all the monitoring, and you won’t need monitoring centers and you won’t need alarm companies. That just makes no sense and never has. What ADT brings to the table is really important in terms of the ability to manage customer monitoring interactions and technology deployment in the home and all that goes with that.
That partnership is a great statement about the future of the business where we can partner with these bigger technology players. We can get really good analytics technology and Cloud-based technology deployed in our industry and to have this be a point of opportunity.
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