Investors Find No Safe Haven in Security

Following years of stellar performance by the security sector, investors in the industry’s publicly traded stocks saw a sizable portion of their prior gains melt away during 2008. With its average valuations off by about 37 percent, security was undeniably dragged down with the rest of the market.

The major U.S. stock indexes were materially impacted throughout the tumultuous year. The Dow Jones Industrial Average, which was off by 33.8 percent, suffered its worst losses since 1931. The S&P 500 ended the year down 38.5 percent, marking its third worst year, while the NASDAQ Composite was off by 40.5 percent — its worst year ever.

In security, whether you were a video analytics or access control play, a domestic alarm monitoring company or a regional integrator, or even the multinational diversified with significant security sales, 2008 hurt.

Still, the year was not without a few bright spots. Among the shards of optimism: mergers and acquisitions (M&A); selected sales and successful refinancings; the apparent shift in customers finally embracing market change; technology advancements; and the long-awaited convergence between physical and logical security. These all suggest trends that will likely hold true in 2009 and into 2010.

SECURITY SALES & INTEGRATION’s annual industry financial analysis and stocks report discusses the financial well-being of the security industry and offers an insider’s perspective of what investors and industry professionals can generally expect to see in the marketplace in 2009.

Product Sectors Suffer Pounding

Hit hardest in the security industry during 2008 were the high-multiple product sectors (with the exception of biometrics), including surveillance equipment, alarm equipment and ID solutions equipment. Those sectors suffering less value erosion were the cash flow-centric, recurring revenue businesses like alarm monitoring, integration and screening.

Surprising outliers were the biometrics and software sectors. Regarding biometrics, this is likely to be a function of increased market adoption, maturing sector cash flows and a scarcity of publicly traded comparables.

For security software, again the maturing cash flows is a likely contributor but more importantly is the need to continuously invest in IT security to protect existing physical and logical investments. This thusly drives a relatively sustainable sales profile.

Across all sectors, the more commodity-oriented the product or service, the worse it fared in the declining market. This idea is not new and should be a continuing focus for all industry participants — differentiate or be at risk. As with other industries, if your sole means of differentiation is price and/or service, there is a greater risk that you will suffer valuation compression and potential substitution from competitors or replacements.

Causes Aplenty for Decline

Clearly, the credit crisis and subprime meltdown were large factors influencing the overall market performance. That said, a number of particularly relevant macro-economic factors contributed to market and sector declines, and should be actively monitored going forward. Important among these: housing starts, commercial building/lodging occupancy rates and starts, and general economic health indicators (such as CEO/CFO confidence, unemployment, consumer spending, credit card default rates, etc.).

For instance, according to a recent study by Bank of America, less than one-third of U.S. manufacturing company CFOs believe the U.S. economy will expand during 2009.

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