Security Stocks Rise Again

After a tumultuous 2008, publicly traded security companies rebounded to follow major U.S. market indexes on an upward climb throughout most of 2009. Although revenues and profits were generally down, 2010 bodes well for a sustained recovery.

Thankfully, the worst seems to be over. The equity, debt, and mergers and acquisitions (M&A) markets appear to be on track for a sustainable recovery from the recession. The overall equity markets showed meaningful strength during the second half of 2009 and the security sector resumed its trend of strong performance, ending the year up on average about 15 percent (as an overall industry group).

Many subsectors significantly outperformed the overall industry and even the broader equity markets. Important for SECURITY SALES & INTEGRATION readers, systems integrators as a group enjoyed significant appreciation and recorded a year-over-year increase exceeding 45 percent.

The resiliency of the United States economy in 2009 was on display with the major U.S. stock indices delivering expectations surpassing results: the Dow Jones Industrial Average increased by 15 percent; the S&P 500 ended the year up 23 percent (posting 70-percent gains off its year low in March);and the NASDAQ Composite delivered a 41-percent gain for the year.

SSI’s annual industry financial analysis and stocks report discusses the financial well-being of the security industry, and offers perspective on what investors and industry professionals can generally expect to see in the marketplace in 2010.

What a Difference a Year Makes
In 2008 every relevant security sector had ridden down the market. This past year the majority of security industry sectors rebounded to post positive gains ranging between 20 to 70 percent. However, some sectors such as asset tracking, biometrics, investigations, large cap diversifieds, life safety and video surveillance were unable to deliver market-beating gains.

The industry’s star sectors for 2009 were access control (+55 percent), alarm equipment(+67 percent), guard services (+56 percent),ID solutions (+42 percent) and systems integrators (+47 percent). Note: Gains were adjusted to eliminate share issuances in the access control, alarm equipment, ID solutions and integrator sectors.

Regardless of star status, security sector stocks were better off as a group, ending 2009 with the aggregate industry trading at approximately 80 percent of component stocks’ 52-week highs versus 2008’s year-end where industry stocks closed at 47 percent of their respective 52-week highs.

While generalizations always have exceptions, microcap stocks seemed to have disproportionate gains/losses in keeping with the more volatile nature of low-priced stocks. Companies that reduced debt tended to be rewarded with equity value lifts, and stocks in companies with market-leading positions performed better than their peers.

Taking Stock of M&A Activity
While equity market returns and valuation measures are up, don’t expect to see a rash of new initial public stock offerings (IPOs) as the IPO market took the opportunity during the recession’s downfall to rebase its requirements. Companies desiring public listing need to be at value levels above $200 million and must have a compelling “story” meriting access to public investors (e.g. sustainable growth and market leadership).These factors amplify the relative importance and prevalence of industry M&A as being the primary form of liquidity for those wishing to exit or cash out.

On the subject of M&A, 2009 can be looked upon as a harbinger for future deals. The purchase of GE Security’s homeland protection business by Paris-based Safran SA is indicative of the industry’s rising global significance. This deal, and Dell’s acquisition of Perot Systems, reflects the increasing importance of scale.

Both the Axsys sale to General Dynamics and SAIC’s purchase of Spectrum San Diego’s CarScan product line demonstrate the continued convergence between security and defense. Serco Group’s buy of SI Int’l highlights the blending of public- and private-sector-focused services provision.

Activity is also expected to be influenced by a return of private equity players and the desire to get deals done before valuations run further. Multiples should hold for some and rise for some; in fact, multiple erosion is not expected. But as underlying operating performance recovers further, valuations should increase, accordingly.

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