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.

Hot Topics to Watch in 2010
Touching on key industry themes, the following topics will be critical to the security market in 2010.

Software as a Service (SaaS) — If you are in pursuit of recurring monthly revenue (RMR), here is an opportunity to make your software applications deliver recurring revenue via long-term service contracts. Customers want the purchasing flexibility and less daunting return on investment (ROI) that buying an ongoing service represents.

Credentialing — Are you who you say you are? Authentication is a critical question for access control, consumer transactions, financial records, data permissions, etc. Beyond the mundane, the terrorist threat associated with credentialing is huge: According to Department of Homeland Security (DHS), nearly 3 million individuals in the U.S. held expired visas as of 2008.

Cyber Security — The military and DHS are finally giving this vital discipline its just attention. Given the U.S.’ open market, sociopolitical environment this nation has the greatest risk for exposures. Integrators and the security industry need to be smart relative to cyber security strategies and initiatives in order to best serve clients.

Vertical Markets With Promise
Now let’s take a look at what customer markets will be hot in the coming months. Among the best targets are health care, chemical facilities, energy, financial services, transportation and public campuses/venues.

Health care has received massive government appropriations (exceeding $10 billion) relative to security and IT upgrades. Congress has enacted Chemical Facility Anti-Terrorism Standards(CFATS) that mandate security upgrades to facilities that use and store dangerous chemicals, and has earmarked approximately $1 billion to be spent on plant security within the next 24 months.

The energy industry has unknowingly created one of the most compelling targets in recent history — the smart grid. To protect against criminals and/or terrorists, the energy sector will need material to secure generating assets, the “dumb” grid, customer accounts and the smart grid.

An extension regarding this point is the smart building or home, where just about everything is linked. Manufacturers and integration providers need to remain at the forefront of technology and product innovations to keep current in this rapidly evolving domain.

“Leakage” within the financial services sector will drive new security measures as well. The problem has become so large that industry players are waking up. Heavyweights like MasterCard, Visa, Citi and others are looking at how to change the technology and product platforms to better secure funds, transactions and customers.

Transportation will again spend (or be spent on) as airline/airport security is due for another round of evolving priorities. The Transportation Security Administration (TSA) has already indicated it will place more than 150 full-body scanners during 2010 and have funds for 300 more detectors; as well they will test placement of nuclear detection technologies at domestic airports.

The recent murder of a Yale University student, the massacres at Virginia Tech and Columbine
High School, and the U.S. Army base shootings shed light on how vulnerable our larger public venues remain. Despite tight budgets, universities and states are not prepared to have these institutions and facilities be sources of risk. Investments will go into security applications and technologies that reduce manpower reliance, enhance overall protection and provide for rapid mass notification.

Running With the Bulls
So which companies are ready to run in 2010? Stanley, Niscayah, Diebold, Johnson Controls, United Technologies Corp., Ingersoll Rand and Schneider Electric, to name a few. If you note a certain commonality, congratulations, it is explicit:  scale and/or focus wins in integration (as well as other areas). Little dislocation is expected of the top tier integrators during 2010.

Also anticipated is consolidation of the fragmented smaller private market niche players. There will also likely be increased focus on participation in government programs.

Revenues within the security sector, and specifically for integrators, will rise and margins should continue to recover, but do not expect miracles. Despite the current market fervor for good debt, credit has tightened and credit underwriting practices have been materially rewritten. The result for the industry and the sector will be better companies get credit and others do not. That will translate into the haves and the have-nots – which will fuel additional M&A consolidation.

As a final point, 2010 will be a year where earnings shore up valuations or the company’s stock gets punished, where leadership and vision will be rewarded assuming such actually deliver results. 

Walter Bailey is Managing Partner of The EpiGroup LLC, a New York-based investment banking and research firm covering the security and other industries. He can be contacted at (917) 209-7707 or [email protected].

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