TheSecurityAnalyst

I am gratified by the encouragement and response from the several thousand unique visitors to the site TheSecurityAnalyst.com since I started it in May.  Since being picked up by Seeking Alpha at the end of June, I have been swamped with requests for a listing of the earlier blogs on the industry that are not currently on the website.  So here is the complete listing of our blogs in reverse chronological order.

 

07/02 – In An Economic Slowdown, Government Contracts Become Important for the Security Industry.  Four security companies demonstrating good growth in a bad economy, thanks to strong Government contract flow: FLIR, L-1, ICx Technologies, and China Security & Surveillance.  (Note:  ICx announced today yet another contract for its “Cerberus” surveillance towers, this time its first from the Secure Border Initiative).

 

06/29 – Has Single-Sign On Finally Hit “Prime Time” With Security End Users?  We may be at the inflection point of improved technology and enterprise end user demand for single-sign on solutions as part of the convergence of physical and logical security systems.

 

6/26 – China Security & Surveillance: Go-to-Market and Strategic Leadership in Security in China.  The leading domestic security company in China has developed a huge advantage (no channel conflicts between its manufacturing, installation, integration and monitoring businesses), in the world’s fastest growing security market (independent of the Olympics).

 

6/23 – “REAL ID” Controlled by a Foreign Entity?  Safran S.A. Bids Against L-1 for Digimarc’s ID Business.  With all of the hoopla over personal privacy and REAL ID, we just thought it a bit odd that an foreign entity, 30% owned by a foreign government would bid against L-1 for Digimarc’s ID (drivers license) business.  Oh well, at minimum they forced a competitor to pay $50 million more.

 

6/18 – Guest Blog: Risk of Critical Failure in Monitored Alarm Industry.  Guest blogger, and long-time monitoring industry consultant Lee Jones emphatically warns against industry laxness regarding false alarms and the looming threat of non-response without verification.  His point:  “The alarm customer and the police, the two most critical segments of the infrastructure, have been abused. We believe the alarm industry is losing the loyalty of both parties. Without the loyalty of the customer and the police, the entire infrastructure as we know it today, could collapse. “

 

 

6/15-6/16 –  Do Not Ignore L-1 Identity Solutions As the ID Market Grows.  The identification market (along with biometric technologies) is now sprinting in its growth and here is the undisputed market leader – like it or not.

 

6/12 – Stanley-Sonitrol: Strategically Smart, But with Franchisee Relationships to Fix.  Stanley Works is becoming a legitimate security systems integration threat to the likes of Siemens, ADT, and Securitas Systems (recently renamed Niscayah), with its acquisitions of HSM Security and now, Sonitrol Management (the leading brand for verified, quick response by police).  However, Stanley has also acquired some very frayed relationships with Sonitrol’s significant franchisee system, which will have to be fixed.

 

6/10 – ADT’s Growth Strategy Unveils its Underestimated Integration Business.  ADT now comprises the largest single entity of any of Tyco International’s revenues and over half of its EBITDA.  We think Wall Street analysts are missing a key development underlying ADT – its already well-regarded and now growing systems integration business.

 

6/4 – BHS Steady State Cash Flow Still High, per SEC Filings.  As a follow-up to our June 2 blog, with the SEC filing by Brinks Home Security on its proposed spin out from Brinks, several investors asked us to recalculate the 2007 steady state free cash flow of the company (SSCF being the most important metric besides attrition).  Taking on its own corporate overhead, BHS SSCD for 2007 falls to 178.5 million (36.8% margin) from our previous estimate of $191.3 million (39.5%).  However, that is still way above the margin of any other public monitoring company and virtually the highest of any public or private company.

 

6/2 – Sonitrol: Can the Vaunted Franchise System & Brand Hold Together?  With rumors in the industry that the Sonitrol business was close to being sold by its private equity owners, we issued a warning to any buyer of this verified alarm leader:  Fix the relationship with the franchisees.

 

6/2 – Brinks Home Security:  A Brief Look at “The Surprises.”  On May 30, BHS filed a “Form 10” with the SEC, representing its preliminary pro forma financials as well as its ongoing relationship with Brinks Inc.  Along with the financial pro forma’s, there are two “surprise” issues which popped up in the filing (you have to dig to find them):  (a) the loss by BHS of its “Brinks” brand in three years and (b) the royalties that BHS has been paying to Brinks – over $30 million in 2007 — which were formerly not reported (or at least never seen by me).  The ongoing royalty payments fall dramatically, however.

 

5/13 – Somebody Needed to Love Protection One.  Protection One has a great management that has fixed a disaster and stabilized the company, the third largest monitoring business in the U.S.   However, a thinly traded stock, lack of growth and a balance sheet that won’t allow a lot of acquisitions has investors snoozing on this name.  We still think investors may be asleep at the switch on this one.

 

5/13 – Video Standards That May Finally Mean Something.  On May 12, a consortium of Axis Communications, Sony and privately-held Bosch – three of the leading names in video surveillance, formed a group aimed at developing a standard for the interface of network video products. Currently, while there are video compression standards (MPEG-4, and the new H.260), there is no global standard defining how network video products such as cameras, video encoders and video management systems should communicate with each other.  Note: This blog actually generated a lot of comments around why it has even taken this long for open systems to emerge in video, along with skepticism that proprietary video systems (which are maybe good for individual companies, but bad for overall industry growth), can be “overcome” any time soon.

 

5/13 – FLIR Systems and Axis AB:  A Tale of Two Video Technology Companies.  Axis Communications (Axis AB, based in Lund, Sweden) and U.S. based FLIR Systems are the two leading companies in their respective technological niches in the $7 billion video surveillance industry.  Axis is the leading provider of IP network video cameras, while FLIR is the leading provider of infrared cameras for surveillance and thermographic (temperature control) use.  Unfortunately, for Axis, a couple of its key commercial markets are slowing due to the economy – and hurting its stock.  Fortunately for FLIR, its Government business is booming, as is the rapid expansion of infrared in non-military use – helping its stock.  We like both companies; investors will have to talk to their analysts to make their own timing choices.

 

The writer current holds positions in L-1 Identity Solutions, ICx Technologies, and is considering a position in China Security & Surveillance.

Axis Communications (Axis AB, based in Lund, Sweden) and U.S. based FLIR Systems are the two leading companies in their respective technological niches in the $7 billion video surveillance industry.  Axis is the leading provider of IP network video cameras, while FLIR is the leading provider of infrared cameras for surveillance and thermographic (temperature control) use.  While the video industry is growing at nearly 13-15% annually these two companies have been growing at 2x-3x that rate, or slightly faster than their own subsectors.  Both companies traded at similar P/E ratio premiums to the market with 28x-30x forward 12 month ranges and 22-25x forward 18-24 month ranges.

 

However, those valuations recently diverged dramatically, along with stock performance, and therein lies the tale of two video companies.  Over the last several quarters, FLIR has maintained a 40% revenue growth rate amid gross margins in the mid 50’s% as demand for its Government (usually DoD related) business continued to show contract wins and growth over 40%, and the Thermographic division (used for monitoring industrial processes) maintained 15%-plus growth, even into a declining industrial market.  However, in our opinion, the big winner for FLIR has been its relatively new Commercial Vision Systems division (17% of revenues, growing over 50%), covering everything from commercial and homeland security, to maritime and commercial airplane vision, as well as building inspections.  The explosion in end user possibilities appears only limited by FLIR’s ability to find the right channel partners and market the products effectively – which is no slam dunk.  But FLIR has been helped by dramatic cost price drops in its infrared sensor costs.  So, despite the economic slowdown, the company has maintained its operating margins at 22%-23%, and the 2008 consensus P/E of 28.7x the estimates of $1.18 appear quite fair.

 

If Axis were only so insulated from the economy!  Axis as a brand is rapidly becoming to the world of IP camera end users what Pelco (now owned by Schneider Electric) has been to the legacy analog market.  But the economy doesn’t care about that.  With both U.S. and Western European sales slowing just a bit, top line growth has slowed from the mid-40% range down to the “tortoise-like” 35% range.  This should not be a problem were it not for a major operating expense program the company has undertaken over the last six months to dramatically increase its admired “two-channel” go-to-market strategy and to pioneer the H.264 compression technology (80% faster and more storage than JPEG and about 25% faster and more storage than current MPEG-4).  In the middle of slowing growth, this has lifted S,G&A to 26% from 24% of revenues and R&D to 15% from 13% within one year, resulting in an operating margin hit of 400 basis points to 15.7% from 19.7%, and relatively flat operating income growth.  The cause is all for the good, but we won’t see the first returns on these investments until at least later in the second half of 2008.  The effect on the stock has been predicable – a forward P/E of 28-30 has shrunk to 23.5x on consensus earnings estimates that have shrunk by 10%-15%, leaving the stock down 40% from its 52-week high, and at one point, 50% off its high.

 

So there rests the tale of two video companies:  one with a high, but not outrageous valuation in a niche business that seemingly is finding new uses every day, and one company continuing to invest heavily – even at the cost of its stock price – in driving a leading marketing and technology strategy that probably will work, but is not certainty.

Both companies face enormous competition from large players – FLIR from the likes of Raytheon and L-3, and Axis from Sony and Panasonic.  However, in their given niches, both companies have proven to be the leaders, with better product and better management.  We like them both.