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.

Sonitrol is truly one of the iconic brands of the security monitoring business.  It is fair to say virtually no other brand has gained as much respect with third-party responders (i.e., police departments) as has Sonitrol, and I continue to believe that with the verification issue not going away, guaranteed police response – because police believe in the brand — within a reasonably short period of time (under ten minutes) is a value-added that cannot be underestimated.  Sonitrol, with its proprietary audio monitoring technology and its move into IP video monitoring has certainly maintained its brand value with responders and kept end users happy.  Gross attrition is 8%-9%, low for a company of its size, and the average customer life of over 13 years is up there (Brinks, in residential, claims about 14 years).  Of course, with an original, proprietary technology that requires a separate monitoring system, there is little organic system-wide organic growth, and transaction multiples for Sonitrol accounts do not exceed the industry averages.  Still, the Sonitrol brand is one of the most respected in the industry and the Sonitrol Management Corp. and its big franchisee system is one of the most fascinating stories in the traditional monitoring business.

 

There is a point to all of this, but first, just a couple of stats to prove that we remain somewhat up to date:

During the 1990’s, until 1997, Sonitrol Management Corp. (the franchisor) was owned by the U.K.’s largest monitoring company, Automated Security Holdings (ASH).  After Tyco/ADT bought Automated Security Holdings in 1997, it basically did very little to disturb the status quo (but did not grow the business, or really provide new incentives to franchisees) until it sold Sonitrol Management Corp. in 2004 for $125.5 million, to a group of private equity investors, including Spire Capital, Carlyle Venture Partners, and Wachovia Capital Partners.  Kevin Dowd, who we knew well as the former CEO and President of Checkpoint Systems, replaced Chris Cobb as the CEO of Sonitrol Management, with the transaction.  At the time of the acquisition, the management company claimed about $85 million in revenues.  Now there is $125 million ($5.7 million in RMR), much of the increase coming from seven acquisitions.  Total system revenues are closer to $225 million and haven’t changed that much over the last five years.  About 45,000 of the 125,000 users are owned by Sonitrol Management Corp., and the rest by franchisees.   Nevertheless, it is fair to say that Sonitrol Management has become significantly larger and more profitable in the last four years.

 

We have been fascinated by Sonitrol and its franchise network for over 15 years, since the days of  us covering Sonitrol Corp.’s then-owner, Automated Security Holdings (ASH) and its predominant equipment provider, Advantor and its own iconic owner, Harry Flemming.  Even though franchisees back then resented the close relationship between ASH’s chairman, Tom Buffett, and Flemming, who controlled a proprietary product that limited Sonitrol’s integration with other monitoring technology, they at least seemed to accept that Flemming believed as strongly in Advantor’s product to Sonitrol, as Sonitrol’s franchisee’s believed in  their own businesses.   This love-hate relationship at least was semi-functional.  Clearly, that relationship seems to have been frayed since the acquisition of ASH by Tyco/ADT in 1997.

 

Now to the nub of this blog:  There is fairly strong evidence throughout the monitoring community that Sonitrol may be on the selling block, and we’d be remiss in not reminding the likely buyers that putting the frayed franchisor-franchisee relationship in better stead should be considered as high a priority as what the ultimate price is.  Our recent forays into the hinterlands to visit multi-brand security monitoring companies – some of whom happen to also be Sonitrol franchisees, shows us that there is indeed discontent with a whole host of items ranging from the structure of the royalties, to right of first refusal, to the overall franchise arrangement.  This discontent is deeper than what we encountered when ADT sold Sonitrol Management and it is FAR deeper than when Automated Security Holdings owned Sonitrol 15 years ago.  Potential buyers of Sonitrol Management should be prepared to deal with franchisees, particularly those that are willing to simply move to other technologies, now that alternative audio and video verification technologies exist.

 

The names of the likely Sonitrol Management buyers are, well the same names we’ve been hearing for a lot of transactions lately:  Siemens, UTC Security, Stanley, Niscayah (Securitas Systems), with what we believe to be Stanley having the inside edge.  The commercial focus, the high regard for the brand all would have attraction to any of these players.  Niscayah could increase its 30%-40% recurring revenue percentage and begin to emulate the Stanley model, following the latter’s acquisition of HSM.  Stanley, for its part, could gain yet another highly regarded brand, and complement its data-intensive HSM business.

 

However, like we noted above, anyone who buys Sonitrol must take into account the franchise system, which may be unlike any group we’ve encountered before.   There are Sonitrol franchisees that have only known Sonitrol monitoring and may never sell their businesses.  Given the past difficulty in integrating the Sonitrol audio system with anything else a monitoring did (there are still “special” Sonitrol rooms inside a much broader based monitoring company), many transactions were done solely “within the family” and at multiples that were 10%-30% lower than commensurate RMR valuations – and that was before the more aggressive stance by Sonitrol Management on right of first refusal, as a way for it to grow.  

 

Most important, no other franchise network that we know of (including businesses outside of security) has developed the near cult-like status that gives Sonitrol franchise meetings as near as a religious camp out.  There are even rifts between those franchisees who are “pure” Sonitrol providers and those who dare to sell other services and products.

 

However, since not all is going smoothly in Sonitrol franchisee land these days, a situation which may or may not have been able to be avoided, given the intensity in which some of the franchisees believe in their business.  Admittedly, had I been the buyer of the Sonitrol Management Corp., and in private equity, I too would have been focused on cutting costs, trying to build up a national accounts program, and buying up franchisees under right of first refusal.  This would in and of itself create tension, but why am I seeing this level of tension?  Again, I don’t know where all the current friction is coming from, but something in the always critical franchisor-franchisee relation is amiss.   Sonitrol cannot become more successful – without a major downward ratchet in size — with franchisees ready to bolt, if the new buyer pushes a centralized policy without repairing these relationships.

 

Conclusion:  Whoever is the ultimate buyer of Sonitrol, take this little piece of advice:  please talk to the franchisees, and make them feel wanted.  It will make for a lot better company future.