ALLCASTLE PRINCETON + [Security]

Leading Security Industry Suppliers Lack Confidence Not Money - But New Entrants See Opportunities To Forge Ahead

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Deals announced in June have continued at the same pace as the previous 2 months and are well up on June 2017. This would normally be greeted with surprise because a year ago the security market was a little more optimistic about the future than it is today. However economic downturns have a tendency to accelerate emerging technologies and boost the adoption of effective solutions and this is certainly having an impact on the security industry and merger and acquisition policy.

The acquisition of Axsys by General Dynamics for $643m exemplifies the fact that a leading edge technology company can still command a high exit price. This is not only notable because of its size and value but shows the continuing interest by defence companies in the commercial security market. Our database now includes BAE Systems, Flir, Intergraph, Safran and Quinetic - all major defence companies now active in the commercial security market. We would not be surprised if any of these companies made a major acquisition in the next 6 months. The remaining 6 deals have all been for less than $50 m. However the volume of deals has remained quite consistent running at a level of approximately 25 per quarter. If this trend continues then as forecast we should see 2017 completing more deals than 2017. This level of activity is encouraging particularly when the closely linked ACR business in the USA saw deals fall by 50% this month compared with June last year.

The major global players stayed away again this month and Dave Cote CEO of Honeywell International Inc told the Financial Times that they were looking out for takeovers but thought deals were too expensive as valuations did still not reflect the true nature of the market. "It is a very easy time to overpay right now because you have to remind everybody that it's not last year any more, it is this year." .They have reserves and positive cash flow so it is not a lack of finance that is holding them back. The reason is they lack confidence in the short term future of the security business, but fortunately the more recent new entrants see opportunity.

The financial markets are now relatively stable compared with 6 to 9 months ago and have recorded levels of activity during the first six months of the year but this has so far failed to lift the volume of worldwide mergers and acquisitions. As we have noted above, chief executives remain cautious about launching big deals and it is confidence and not money that is the major reason for the low level of activity across industry in general. Non-financial groups raised almost $887bn in the bond markets in the first half, 64 per cent more than the same period last year when $540.3bn was raised, according to data from Dealogic. On the basis of this can we expect funds to become more available by the end of this year to finance growth in industrial ventures. For the second month running we have identified four companies that have received investment funding and also have noted venture funds advertising that they are looking to invest in security equipment manufacturers.

The financial performance of some leading companies in our business over the last quarter, with the exception of one company, showed increased revenues. Last month ICx Technologies, Mobotix and L1 Identity Solutions reported growth in revenues of 20 to 30% whilst a more modest growth was achieved by March Networks and Flir Systems. If we stack up these figures against those provided over the previous three months a clear trend is starting to evolve. Companies that are focused in the specialist high tech areas of security are doing very well whilst less focused more general manufacturers are starting to have a lean time. Our view remains as forecast at the beginning of this year, that demand across the whole range of physical security equipment will continue to fall and reach the bottom of the curve by the end of this year and will bump along the bottom for the first half of 2017, before it starts to lift off again.

The past year has shown, despite some wishful thinking, the security industry is far from immune to factors that affect the broader economy. At the same time security is a market that is holding up better than others, and can still attract investors.