What's Driving Consolidation (And What it Means for Integrators)

The current wave of consolidation among security equipment manufacturers will continue, driven largely by the sector's fragmentation, a new research report predicts. The study, from memoori ltd., a U.K.-based research firm that follows the building automation sector, found that 50 percent of the companies in the security products industry lack the economic size to remain viable beyond the short term, and for many, acquisition will be the only alternative to dissolution.

"There will be marked growth through mergers and acquisitions over the next four to five years," said Allan McHale, pictured, a director at memoori and author of the report, Survey of the Security Business 2017 - Shape, Structure & Consolidation. "There will be growth in mergers and acquisitions despite lack of money to finance them," he said, adding that many deals may be stock transactions. "And it will take place in a climate that's down-turning in some market sectors," McHale said. "Exit prices will fall."

The report focuses on how global companies with extensive building automation and fire protection businesses will influence the security industry's restructuring over the next few years as they face a surging, yet scattered group of IP video security vendors on one side and an opportunistic IT sector on the other. Video stands to be a wild card because it is among the most fragmented of the industry sub-segments, yet the sector is attractive because users want to give surveillance systems a greater strategic role in security. Meanwhile, access control systems, another fragmented segment, are becoming more tightly entwined with IT-based identity management.

For integrators, the coming restructuring will present challenges and opportunities. The challenges will come from larger companies that, aiming to assemble end-to-end solutions, will make strategic acquisitions that will fill gaps in their product portfolio and then attack specific verticals through their own integrator arms. The opportunities will come from the growing interest in converged security systems, which, aided by standardization, will give integrators and value added resellers more options and allow them to bid more competitively.

The memoori report's release comes amid a flurry of acquisition activity in the security sector at several levels. Two weeks ago, Tyco announced it was purchasing Broadview Security (formerly Brinks Home Security) for $1.9 billion with the intent of merging the operation with its ADT security business. That deal came two months after United Technologies Corp. (UTC) agreed to buy General Electric's security business for $1.82 billion. Most of GE Security is expected to be folded into UTC's Fire and Security unit.

In addition, there have been a number of recent deals involving smaller players, including NICE Systems' $22 million acquisition of Orsus and DVTel's $80 million purchase of ioimage. Both cases could illustrate the pressure industry fragmentation is having on acquisition valuation. Industry analyst John Honovich, for example, has commented on what he sees as relatively low valuations in both cases.

Memoori's report suggests it's a buyers' market. It reviews start-ups, entrepreneurship and venture capital activity in the physical security sector and concludes that few companies are ready for IPOs and that a significant proportion will be acquired through strategic buys. It lists some 50 companies as potential acquisition targets.

Filling gaps
While the specific products and technologies differ, the common aspect is that larger vendors are looking for ways to provide broader end-to-end solutions that go beyond what they once could assemble in-house. For the largest companies, the acquisition path offers a way to leverage the trend toward a greater user preference for best-of-breed components while defending their positions as end-to-end solution providers.

But it's not all about the "big boys," as McHale calls them. As seen in DVTel's ioimage buy, medium and small venders have acquisition opportunities, but they also have more options that can fill product gaps, including alliances and partnerships, which can boost their channel. Standardization, which will increase product interoperability while lowering vendor costs, will be a further boost to the competitiveness of these alliances, McHale said.

Memoori forecasts 50 percent growth in the value of deals completed in the first half of the new decade (see top graph; click to enlarge). Total value of deals will reach close to $7 billion by 2018, up from about $6.3 billion in 2007, which was a peak year. Cash deals follow a similar trajectory, reaching $5.5 billion in 2018, which would be equivalent to the value of cash deals in 2007. These values dipped to $3.3 billion in 2017, rising to $4.3 billion in 2017 (see bottom graph; click to enlarge).

But McHale said the numbers tell only part of the story. "Everyone in this business will tell you that the security market is highly fragmented, evidenced by the fact that there are a lot of players, but unless you know how many and their spread of revenue, combined with a well- defined market size, you have no idea whether this has any impact on consolidation and the future prosperity of the business and its stakeholders," he said.

The report structures the global security business into four major groups by size of equipment sales, analyzing the average revenue per group and the subsequent average market share to illustrate the degree of fragmentation in the industry. The report finds that more than 50 percent of the companies in the business are below the minimum economic size to remain viable. Some will fall by the wayside, McHale said, leaving survivors to be merged or acquired. The report than goes on to analyze specific M&A drivers and why specialization in certain vertical markets is particularly important at this time.

What's driving M&A?
The top 15 security manufacturers, memoori found, are battling over only 40 percent of the market. Meanwhile, in building automation, a handful of companies worldwide--Honeywell, Johnson Controls, Siemens and Schneider--have close to 80 percent of the market share. UTC and Tyco dominate fire systems. The trouble, said McHale, is that fire sensors and intruder alarms do not have much technology in common with access control and video surveillance systems. "They will look at all three areas [intrusion protection, access and video], but maybe concentrate on one or two," McHale said. That decision, he added, may come down to the verticals they serve.

With the Broadview acquisition, for example, Tyco moved to shore up its alarms installation and remote monitoring businesses. Not exactly an overt step in the direction of network-centric security, but a safe play. "This does really reinforce the value of [remote monitoring] with the investment community taking a particular liking to this business," McHale said. "The most significant thing to us about the Broadview purchase is that it follows on from a string of transactions in the alarms installation and monitoring business. We estimate that 25% of the acquisitions made in 2017 involved buys in this segment of the market."

The deal could yield further dividends if hosted video and access security services become more widespread at the high-end consumer level, although McHale said they have not yet seen indictators that interest in software-as-a-service (SaaS) is driving consolidation. "It would be a surprise if Tyco, with all of their experience about the security industry, do not consider [SaaS] a prime attraction for building up this sector of the business," McHale said. "But as remote monitoring accounts for 40 percent of its security revenues, according to its accounts, maybe they are just happy to see the cash rolling in."

Johnson Controls, however, illustrates how a legacy company can plumb its core vertical markets. With a massive presence in building automation systems, Johnson has assembled a portfolio of security industry partners, ranging from physical security information management (PSIM) to physical identity management vendors. Further, Its latest release of Metasys, its flagship building automation software, includes integration of Johnson's P2000 security management system. Johnson Controls intends to be lead integrator on projects incorporating these various security components, Michael Mann, director, Global Security Solutions for Johnson, told Security Squared last October.

Schneider, on the other hand, offers one of the best examples of how a building automation company is adding a video portfolio while using the VAR channel for competitive differentiation.

"Schneider bought Pelco because it was very strong in video surveillance," said McHale. Further, Pelco's "heritage," or legacy, business may have been the factor that tilted Schneider's decision away from other strong but all-IP video vendors, such as Axis.

Significantly, Schneider did not change Pelco's relationship with its integration channel. While three of its competitors--Honeywell, Johnson Controls and Siemens--have channel partners, they also reserve their biggest contracts for their own installation and service arms, McHale said. So do UTC and Tyco. "They made it clear they will offer value-added services. They are making sure that within their groups [UTC and Tyco are] promoting total solutions and will bid on the largest contracts," McHale said. Within the Schneider Building Group, total business will not be ignored, but each operation within will serve its installer and distributor customers first.

Schneider, however, did change Pelco's product strategy, launching a major partnering initiative, PartnerFirst, that promotes interoperability of its video systems with cameras, analytics, access control systems, storage systems and controllers from other vendors, a program that has won praise from its VARs because it allows them to bid on expansive security contracts knowing they have components certified to work with the Pelco platform.

Pelco's partnership with Cisco Systems also factors into the Schneider strategy. For Pelco, it served again as both a validation of and a way to leverage its integrator channel, giving Cisco an entrée into the security departments of its huge customer base. Schneider-Pelco is also embracing a company that its competitors have eyed warily. Cisco, McHale said, for several years had been trying to persuade the bigger building automation companies that they had to be open and integrated, but it didn't get very far. "In the long run, Cisco is correct, all things are going to be connected, but there is resistance to it," he said.

Some of the resistance is justified. Cisco's IP switches and routers, after all, ended the dominance of Alcatel-Lucent, Northern Telecom and Siemens in telecommunications switching. "Cisco is great at taking their technology and bringing it into new businesses," McHale said. Ultimately, they will infiltrate network-centric security, although he sees the established building automation industry as less vulnerable than telecom because of less centralization among customers and, again, greater fragmentation in the overall security sector.

Level playing field
While there will be more consolidation, IP and IT, with their emphasis on open platforms, however, will militate against vendor concentration, McHale said. "The big boys are not big enough to monopolize it. There are companies that have been successful by doing something slightly different--finding solutions to integration but dealing through the integrator."

SCM Microsystems offers a good example of how the IT side is maneuvering into security. A provider of equipment and software for secure IT access, identity and exchange, the company acquired Hirsch Electronics, a leading manufacturer of physical access control systems. That was followed by its acquisition of Bluehill ID AG, a German-Swiss developer of automatic identification and RFID technologies, products and services.

For integrators in Hirsch's channel, the deal provides an immediate source of IT access and control solutions combined with an integration strategy. For Hirsch, IT convergence in access control is a "perfect storm."

What McHale finds unique about this triple tie-up is that it came together through stock-for-stock transactions, not cash. "This requires a great deal of trust between the senior executives and full agreement on the business strategy," said McHale. "The major benefit is that the business is not saddled with major debt from day one. Sadly, we don't see many people doing that," he said.

Nonetheless, even if they remain linked to the larger building automation companies, successful integrators and VARs will embrace best-of-breed. Looking at the IP-based platforms offered by companies such as Milestone Systems, Genetec, Avigilon and March Networks, McHale considers these proprietary systems supporting open platforms in that they accommodate IP connections to cameras and other devices, but are still limited when it comes to interoperating with each other. Standardization efforts such as those by the Open Network Video Interface Forum (ONVIF) and Physical Security Interoperability Alliance (PSIA), which these companies support, will erode those barriers.

"The next stage will be full integration with open standards--integration within systems, web-enabled and less restrictive to open networking across all the different control services in buildings," McHale said. "Common standards will level the playing field. You'll be able to find the best available. We will get a system that works together--a solution that gets best performance. Big buyers will be a big part of that. The heritage companies will have no advantage other then size."

Building Automation, Fire Alarms, happy, Intrusion Detection, IP Security, IP Video Surveillance, Mergers and Consolidations, Security Integration, and more:

What's Driving Consolidation (And What it Means for Integrators) + Security Strategy