Finance virtual roundtable: The most interesting deals of 2013 and predictions for 2014

Holloway, Epstein and Schmidt opine on valuations for alarm companies and integration firms, offer advice for sellers
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Monday, December 30, 2013

Every January, Security Systems News asks security finance experts to share their opinions on deals done, valuations sought and won, and prospects for buyers and sellers in the coming year. This year, the following experts participated in a virtual roundtable discussion: Jennifer Holloway, managing director, Security Industry Group, at The PrivateBank and Trust Company, a Chicago-based commercial bank and wealth management institution with a national specialty lending group dedicated solely to the security and PERS industry; Barry Epstein, president of Vertex Capital, which represents buyers and sellers in the acquisition process in the life safety sector; and Will Schmidt, managing director, Security Lender Group, CapitalSource, a senior lender, and provider of capital to the security alarm industry. 

Martha: What do you think is the most interesting deal of 2013? Why?

Jennifer: One of the most interesting deals in 2013 was the Monitronics acquisition of Security Networks. While I think the acquisition was a great move for Monitronics, it took me by surprise because Oak Hill had only owned Security Networks for three years. This speaks well of the rapid growth of Security Networks as Oak Hill was able to realize their investment in a short horizon. Whenever a sponsor is able to invest in our security market and successfully exit, this is a win for our industry since it attracts others. We see this today with a large percentage of sponsor-owned companies in our space. The PrivateBank, as a specialized lender, gets frequent calls from sponsors interested in security. The continued interest from outsiders is a good thing; it’s when there is no interest that we should all be worried. So I count the Security Networks sale as a “win.”

Barry: The most interesting deal in 2013 was Kastle’s acquisition of Mutual and Statland from ADT. What makes the alarm industry transaction market so buoyant is the constant interest and new investment from companies outside the traditional burglar alarm monitoring space. While Kastle has a large amount of RMR, it is from integrated managed services and not the traditional retail RMR of most alarm companies. Having another large player enter this part of the market attests to the continued demand for alarm recurring revenue from well-managed alarm companies.

Will: I believe that Monitronics’ acquisition of Security Networks was one of the most interesting deals of 2013. Over the past ten years, private equity investors have become an important part of the landscape. This transaction not only created a high-profile win for Oak Hill Capital Partners, the private equity firm that invested in Security Networks, but also allows Monitronics to continue to leverage its infrastructure and harness the growth of Security Networks' dealer base. Furthermore, both the debt and equity markets have been supportive of Monitronics (through its parent Ascent Capital Group),providing another important public reference point for investors.

Martha: Compared to 2012, how would you characterize the number and activity among buyers and sellers this year for a) alarm companies, b) integration/commercial security companies and c) PERS/other security related deals?

Jennifer: The M&A activity had nice activity in 2013 in all segments. We expect a bigger year in 2014. PERS does not have the long market valuation track history seen in the security space. As the most active lender in the PERS space, we look forward to seeing new M&A activity in PERS to establish longer-term market valuations.

Barry: The integrator market had a strong year as profits were up for the sellers. Unlike the alarm market, which trades on multiples of monthly recurring revenue, the integrator market trades on multiples of adjusted EBITDA, or “cash flow plus the owner’s total benefit added back.” When the financial crisis of 2008 hit, construction came to a standstill and the cash flow for many of the integrators went away. Selling one’s company for a multiple of cash flow when cash flow was zero was ludicrous and therefore there were few if any transactions not only that year but for the next couple of years as the market slowly recovered. We are now seeing strong profitability from the integrators and, as a result, the math makes sense when they go to market. Additionally, there are now more private-equity backed companies looking to grow through acquiring integration companies.

Will: From my perspective, transaction volume in the core alarm market was down in the first half of 2013 and has rebounded to more normal levels in the second half of the year. I believe some transactions were "pulled forward" into 2012 in order to eliminate tax uncertainty and this negatively impacted pipelines in early 2013. Furthermore, while low interest rates have spurred prices north, they have also limited investing opportunities for sellers, discouraging sellers who are looking for ways to replace lost income through investment yields. The commercial security market is a more challenging M&A environment due to the specialized nature of customers and services. We remain intrigued by the transition in this market toward managed services models (managed video, managed access control, etc.) and believe that companies embracing this challenge will be well positioned for future growth. CapitalSource is very bullish on the PERS market. The confluence of strong demographic trends and improved technology (cellular PERS units, mobile PERS and other enhanced features), will continue to drive strong growth in this market. The market is highly fragmented with few companies having the necessary scale to attract outside investors. Due to this factor, there were few notable transactions during 2013.

Martha: What about valuations/multiples paid? Were there many changes from 2012? 

Jennifer: We’ve seen purchase multiples increase in 2013 for larger acquisitions due to competitive pressures. Many companies seek to layer in acquisitions as a portion of their growth strategy. Buyers anxious to win an acquisition may be tempted to chase multiples higher than in prior years.

Barry: Valuations remained high for 2013. The biggest reason for the high valuations is the number of bidders. The majority of the bidders in today’s market are operators backed by private equity. The private equity companies buy with the general intention of selling in a five- to seven-year time frame. They look for companies with a very strong likelihood that they can grow at a rapid pace. In the alarm industry this rapid growth comes from either dealer programs or through acquisitions. When properties came to the market this year, those with well-run companies ([with] contracts on the accounts, owned phone lines and low attrition) and/or a growth engine had the private-equity backed companies bidding against one another. The auctions conducted yielded valuations that were very strong.

Will: Valuations remain robust in 2013 driven by continued strong operating results and further lifted by low interest rates. As values reach the high end of the range in 2013, structural and other non-economic points became key differentiators that buyers competed upon. It has become a market in which a high price is assumed, so you must differentiate your offer with speed and certainty of execution. Furthermore, the favorable pricing that was typically reserved for companies with more than $100,000 in RMR has migrated south and we are seeing sellers with $25,000 to $100,000 in RMR receive offers that previously were reserved for only larger companies.

Martha: If you had to give a "do" and a "don't" piece of advice to anyone getting ready to sell in 2014, what would the advice be?

Jennifer: 2014 is promising to be a great year for sellers and buyers. The market is competitive; buyers are actively seeking acquisitions. A robust M&A market is great for specialty lenders like The PrivateBank with an expertise in structuring transactions to support acquisitions. The credit market is strong and so credit availability is not an issue. My advice would be for sellers to take this time to ensure their assets are in pristine condition for sale (ensuring all customers are under contract, on dedicated phone lines with proof of recent signal activity). They should develop reporting and metrics that support the quality of the accounts for sale (attrition, payment history, payment type, aging analysis).

Barry: The best advice for sellers is twofold. The first is to have your financials and contracts in order. Those two items will cut the sell time dramatically as the buyers can quickly ascertain the value they put on the company and it eliminates the back and forth of endless questions. The second is not to sell your company yourself but to use a representative. With so many buyers out there and so many options, selling it yourself guarantees you will not maximize the triad of price, terms and structure.

Will: Do—do your homework and be prepared. While this is a very rewarding environment for sellers, buyers are disciplined and due diligence will be demanding. Preparation will not only make the process easier, but will also reduce risk for the buyer allowing the highest valuation. Don't—don't be unrealistic. Not all businesses are created equal. Every operator needs to have a sober understanding of the operating metrics of their business and the impact that these metrics might have on value. General valuation multiples are helpfulness guideposts, but cannot be applied in a vacuum.