PE ponders PERS
ST. LOUIS—There will be more transactions in the typically quiet PERS space over the next six to 12 months, and maybe even sooner, according to Henry Edmonds, president of The Edmonds Group, an investment bank here, which specializes in recurring-revenue businesses.
An aging population, soaring medical expenses and outside financing could be enough to galvanize the trading market, Edmonds told Security Systems News. He expects private equity to play “a very significant” role, because only a small number of PERS companies are currently large enough to attract a major strategic buyer.
“We’ve got a handful of very large players and lots of small players and not so many people in the middle,” Edmonds said “But there’s more interest in the PERS industry and I think that will attract stronger management teams. It’s going to attract private equity capital and it’s going to attract investors.”
Earlier this month, at the Medical Alarm Monitoring Association’s fall meeting in Orlando, Edmonds said that four of the six new MAMA members were investment banks or “capital providers.” That underscores that the industry is “beginning to attract more of the elements it needs to finance significant growth,” Edmonds said.
Large PERS providers such as Connect America, Valued Relationships and Critical Signal Technologies already have private equity backing, Edmonds noted. Smaller companies, however, will rely on significant equity and debt capital to fuel growth. And the more rapidly a company grows, the more capital it needs.
“If you’re selling lots of systems, you need investment capital, because with PERS you’re not charging a lot of money up front,” Edmonds said. “You have to buy the equipment, incur marketing costs and ship the equipment out, and all of those things cost money.”
At the same conference, Edmonds delivered a PERS presentation where he discussed valuation and how to look at RMR.
He said valuation revolves around four key metrics: cash flow; churn (attrition rate); growth rate/new account volume; and creation cost.
On RMR, Edmonds stressed that RMR is an output, not an input. “If you see a PERS company that trades at 40 times RMR, that does not mean the company is worth 40 times its RMR,” he said. “What’s going to drive where they trade is the interplay of these metrics, and at end of day what those metrics are really telling you is the expected cash flow a buyer can expect from the business over the longer term.”
So where do alarm companies factor in? From a value standpoint, can they compete with independent PERS companies? Familiarity with the RMR economic model is one advantage for alarm companies, but PERS accounts are also a little different from alarm accounts, Edmonds said.
How do they differ? Most obvious are the higher attrition rates, but PERS also presents various challenges in terms of channeling the product to market, Edmonds said. With PERS, there is also a greater onus on generating revenue by efficiently redeploying the units.
The success of alarm companies in the PERS space, Edmonds said, may rest on a company’s capability to develop a separate PERS division within the company. “Most companies that have successfully moved from the alarm into the PERS space have not done so by using the infrastructure they have to sell alarms, but by setting up their own PERS division and having people focused on that business,” Edmonds said. “It takes different expertise.”
That relatively few PERS transactions have occurred, particularly in the last few years, makes the industry somewhat difficult to predict. However, Mark Sandler, a principal with SPP Advisors, an investment-banking firm in the PERS and security industry, noted that some large transactions have closed in the not-too-distant past. In 2006, Dutch conglomerate Philips acquired Lifeline in a $750 million deal, and a year later, the same company acquired Healthwatch for $130 million.
“If I had to rely on PERS transactions to pay my mortgage, I’d be out on the street,” Sandler said. “There are very few who have been involved in transactions and understand the ins and out of the purchase-sale agreement in this industry. There’s lots that go into all of this.”
Sandler added, “[SPP] has probably done a half-dozen deals, which is a lot, but not a lot in the overall scheme of the world; it’s just a lot in the PERS industry.”
Despite the small sample size, reliable formulas exist for PERS valuations, Edmonds said. But as he pointed out in his MAMA presentation, buyers will never pay more than they think they have to.
“We don’t have a lot of data points, but the underlying evaluation methodology is proven,” Edmonds said, adding that the industry has “good tailwind” at the moment. “Everybody’s looking at out of control health care costs and an aging population, and saying there’s a role for technology, there’s a role for PERS in that space,” he said.