Given the post-9/11 national preoccupation with homeland security, you might think this is a pretty good time to be in the business of home security. But the dominant player in the $11 billion industry is reeling from disclosures of huge accounting irregularities, and at least two of its biggest competitors are for sale.
Just last month Tyco International, the troubled conglomerate that dominates the industry through its ADT subsidiary, dismissed the president of its fire and security division along with four other executives and said it would take a charge against earnings of at least $265 million because of the accounting problems.
Protection One, the No. 2 provider of home security services, has seen its stock price drop 50 percent in the past nine months, and its majority owner is seeking to sell the company, at least partly because of regulatory issues.
Honeywell, ranked No. 4 in the industry, also has put its security monitoring business up for sale to focus on “the higher-growth security products and high-end integrated building solutions business,” company spokeswoman Shawna Todd said.
Certainly many companies have benefited from increased security in the post-Sept. 11 world, including makers of airport X-ray screening devices, closed-circuit cameras, biometric identification systems and even duct tape. Spending on security systems, private guards, alarms and related products and services should grow a healthy 7 to 10 percent a year in the United States from current levels of about $43 billion, according to the Freedonia Group, a market research firm.
But so far the heightened focus on security does not seem to have boosted the fortunes of the alarm and monitoring business, a highly fragmented, intensely competitive industry that is paying the price for some costly acquisitions in the late 1990s.
The turmoil in the industry “doesn’t reflect so much a deficiency or flaw in the alarm business, but at the same time there is no question we went through an aggressive period in the late ’90s, with acquisitions at some high multiples,” said Jack Mallon of Mallon Capital, which advises security firms on mergers and acquisitions. “Many companies are paying the price of those heady days.”
Mallon said that acquisition prices for alarm companies rose as high as 60 times monthly revenues in the late 1990s, far higher than the cost of recent acquisitions.
No one played the acquisition game more aggressively than Tyco, whose former CEO Dennis Kozlowski has been charged with stealing $600 million from the company. ADT, considered one of Tyco’s crown jewels since its acquisition in 1997, dominates the industry with about $2.5 billion in annual revenue. It controls more than 30 percent of the market, seven times the size of its biggest rival, Protection One, according to Security Distributing & Marketing, a trade publication.
The revelation of accounting problems in Tyco’s security business came as an unwelcome surprise to shareholders and the company’s new executive team, coming less than three months after the conclusion of a specially commissioned report that found no such issues. Security division President Jerry Boggess, who earned $8.5 million in 2001, was fired. Tyco’s new CEO Ed Breen appeared before analysts the next day and promised to clean up the “crap” at the company.
Michael Hoffman, a stock analyst at Friedman Billings Ramsey, said the problems at ADT reflect the aggressive way Tyco and other companies tried to grow market share in the 1990s. The alarm business can be a license to “print money,” he said, but first the monitoring company needs to recoup the $1,200 to $1,500 it invests to install a system in the typical home. That means monitoring companies don’t begin to make money on new customers for more than two years. But in addition to overpaying, ADT focused on building volume almost regardless of customer credit quality, Hoffman said. That led to a high disconnect rate, or “churn,” cutting deeply into profit margins and contributing to the accounting issues.
Another major issue for the home security industry is the high percentage of false alarms — 95 percent or more. Many cities now charge homeowners for false alarm calls, and Los Angeles has announced it will stop responding entirely to unverified home burglary alarms. One possible solution is for monitoring companies to respond with private security guards, but that would likely result in higher expenses and higher customer fees than the current average of about $30 a month.
And the bottom line is that even in these security-conscious times, homeowners are reluctant to shell out for yet another monthly expense.
It’s an old story, said Paul Bailin, senior industry analyst for Freedonia Group.
“Security has an interesting relationship to the economy,” Bailin said. “When the economy goes sour you have more crime, and so people are more concerned about security. On the other hand there’s less money to spend on security.”
With ordinary crime down sharply over the past decade, the impulse to beef up security has a different origin this time around, but so far the result has been the same: slow growth for a mature industry.
Likewise in the post-Enron era companies are more diligent than ever about doing background checks that may require private investigation, but in the current economic environment they are doing little hiring.
Kroll, the high profile security company once known as “Wall Street’s Private Eye,” said its security services revenue fell 43 percent in the latest quarter, largely because of the sharp decline in demand for travel security by businesses.
Demand has been stronger in Kroll’s other business divisions including background screening, consulting and training, but the slow economy has taken its toll, said Jack Stradley, managing director of Kroll’s security services.
“Our phones are burning up with people who want to know what to do and how to do it, but when it comes to spending money they are still answering to their shareholders and they are still hurting,” he said. “They are looking to do as much as they can with as little as possible. The floodgates have not opened up — because of the economy.”
Hoffman, the stock analyst, agreed, saying that individuals and small businesses may be more concerned about security than ever before, but in tough economic times they are reluctant to add an extra $20 or $50 to their monthly budget for an alarm monitoring service.
“Is there upside because of 9/11? The answer is yes, but….,” said Hoffman. “This is a dollar expense that almost nobody likes spending in this country. Unless forced to do it, they do it at some minimal level.”