UTC Fire & Security Goes for Growth with Acquisition of GE Security.

UTC announced today that they will buy GE Security for $1.8 billion. The full details have not yet been disclosed but this looks to be an exit price based on sales revenue of around unity. This seems like a good buy particularly considering that it cost GE Security at least $2 billion to assemble the main parts of it's business.

Clearly it is not the best time for selling such a major business unit but I guess that this now gives GE the opportunity to buy something else at a bargain price, which makes a better fit with their enshrined ruling; "if you can’t make No 1 or 2 in the business then divest."

So the opportunity to buy a $2 billion business has come at a good time for UTC. A number of the major competitors in the market were keen to bid but the fit was not so good for them at least not at this price.

The purchase of GE gives UTC a significant boost in the US market both for security and fire detection. In particular they will gain market share in fire detection through acquiring the well respected brand name and business of Edwards Systems Technologies which cost GE some $1.4 billion in 2005.

UTC started their Fire & Security business in 2003 and has since spent some $5 billion in buying or investing in fire detection and electronic security companies around the world. The majority of these acquisitions have been in Europe and China. Kidde and Chubb, UK based companies were acquired in 2003/4. These have proven to be shrewd buys. Both were underperforming and have grown significantly since becoming part of UTC.

We expect that UTC will prove to be a better home for GE Security and through this acquisition and others they will continue to increase their market share in this business.

This acquisition is going to have a major impact on the progress of consolidation in the security industry. We cannot see the major players in this industry, none have a market share much above 10%, sitting back much longer on their cash reserves.

Majors in the Security Business are Losing Share, Confidence and Ambition Whilst They Sit on Their Cash.

The third quarter results of the major security players reported this month would
suggest that the market for electronic security products and systems has not yet
bottomed out. The decline in security sales, where reported, was around 15% compared
with the same period last year. As also noted last month it is evident that the
specialist suppliers such as Axis, L-1 Identity Solutions, Milestone and many others are still producing remarkable growth in sales given the present difficult trading conditions.

These medium sized focused and well established companies have seen their growth decline but have confidently pressed on with expansionist plans. By comparison
the major traditional global suppliers have cut back heavily on expenditure and
have built up their cash reserves. We can deduce from this that the majors must now
be losing market share whilst the market is becoming more fragmented, for there is
no progress in consolidation which not surprisingly is well down on its peak in 2006/7.

There has been a rapid slowing down in the consolidation process since the start of
2008 but it was not until August and the financial melt-down that this trend became
manifest. However as we have seen during the last three months merger activity has
increased significantly on the same period of 2008. So are the green shoots of consolidation starting to appear and will they grow and flower? Well if so, don't expect the majors to prime pump it for so far they have been conspicuous by their absence from this process. Most of the activity in the last nine months has come from relatively new players such as Stanley Works, Cisco, General Dynamic and Flir etc. If we extend this period by another year then relative new entrants such as UTC Fire & Security and Schneider Electric dominated consolidation activity.

This business prior to 2007 was in the major throws of consolidation and it is vital
that this continues for all stakeholders in the business. Our analysis shows that the main restriction is the fact that the major global suppliers have for the most part withdrawn from the acquisition market, because they have lost confidence at this time to commit to the future. It has been left for the medium sized businesses to maintain their strategy for growth through acquisition and now merger and a number of relatively new entrants have recently bought into the security business.

The current situation does give rise for caution but it also presents opportunities to pick up technically smart companies that are badly in need of cash injections to continue product development and capital venture companies are not know so interested in taking a risk in this business.

Last month we discussed the various implications and options of a bid for GE Fire &
Security for if this goes ahead it could remove the log jam. There has been very little news or rumours this month but analysts are placing their bets on UTC Fire &
Security and have also put Tyco into the frame. These are probable candidates but
there are also at least another four possibles. Whichever of these companies acquires
GE Fire and Security will become the number 1 supplier. Will the others then be
tempted to grow their business or will they continue to sit on their cash?

Will The Security Industry "Majors" Take This Opportunity To Rapidly Increase Their Market Share?

Despite the fact that in September we identified 10 acquisition / merger transactions
(double the number in the same month last year), the consolidation process has
dramatically slowed down this year, when measured by value. This is hardly surprising
given the liquidity crisis and the financial melt-down over the last two years, which has dislocated the ability to fund acquisitions. However consolidation will be driven by the massive fragmentation of this business with many companies being well below the minimum economic size and unable to support the ever increasing need to develop new products. The consolidation process is therefore getting jammed up but the dam will inevitably burst. Our analysis shows that the main restriction is the fact that the major global suppliers have for the most part withdrawn from the acquisition market, because they have lost confidence at this time to commit to the future. It has been left for the medium sized businesses to maintain their strategy for growth through acquisition and now merger and a number of relatively new entrants have bought into the security business. The current situation does give rise for caution but it also presents opportunities to pick up technically smart companies that are badly in need of cash injections to continue product development and capital venture companies are not now so interested in taking a risk in the security market.

Well the acid test is about to take place, for with the sale of GE Fire and Security we will learn the truth. Are the majors in this business prepared to spend their cash and commit to growth and will it amount to the $2 billion that GE paid to assemble the business over the last five years with some first class companies? Or will they leave it to the relatively new aspiring majors to rapidly increase their market share at depressed prices?

The market waits in anticipation for this big one; a deal or deals being taken up on
the sale of GE Fire and Security. Last month we identified the companies that we
though would be the main contenders to make a bid. We neglected to include the
recent entrants from the Defence Industry on the basis that GE would much prefer
one bid and none of these companies would want to get involved in fire detection.
However because of the lack of confidence and liquidity in the market we believe that
the break-up value is much more likely to realise a better deal for GE, so we do
expect at least separate bids for Security and Fire Safety. This would then allow the
likes of General Dynamics, BAE, Flir and Federal Signal to enter the fray to grow their commercial security business. There are at least 4 companies that would like to
acquire the old Edwards fire detection operation now part of GE Fire division. We
have in section 1.4 set out the rationale for a swap with Honeywell’s Process Automation business, which in the present economic circumstances may be appealing.

None of the majors in the electronic security business across the three main applications, Video Surveillance, Intruder Alarms and Access Control have got more than a 15% share of the business and there are many hundreds of companies out there that alone make up the products business. So this is a major opportunity to make a very significant leap forward. Can they afford to ignore this opportunity?

Eureka – GE Fire & Security swap for Honeywell Process Automation?

There is no further factual news on the sale of GE Fire & Security since Bloomberg News announcement last month that GE Security had hired J P Morgan Chase to find a buyer. So the speculation continues and the list of potential suitors grows. But unfortunately GE, like all major corporates, is obliged to continue the line of “no comment”.

Clearly it is not the best time for selling such a major business which has cost some $2 billion to assemble. So this begs the question why would you want to sell, at this time. I suspect that the answer to this is, to buy something at this time, which makes a better fit with your business strategy and at the same time meets GE’s enshrined ruling; if you can’t make No1 or 2 in the business then divest.

Interestingly in August GE and Fanuc announced that they will dissolve their partnership by the end of this year reflecting the reality that factory and process automation and CNC/robotics technologies and markets do no have the required synergy to continue the partnership. Under the terms of the breakup, GE retains the software, services, embedded and control systems businesses worldwide and the new
operation becomes "GE Intelligent Platforms". GE must now be looking for an acquisition to retain a dominant position. The most likely candidates are Invensys and Rockwell, both struggling at this time.

But what if you could find a solution that solved both problems at the same time. Eureka; swap the Fire & Security business for Honeywell’s Process Automation division and save millions of dollars on bankers fees. After all GE came close to acquiring Honeywell almost a decade ago.

This solution would be quick and would end the speculation that is damaging for GE Fire & Security and all its partners in the value add chain.

Never Mind the Security, Feel the Fire.

Back in April this year we placed GE Fire & Security on our list of the top 50 potential acquisition prospects for 2009. This followed the decision that month for the sale of 81 percent of its Homeland Protection business to Safran, a French company known mainly in the security industry for its Sagem Securite business, for $580. At the time GE Security CEO and president Dean Seavers said the deal would allow GE Security to focus on its "core business": intrusion, access, video and transmission, key control, and fire and communications. However many watchers in the industry including Memoori had already decided that it would not be long before the remaining parts of the security operation would be up for sale. So the announcement last Thursday by Bloomberg News that GE Security is for sale, having hired JPMorgan Chase to find a buyer, was no surprise even to those without a crystal ball. So the biggest deal in the Security and Fire business for many years has now started.

The Blogs covering the security industry are quite dismissive of the quality of products and service of their security division and doubt that any of the majors would be interested unless it was at a fire sale price. The heritage estate would be the only attractive asset, whilst the products would just duplicate with no leading edge technology, is the claim being made.

However their Fire Detection business is a much more tasty morsel. Built around the Edwards System Technologies acquisition of $1.4 billion in March 2005, this is a well respected business having a significant market share in an industry that is more mature and far less fragmented than the security market. The opportunity to buy a Fire Detection business of this size and geographic coverage is unlikely to happen again for many years. It may not have the growth prospects of the security industry but neither does it have the hundreds of small innovative companies creating a constant need to develop new products.

We believe that the Fire Detection business will be key to the acquisition strategy that will unfold during the next few months. The last major fire business to be sold was Novar in 2005, completed 2006 and it has given the acquirer, Honeywell, the number 1 slot in Europe. The other majors in this business Tyco, UTC, Siemens and Bosch must have a real interest in this opportunity and will put up a stronger fight than last time. Significantly these companies are also major players in the security industry. If Schneider want to make a push into Fire Safety, this is the time and they will not be hampered by any monopolistic considerations.

The next few months will for sure see a flurry of interest and activity. This acquisition is complex because of its size and the number of different businesses making up GE Fire & Security and the current economic climate. A break up is likely to produce the best outcome for GE.

The Security Business is not Taking up the Opportunity to Achieve Growth and Consolidation Through Mergers

July and August are traditionally slow months for acquisition activity. We saw the completion of 8 deals, the same number as realised in 2008. However with the exception of Google's purchase of ON2 Technologies, at just over $100m, none of the other 8 deals cost more than $20m, whilst in 2008 the value of deals was at least an order of magnitude higher. Google’s purchase of codec specialist ON2 Technologies does not herald its entry into the video surveillance market but confirms its intention to support video, so it is not of particular significance to the security industry.

All the other transactions were related to either completing full ownership of companies, filling gaps in product or service offerings and increasing geographic scope. Surprisingly at least 80% of the deals were cash transactions and our prediction that merger would be a dominant feature in 2009 has just not happened yet.

The logic here was that the credit crisis would drastically reduce the possibility of consolidation but at the same time the recession would drive this very fragmented business to find its solution in merger. Apart from the merger of SCM Microsystems with Hirsch and Panasonic with Sanyo Electric little more has happened. However Felix Marx, chief executive officer of SCM Microsystems quotes in their recently published financial report, "Our merger with Hirsch is proving a strategic success, as it has strengthened our financial performance across multiple metrics, our ability to capture new and existing sales opportunities and our overall business profile. With only two months of operating results from our Hirsch subsidiary included in the second quarter, sales doubled in our Security and Identity Solutions business, overall gross profit margin increased by eight percentage points and the Hirsch subsidiary generated operating profit on a standalone basis". So when will the laggards follow suit?

In our last M&A report in June we commented on the fact that whilst the majors are always looking to acquire they believed that deals were too expensive as valuations did still not reflect the true nature of the market. Well this month most reported on the 2nd quarter performance to the end of June and now we can see the reason for their lack of confidence. For the majority sales were down by 20%, but the smaller, more focused suppliers such as AXIS, Mobotix, Flir and SCM Microsystems performed far better and those in the IP Video segment are still realising significant growth.

The majors clearly have a dilemma, do they concentrate on the short term by cutting expenditure and increasing margins to improve profitability and so keep up their share price, or do they take the long term policy of investing their cash in more leading edge companies / products and therby upset the investment community.

Until today it seemed likely that they would sit on their hands for a little while longer but the announcement by Bloomberg News that GE Security is for sale, having hired JPMorgan Chase to find a buyer will change all that. Bloomberg is reporting that "GE asked potential buyers to submit preliminary bids about a month ago," but GE Enterprise Solutions will not confirm or deny.

In April, GE sold off 81 percent of its Homeland Protection business to Safran, a French company known mainly in the security industry for its Sagem Securite business, for $580. At the time GE Security CEO and president Dean Seavers said the deal would allow GE Security to focus on its "core business": intrusion, access, video and transmission, key control, and fire and communications. However the cynical watchers in the industry had already decided that it would not be long before the remaining parts of the security operation would be up for sale.

There are only a few companies that could take on the whole of this business and of these we suspect Honeywell, Tyco and UTC Fire and Security are likely to be the main contenders but Schneider will give this a serious look as it would provide an entry into the fire detection business. Siemens and Bosch have in the past shown a strong preference to add more focused operations to their portfolio.

Convergence & Integration – Part 2 Proving the Business Case.

Allan McHale, Director of Memoori, reviews the business case for convergence and integration in buildings. Part one of this article ran in the May issue of A&S, with the second part focusing on security systems delivering holistic solutions.

Building automation is specified at the design stage for new construction, while security is frequently purchased after the building’s completion. This can pose the first barrier to integrating security with other building control infrastructures, but not convergence with IT.

The emphasis is now on convergence with IT. For one, IT security issues are the responsibility of the IT department, including all data networks. The IT department increasingly takes the initiative to ensure more robust security solutions, particularly for use of existing data networks. More importantly, it appreciates the potential benefits for the business enterprise, which has become the driver for IT convergence with security. If there is a case for IT convergence, why is it taking so long to become standard? And why is it only used by large companies and for major infrastructure projects?

Dominic Bruning, Marketing Director for EMEA at Axis Communications, said that all too often, physical security and IT are treated as two separate silos. This results in high personnel and material cost, along with inefficiencies, making it easier for security gaps to occur unnoticed. He suggested a management structure change to overcome this scenario, with the CSO reporting directly to the CEO and implementing a converged strategy.

CIOs, until recently, had little interest in physical security and often regarded it as a threat to IT security. Combining these roles would ensure a more comprehensive security solution, which is gradually taking place.

Proprietary Standards
The second barrier to integration was convergence offering fewer connectivity options, forcing users to be locked in to one supplier. This has changed, with more standard communication protocols being adopted and applied to security. It is unlikely to integrate all the sophisticated applications offered by some proprietary systems, but interconnectivity between brands has improved over the last five years. In the physical security business, supervisory software from suppliers such as Milestone Systems melds together hardware from different suppliers in fire safety and building environmental automation systems.

On the supply side, installers and integrators have not played a dynamic role in delivering holistic solutions. In the early years, it was left to global manufacturers and solution providers to take the initiative, such as Honeywell Building Solutions, Siemens Building Technologies and Schneider Electric (TAC). These companies have delivered comprehensive solutions in vertical markets including airports, hospitals, shopping malls and industrial complexes. These are large projects on new construction sites and connect many aspects of the business enterprise with security, safety and environmental controls.

IT-data network practitioners have entered the market recently, adding much-needed expertise. As early as June 2005, Cisco Systems introduced its Connected Real Estate program. In January 2009, it expanded products and services. First, Cisco launched its comprehensive physical security solution after a series of smaller acquisitions. The company now offers network video surveillance — from capturing video to processing video at the back end — and access control. These edge devices plug into the IP network like a mobile phone or laptop.

A second component of Cisco’s Connected Real Estate vision is its Digital Media Systems. The company offers end-to-end content systems, including digital signage and media, to commercial real estate. In 2008, Cisco signed its first strategic alliance for Connected Real Estate with Johnson Controls (JCI). The JCI partnership allows Cisco global access to facility management world, securing far-reaching integration of building systems and IT networks. Cisco also launched EnergyWise, a networked energy management solution which monitors and controls the power consumption of all networked devices. Other IT companies also have a significant presence in security, such as March Networks, Controlware Communication Systems and Optelecom-NKF.

Market
With both technical and commercial solutions available to eliminate barriers, how will the market develop? In 2006, Memoori estimated the world market for electronic security solutions to be worth US$20 billion in 2004 to 2005 at installed prices.



As Figure 1 shows, IP solutions accounted for less than 10 percent of the market. We projected an annual growth rate of 6.5 percent for electronic security over the next 10 years, with IP-based systems to take $8 billion in 2008 or approximately 30 percent of the market. By 2014, we forecast IP-based systems to account for 80 percent of the business. According to anecdotal evidence today, the recession has reduced demand in the last 18 months.

However, forecasts indicate that IP-based solutions have increased their market share and will accelerate after mid-2010. All security systems will grow less than 6.5 percent between 2008 and 2010. Regardless of whether these predictions are accurate, what is critical is that IP-based solutions will become standard within the next six years. This is driven by demand for security systems to converge with IT and deliver holistic solutions. However, as mentioned in part one, few suppliers have spent sufficient time and effort in proving the business case for convergence and integration to their customers. Until they do, all their efforts to promoting it will fall on stony ground. It may require more successful partnerships and alliances between manufacturers to reach the targets set above. Certainly, more care on delivery is required to maximize opportunities. Suppliers who are prepared to offer their solutions through managed services will be welcomed by customers.