The COVID-19 pandemic has not only turned the day-to-day operations of many security companies upside-down this year, but it has also had a significant impact on their overall financial outlook. Indeed, the global outbreak of the coronavirus has affected the volume of industry mergers and acquisitions (M&A), as well as the ability of companies to raise funds via the private equity or debt capital markets in what will undoubtedly be a time of decreased revenues across the board.
In a presentation during last week’s virtual Securing New Ground conference, John Mack, Executive Vice President at Imperial Capital, and Alper Cetingok, Managing Director, Head of Diversified Industrials at Raymond James, discussed how investors are approaching the market overall during this time of uncertainty and the outlook for security firms as they navigate these uncharted waters.
Though M&A activity overall may be down across the industry, there certainly has not been a dearth of industry deals during the pandemic. In August, Google made a $450 million investment in ADT by purchasing a 6.6% stake in the firm as part of a partnership that will see the home security giant offer Nest products to consumers. And earlier this week, Eagle Eye Networks announced that it has secured $40 million in funding from venture capital firm Accel to build out its portfolio of artificial intelligence (AI) solutions.
“Security has always been considered to be a more resilient, counter-cyclical market. So, even though M&A activity more broadly is down… the activity levels in security are down 15% roughly year-over-year,” Cetingok says. “This is very analogous to what happened in the last downturn. What the downturn looks like ultimately who knows because of the overlay of the pandemic and its lasting impact. But in the Great Recession time period, you saw activity levels, in fact, go up for security M&A and I think our expectation would be the same.”
One of the areas that has seen increased activity as of late for the wrong reasons, according to Cetingok, is the residential security market due to distress related to debt maturities or covenant defaults by industry firms. “We’re working on quite a few restructuring, recapitalization transactions and really trying to help companies cross the chasm as I call it and hopefully get to the other side with a better balance sheet and be able to continue running their businesses,” he says.
On the commercial side, however, Cetingok says the opposite has been true with an “over-indexing,” particularly by private equity firms, in the space.
“Private equity has been such a driver of activity in the space and that continues to be the case,” he explains. “What you’re seeing in the private equity community today is being more focused, more targeted and self-selecting out of processes very quickly and really pursuing a narrower set of opportunities, but in doing so, they are pursing them very aggressively. I think that really does suggest that activity levels in the space should be strong and hold up even if we go into a near- to intermediate-term economic downturn in the aftermath of COVID.”
The Big Picture
Mack told attendees that at this time last year, Wall Street had already seen approximately 14,000 M&A deals worth $1.9 trillion, whereas the market to this point in 2020 has seen 12,000 deals worth $1.2 trillion, a 37% decline.
And while the Dow Jones Industrial Average took a significant hit when the coronavirus initially began to spread across the U.S., it has come roaring back as of late. “The bull market continues but it is a little harder to say it is reasonable to accept that will be sustainable given the kind of challenges we’re going to have in the economy given the pandemic,” Mack says.
When it comes to private equity investment, Mack says that deal flow has increased over the past few years but that there will undoubtedly be a pull back as these firms sort out the impacts of the pandemic and the businesses that stand poised to perform the strongest moving forward.
“It has come back with a very strong effort in the fourth quarter. Both Alper and I are comparing notes that we’re very busy right now and people are looking to get transactions done,” he adds. “Valuations have held up nicely and we’ve seen most of the activity in the lower end of the private equity market, which is good because that is likely where most of the activity is for the security industry.”
In the wake of the pandemic, investors have also taken a keen interest in cybersecurity firms as some of the challenges brought about by the transition to work from home has shined a spotlight on the need for solutions in this area, which has subsequently sent valuations for some of these companies through the roof.
“We’re talking about millions and millions of people working from home and completely new paradigms for how security is going to be configured to protect data and otherwise and companies weren’t necessarily fully setup for that. They’ve had to race to make investments to make sure all of that infrastructure is properly protected for work from home strategies, Zoom meetings, etc.” Mack says. “That is why that spike in investment is happening and I think it will be sustained for some time because there is going to be a lot of infrastructure that has to be put together to build out all of that capability.”
Despite the high valuations for cybersecurity, Mack says that, by and large, there are still meaningful valuations for all businesses across the security spectrum.
“We’ve got a sector that is in demand and that’s generally attracting higher valuations,” he explains. “The move to managed services and SaaS-based business models across these different subsectors is having an impact on valuations and increasing valuations. It is encouraging to see that, as an industry, we’re attracting higher than average valuations overall.”
Joel Griffin is the Editor-in-Chief of SecurityInfoWatch.com and a veteran security journalist. You can reach him at [email protected].
