maximizing the value of your alarm business

7/22/2019 Maximizing the Value of Your Alarm Business

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Maximizing the Value of Your

Alarm Business

Confidential

Not to be relied upon, forwarded or duplicated without consent of The Edmonds Group, LLC.



Confidential - Not to be relied upon, forwarded or duplicated without consent of The Edmonds Group, LLC.

Summary

• Introduction• Value drivers

• Valuation Methodologies

• Historical valuations and current market conditions

• Impact of entry of cable and phone companies

• Valuation of new RMR-generating services

• Data-tracking: What to track, how to track it, how it

effects valuation• Lessons for buyers and sellers

• Q&A




INTRODUCTION




Henry Edmonds

• 30 years of capital markets experience, over 20 years in thealarm industry

• Wall Street investment banker (1985-1990) – $2B in transactions in the airline industry

•Co-Founder (1990) and CEO of SLP Capital (thru 2004) – Largest lender to alarm industry when sold to CapitalSource in

2004

– Over $400M of alarm loans

• Started Edmonds Group in 2004

• MBA, Harvard Business School• BS, with distinction, civil engineering, University of Virginia




The Edmonds Group

• One of the top investment banks in the securityalarm/PERS industries

• Services include capital raising, M&A advisory,strategic consulting

• Work with dealers that have $100,000 in RMRand up – Including some of industry’s largest companies: ADT,

Vivint, Monitronics, Security Networks

• TEG has closed deals with over $3 billion in value – Broad experience representing sellers, buyers,

borrowers and capital providers




Who We Are Not

• We do not have gray beards

• We do not run an industry conference

• We are not a large investment bank thatdabbles in the industry, takes on multipledeals simultaneously, staffs them with juniorpersonnel, and executes indifferently for

clients• We do not throw things up against the wall

and hope they stick




VALUE DRIVERS




What Determines Your

Valuation?

• Market conditions

– Time your exit/sale

• Size of transaction

– Bigger is better

• Key operational metrics

– Quality of operations/ability to generate cash flow




Key Metrics that

Determine Value• Margin on existing customers

• Attrition rate

• Growth rate

• Creation cost

Taken together, they will allow us to determineexpected CASH FLOW over time

Dealers must have the ability to provide good dataon these metrics if they are going to maximizevalue!




VALUATION METHODOLOGIES




Valuation

Methodologies

• Discounted cash flow analysis

– This is the most commonly used as primary

approach

• Multiple of earnings

– Adjusted EBITDA and SSFCF for the alarm industry

• Multiples of assets

– RMR multiple for alarm industry

• Multiple of book value of equity




Valuation

Methodologies• Multiple of earnings

– Could be net income, EBITDA or cash flow

– Based on comparable companies, either completed transactions or publically traded

– For alarm companies:• Adjusted EBITDA

– Earnings (Net Income) before interest, taxes, depreciation and amortization

– Additional adjustment – add back all costs related to creating new accounts

•

Steady State Free Cash Flow (SSFCF) – Start with Adjusted EBITDA and add back creation costs (expenses) required to replace attrition

• Multiples of assets – Based on comparable companies, either completed transactions or publically traded

– For alarm companies:• Multiple of RMR

• Multiple of book value of equity –

Based on comparable companies, either completed transactions or publically traded – Not typically applicable for alarm companies as most have negative net worth




Discounted Cash Flow

Analysis

• Buyer will develop key assumptions based ontarget company’s past performance

• Determine a capital structure

– Influenced by market conditions including cost andavailability of debt

• Buyer will do a financial model for targetcompany

– 5+ years into the future – Key metrics (creation cost, margin, attrition, growth

rate) will drive model cash flow




Discounted Cash Flow

Analysis

• Buyer’s required return on investment (“ROI”)

will determine what buyer CAN pay

– Required ROI driven by buyer’s strategy, its investors,

market conditions, “next best alternative”

• Negotiation will determine what buyer WILL pay

– Buyers never pay more than they think they have to

•The multiple (of RMR, Adjusted EBITDA, SSFCF) isan outcome of the valuation and is used as a

reference point




Sensitivity Analysis

• Buyers will start with a base case valuation

– Typically a scaled back version of projectionsprovided by seller

• Run scenarios to determine how sensitive theresults are to different assumptions

– Slower growth, lower margins, higher attrition etc.

– Will also look at upside scenarios

• Confidence in the assumptions and impact ofsensitivities influence the purchase price




Acquisition Process

• Preliminary purchase price is provided in a letter of intent (“LOI”) – Based on initial information from seller

– Non binding and subject to due diligence

• Buyer conducts due diligence to verify information and assumptions – Confirm there are not undisclosed problems, liabilities

• Often will make adjustments to preliminary purchase price – Poor quality data (more on that later)

– Metrics worse than reported (higher attrition, unreported costs,slower growth/weaker sales pipeline)

– Personnel issues, undisclosed liabilities, tax problems

• Adjustments are never in seller’s favor! – The more/better information provided by seller (before LOI), the

better seller’s negotiating position will be

• Documentation and closing




HISTORICAL VALUATIONS AND

CURRENT MARKET CONDITIONS




Security Alarm RMR Sale

Multiples

Source: Barnes Associates

34.1x36.9x 37.2x

42.5x

0.0x

5.0x10.0x

15.0x

20.0x

25.0x

30.0x

35.0x

40.0x

45.0x

Under $50K RMR $50-100K RMR $101K-500K RMR Over $500K RMR

10 Year Average 2003-2012




Security Alarm RMR Sale

Multiples

Source: Barnes Associates

36.1x

39.9x 40.2x

50.8x

31.1x

34.2x 34.7x

28.9x

20.0x

25.0x

30.0x

35.0x

40.0x

45.0x

50.0x

55.0x

Under $50K RMR $50-100K RMR $101K-500K RMR Over $500K RMR

Max & min yearly averages 2003-2012




Major M&A Transactions 2013

YTDBuyer/ Investor Acquired RMR

(millions)RMRmult.

SAFE Security Pinnacle (accounts) $1.9 30’s

Central Security Group SecureNet $.7 40’s

Goldman Sachs/The

Beekman Group

NorthStar $1.0+ 46x

ADT Security Services Devcon International $3.6 41x

Ascent

Media/Monitronics

Security Networks $8.8 58x

SAFE Security CastleRock (accounts) $0.7 30’s




Major M&A Transactions 2012

Buyer/ Investor Acquired RMR (millions) RMRmult.

BV Investment Partners DTT $1.5 60x

Interface Westec $1.7 32x

Norwest Venture Partners ACA $3.6 50x

Ascent Media/Monitronics Pinnacle $4.4 30x

Blackstone Group Vivint $31.6 57x

Protection 1 Vintage Security ~$.4 DND




State of the Market

• Currently a “seller’s market”

• Capital markets conditions are very favorable – Lots of capital available, low cost, flexible terms

– Lenders are competing on growth, not worried about portfolioproblems

• Many interested buyers with pressure to grow/put money to work – Public companies like ADT, Ascent/Monitronics, Stanley

– Private equity backed companies like Protection 1, CSG, ASG, ACA

– Private equity firms on the sidelines looking to get into the industry

• However, most buyers are knowledgeable/sophisticated

– Can identify quality and are willing to pay a higher price for it




Debt Markets

• Middle market senior debt (under $250M facility) – lending multiples 18-26x RMR

– Stretch Senior multiples 26-28x RMR

– Subordinated debt up to 30x RMR

• Large debt transactions ($250M+) – Total debt/RMR availability in the 30’s

– Only a few data points• Monitronics

• Vivint

• Protection One

• ADT




Private Equity

• Over 2,000 private equity firms in the US

– Firms come in all sizes

• Close to $500 billion in money to spend

• Many more PE firms interested in the alarm

industry

– Industry performed well through 2008/2009 recession

– Viewed as safe harbor with good upside potential

• Favorable debt market conditions help valuations




Strategic Buyers

• Large alarm industry firms are acquisitive – ADT, Protection One, Monitronics, Stanley

• Midsize firms too – SAFE, ACA, ASG, CSG, Guardian, Vector

• Private Equity is doing more alarm industry deals – Blackstone, GTCR, Goldman, Beekman, BV

• Non-industry strategics too – Ascent Media bought Monitronics (2012), SN (2013)

– Stanley bought HSM (2007), Sonitrol (2008), Niscayah(2011)

– Philips bought Lifeline (2004), HealthWatch (2007)

– Phone companies, cable companies




What People Hear Isn’t

Always What You Think




Valuations

Expected valuations for companies with average

performance metrics:

• Less than $50k in RMR – high 20s to low 30s

• $50k to $100k in RMR – low to mid 30s

• $100k to $500k in RMR – low to mid 40s

•

$500k to $2M in RMR – mid to high 40s• $2M+ - 50’s




IMPACT OF ENTRY OF CABLE AND

PHONE COMPANIES




Cable and Phone

Company Entrants

• 7 of top 10 cable companies in the alarm industry

• 5 of top 10 phone companies in alarm industry

• Why are they entering?

• How big a threat are they to alarm companies?

• Will they stay?

• What is overall impact?




Top U.S. Cable Television

CompaniesCompany Approximate # of

subscribers

(millions)

SecurityProduct

Offering?

Date of Entryinto Security

Comcast Corp. 23.0 Yes 2010

DirecTV 21.0 Yes 2013

Dish Network Corp 14.0 No

Time Warner Cable 12.0 Yes 1995

Cox Communications 4.6 Yes 2011

Verizon 4.6 Yes, but no

monitoring

2011

AT&T 4.3 Yes 2013

Charter Communications 4.2 No

Cablevision Systems Corp 3.2 No

Bright House Networks 2.5 Yes 2012




Top U.S. Phone Companies

Company Approximate # ofsubscribers

(millions)

Security Product Offering? Date ofEntry into

Security

Verizon 139.7 Yes, but no monitoring 2011

AT&T 137.1 Yes 2013

Sprint 62.4 No

T-Mobile US 44.0 No

CenturyLink 13.2 Yes 1997

U.S. Cellular 5.0 No

Windstream 1.8 Yes, but no monitoringFrontier Not reported Yes – ADT and P1 partnerships 2011

FairPoint .9 No

Cincinnati Bell .9 Yes – through Guardian Alarm 2001




Selected Entrants vs. ADT

Company Revenue(billions)

Annual adspend

(billions)

Total Customers(millions)

MonthlyRevenue/cus

tomer

Customerattrition rate

AT&T $127 $1.9 137.1 $110.82 16.2%

Verizon $116 $1.6 139.7 $84.8 17.5%

Comcast $63 $1.6 23.0 $103.25

DirectTV $30 21.0 $70.22 18.1%

Time

Warner

$29 $1.3 12.0 $158.61

Cox $10 Not

reported

4.6 $138.89

ADT $3 $0.2 6.4 $39.06 13.8%




Phone/Cable Company

EntrantsCo. Approx. entry Description of entry Product Offering

AT&T Early 2013 Staged roll-out Home security and home

automation

Bright House

Networks

March 2012 Gradual rolled-out through

markets

Home security and

automation

Century Link 1997 Acquisition of two small

alarm companies in

Monroe, LA

Traditional wired and

wireless security system

with monitoring

Cincinnati Bell 2001 Sold alarm business in 2011

to Guardian Alarm, nowmarketing partnership with

Guardian

Home Security plus other

Guardian Alarm offerings(PERS)




Phone/Cable Company

EntrantsCo. Approx. date

of entryDescription of entry Product Offering

Comcast Mid 2010 Started in Houston,

added 6 markets in

2011, today offered

in more, but not all

markets

Total home security and home control (incl.

automation, energy mgmt, video)

Cox 2011 in

Tucson, AZ

Roll-out in selected

markets

Home Security, video and Home Automation

DirecTV 2nd Q 2013 Acquisition of

LifeShield

Self-installed, professionally monitored,

wireless digital security system

Frontier 2008 Tried “go-it-alone” in

one market in 2008,

2011 started

partnerships

ADT services in NY, Protection1 services in PA




Phone/Cable Company

EntrantsCo. Approx.

date of

entry

Description ofentry

Product Offering

Time Warner 1995 traditional security

on the east coast –

expansion in 2011

Professionally installed and monitored

system offers remote connection to

thermostats, lights, video feeds and more

Verizon January2011 at

CES in Las

Vegas

Staged roll-out No professional monitoring. Allow endusers to bundle phone, Internet, cable,

home automation and security features like

motion detectors, remote access control

from Schlage, and surveillance cameras.

Windstream

Communications

Roll-out in selected

markets

DIY “Security Man” equipment offered, but

no monitoring or installation




Why are They

Entering?

• Pressure on their existing businesses – Margins shrinking (e.g. cable co’s spending more on

programming; competition among cellular co’s)

– Losing customers (e.g. rapidly shrinking landline

business; cable losing video customers to internetofferings)

• Believe alarm customers will be higher marginand lower attrition than their existing businesses –

Will help them attract new customers to whom theycan sell other (existing) services

– Will have halo effect – help them retain more existingcustomers




What Are They Saying?

“50% of security customers are new to Comcast”

“96 percent of Xfinity home customers buy at

least two other Comcast services and two-thirds

of these customers have never bought home

security before”

Comcast Xfinity Home SVP Mitch Bowling





“Time Warner Cable, which serves 12 million

video customers, has 30,000 subscribers for its

security business”

Time Warner Cable Chief Executive Rob Marcus





“Price is emerging as a key battlefield, with

Comcast, Cox and Time Warner Cable offering

discounts if customers combine home security

with other services.”

Liana B. Baker, Reuters




How Big a Threat?

• Strengths – Significant resources

– Advertising/selling synergies

– Lots of existing customers

– Alarms use their communication pathways – Can choose to offer security at low cost

• Weaknesses – Poor reputation for customer service

–

Disliked my many people (5 of 15 most disliked co’s in US) – Large, bureaucratic, slow moving

– Few operational synergies

– Alarm industry may not be big enough to make an impact




Phone Company

Service




Most Disliked

Companies

The 15 Most Disliked Companies In America (ByBusiness Insider – June 29, 2012)

– # 4 - Comcast

•….Comcast has been blasted for early withdrawals,faulty equipment and unprofessional service

technicians…

– # 6 - Time Warner Cable

• …. disastrous customer service and high rates….. "TWChas destroyed my business and doesn't give a damn”




Most Disliked

Companies – # 7 - Cox Communications

• “…higher rates and fees are sapping customersatisfaction”

– # 11 - CenturyLink• “….one user recently called the company "the devil,"

and said that "they lie about everything and donothing.”

– #14 - DirectTV

• “….thousands of customers complain about how thecompany changes contract details without notifyingcustomers, …hiking prices without authorization.”




2013 Customer Service Ratings

“The bottom of thebarrel in this survey

is a who's who of TV

and Internet

providers: Charter,Cox, TWC, Comcast,

Verizon, AT&T...”(CNET, August 21, 2013)




Will They Stay?

• Some will execute poorly and exit

• But many will likely stay

– Even if they don’t achieve scale they are looking

for, accretive to offer as part of a bundle• Of those, some will go it alone, some will

acquire and some will partner with existingindustry companies

• Many currently outsourcing monitoring

• Some outsourcing everything except lead generation




Overall Impact?

• Raise awareness for security• Expand market size by increasing penetration

• Will be particularly competitive for “marginal” customers – Those with only mild interest in security

–

Low service expectations• Some will be more acquisitive once they determine to stay

– Will want to gain greater scale

– Security needs separate operating infrastructure

• Biggest threat: could push down prices/margins – Only if they decide to rely less on security to benefit other lines

of business

G l A i i i f




Google Acquisition of

Nest

• $3.2 billion transaction• Nest started by former Apple engineers/designers

• Currently markets smart thermostats and smokedetectors – Stylish design

– Learns from experience

– Remotely programmable by smart phone

•

Nest has built a following thanks to "smart"devices, which memorize users' habits to predictwhat they want




Nest




Nest

“The machine learning aspect is really powerful.

It observes your presence. It figures you out,

and makes your home more comfortable”

Zach Supalla, CEO Spark




Acquisition Rational?

• Google's special sauce is the way it responds and adapts to humanbehaviors and environments as we search and surf the Internet

• Not about hardware – Google will let Nest operate as an independent company

– Google gives away its Android operating system to smartphone makers

and outsources construction of Google-branded Nexus andChromebook products

• It’s about data – Google continues to build massive data base on consumer behavior

– Data collected from home (e.g. power consumption habits) says a lot

• Google's acquisition of Nest isn't just about creating new revenueopportunities - it's about expanding the nodes and sensors it usesto collect data on our world

I li ti f Al




Implications for Alarm

Industry

• Google enjoys a positive reputation – Concerns about Big Brother

• Unlikely to want to be in the alarm business

• However, “Nest-like” products will continue todrive DYI market – Becoming a more significant segment every day

• Just as industry in broadening product offering,easier for customers to do more themselves

• We need to make sure our offerings remaincompetitive




VALUATION NEW RMR-GENERATING

SERVICES




Beyond Alarms

• Home Automation – Arm/disarm/view system status remotely

– Remotely lock/unlock doors, lights on/off, open/close garage door

– Video surveillance

• Energy Management

– Remote thermostats – Remote lights

• Home Health – Traditions (static) PERS

– Mobile PERS

– Mobile health

• Monitoring and/0r alerts for activity, biological/vital signs, medicationcompliance, data integration with health care providers

V l ti f “N ”




Valuation of “New”

RMR

• It’s all about the metrics – Valued the same as traditional RMR as long as attributes

and metrics are similar

• Needs to be truly recurring

• Typically bundled with traditional monitoring services

• Must have similar margins

– Can be somewhat lower as long as overall RMR marginstays within industry normal range of 50%+

• Can enhance overall valuation if new services loweroverall attrition

– Margin deterioration can offset benefit




Home Health/PERS

• Can be as valuable as security alarm RMR, butmetrics are very different

– Similar margins

–

Lower creation costs – Much higher attrition (churn)

• Important to track alarm and PERS metricsseparately

– Combined metrics muddy the waters and couldhurt valuation




Alarm vs. PERS Metrics

Metric Alarm(Industry Average)

PERS(Industry Average)

Margins 70% 80%

Creation Cost - Gross 28.5x 15x

Creation Cost - Net 25x 12x

Attrition 12% 30%

Growth 8% 15%




DATA-TRACKING: WHAT TO TRACK, HOW TO

TRACK IT, AND HOW IT EFFECTS VALUATION




Key Valuation Metrics

• Margin from existing customers – Adjusted EBITDA and SSFCF

• Attrition rate – Total lost RMR on a TTM or trailing 6 mo basis divided by average RMR

outstanding

–

Canceled and change in over 90 days• Creation cost of new customers

– Total direct and indirect cost associated with new account creation,less upfront revenue, divided by newly created RMR

– “Net Creation Cost” – before allocation of corp. overhead

– “Gross Creation Cost” – after allocating corp. overhead

• Growth rate – Revenue, Adjusted EBITDA, SSFCF, RMR

– Not relevant in bulk account sale

How Data Tracking




How Data-Tracking

Effects Valuations

• Need to track consistently and have as muchhistory as possible

• A buyer needs these key metrics to determine thevalue of your business to them

• If they can’t be clearly evaluated, buyers willassume the worst – Their job is to be skeptical

– Only way to evaluate is with good long-term data

• The result will be a lower valuation – Could be significantly lower



Reporting All Alarm




p g

Companies Should

Produce and Use• Detailed monthly financial statements – Balance sheet, income statement, statement of cash flow

• Monthly calculation of creation costs – Gross and net

•

Monthly roll-forward (both RMR and units) – Must capture all components: RMR increase, decreases, resigns, etc.

– Must tie out – be auditable

• Static pool attrition – Looks at each vintage individually (e.g. Jan 2009, Feb 2009 etc.)

–

Tracks attrition over time – month 1 up to most recent month – Compares pools

– Key approach to building accurate projections




Roll-Forward

• Roll-forward for Units and RMR: – Beginning

– Added

– Attrition (including change in >90 customers)

– Sold (excluded from calculation) – Price increases/decreases (RMR only)

– Ending

• Attrition calculations – Monthly: (Attrition / (Beg + End)/2 ) x 12 – Rolling six month: ((Cumulative Attrition for six

months) / (Beg +End)/2 ) x 2




Static Pool “Survivor” Example

2007 2008 2009 2010 2011 2012

0 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

1 93.0% 94.0% 94.5% 96.0% 95.5% 95.0%

2 84.6% 87.4% 87.4% 91.2% 90.4% 89.3%

3 78.7% 80.9% 79.5% 86.4% 85.0%

4 68.5% 69.9% 67.6% 78.3%

5 60.9% 62.2% 60.5%

6 56.7% 56.6%

7 52.4%

Percentage of each vintage surviving at the end of the year

(vintages across the top, years since installation down the side)




Static Pool “Survivor” example

0%10%

20%

30%

40%

50%60%

70%

80%

90%

100%

0 1 2 3 4 5 6 7

S u r v i v i n g a c c o

u n t %

Years since installation

% survivors since installation by vintage

2007

2008

2009

2010

2011

2012




Static Pool example

0%

2%

4%

6%

8%10%

12%

14%

16%

1 2 3 4 5 6 7

A n n u a l A t t r i t i o n %

Years since installation

Attrition by installation vintage

2007

2008

2009

2010

2011

2012




LESSONS FOR BUYERS AND POTENTIAL

SELLERS




Lessons for Sellers

• Track key metrics accurately• Use them to manage your business

• Start now, not at the time you want to sell – Hire someone to help you implement

– Not something your accountant is likely to know/do well• Market timing and deal size matter

• Buyers never pay more than they think they have to – Negotiation will determine what buyer WILL pay

• Hire someone (like us) to help – You will only sell once (or twice)

– We do this all the time



Would You Do This




Would You Do This

Yourself?




QUESTIONS AND ANSWERS



Contact InformationHenry Edmonds

The Edmonds Group, LLC

16 Lenox Place

St. Louis, MO 63108

Ph: 314.422.4649

Email: [email protected]

Website: www.theedmondsgroup.com

Facebook: www.facebook.com/TheEdmondsGroup

Twitter: TheEdmondsGroup

mailto:[email protected]

http://www.theedmondsgroup.com/

http://www.facebook.com/TheEdmondsGroup

http://www.facebook.com/TheEdmondsGroup

http://www.theedmondsgroup.com/

mailto:[email protected]

maximizing the value of your alarm business

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