Security Solutions M&A Update – January 2024

Security Solutions M&A Remains Stable Amid an Evolving Economic Backdrop

The Security Solutions merger and acquisition (M&A) market held strong in 2023, outperforming the prior year. Fragmentation across the sector, and in the systems integrator (Security and Fire/Life safety) segment in particular, spurred a frenzy of consolidation activity from private equity backed buyers. Buyers have also shown continued interest in Residential end market participants, which have seen top-line growth supported by strong demand from homeowners. Across the Commercial end market, increasing construction value has spurred acquirer appetite for targets with strong industrial surveillance capabilities. Robust equity market returns in recent months have also offered an optimistic acquisition outlook for strategic buyers in 2024. Despite an unpredictable macroeconomic environment, the sector’s M&A market in 2024 is anticipated to build on the sustained growth experienced in 2023.

Inflation has cooled in recent months, with the core personal consumption expenditures (PCE) index rising 3.5% year-over-year (YOY) in October 2023, a decline from 3.7% in September and approaching the U.S. Federal Reserve’s goal of 2%, according to the Bureau of Economic Analysis.¹ Equity markets have subsequently benefitted from the disinflation trend. As of December 13th, total return for the S&P 500 was 20.9%, while total return for the Nasdaq Composite and Dow Jones Industrial Average indices were 38.7% and 10.4%, respectively. In turn, Security Solutions sector participants also experienced favorable growth. Allegion (NYSE:ALLE), a leading provider in the Access Control segment, reported a 36.2% increase YOY in net earnings per share (EPS) to $1.77, according to its Q3 2023 earnings transcript.² The company is expected to build on its robust financial performance and pursue a structured acquisition strategy focused on access technology and Software-as-a-Service businesses, according to the earnings call.

2023 clearly demonstrated both the importance and resilience of the security industry. Innovation created exciting new applications and growth opportunities. M&A activity moved in-step with strategic and private equity buyers actively seeking opportunities.

Tom McConnellManaging Director, Capstone Partners

Construction Spending Supports Industrial Surveillance Demand

Continued spending on private nonresidential construction is expected to be a boon for sector participants in the Commercial end market. The value of private nonresidential construction rose 22.4% YOY in October 2023 to $694.8 billion, according to the U.S. Census Bureau.³ As the value of nonresidential construction projects has increased, construction businesses have needed to fortify jobsite security to mitigate expensive delays. In particular, equipment theft has become a costly and disruptive challenge for commercial construction projects, supporting the increased need for sector services. Every year, approximately $400 million in heavy equipment machinery is stolen, with mobile loaders making up 18%, according to the National Equipment Registry.⁴  In 2023, providers offering construction jobsite security products and services have found healthy acquirer appetite. Notably, ASSA ABLOY (OM:ASSA B), an active buyer in the Access Control space, acquired CrewSight in March for an undisclosed sum. CrewSight is a construction technology business supporting both worksite and access control security solutions managed through a mobile application. The company offers security software, cameras, and analytics in partnership with Sensera Systems to provide an accessible platform for jobsite surveillance.

Package Theft Drives Demand for Surveillance Products

Residential demand for accessible security solutions has led to increased adoption of video surveillance products, driving revenue for leading segment players. In a recent survey, 17% of people in the U.S. have had a package stolen within the past three months, while 44% of people in the U.S. have had a package stolen at some point in their life, according to Security.org.⁵ The pervasiveness of package theft has expanded the market for smart home surveillance and Internet-of-Things (IoT)-integrated products. The size of the global Smart Home Security Camera market was valued at $7.4 billion in 2022, and is estimated to reach $30.1 billion by 2030 through an annual growth rate of 19.2%, according to Research and Markets.⁶

To capitalize on elevated demand, smart home security providers have begun to offer all-in-one services that include package detection, alarm detection, motion-based notifications, emergency response, and 24/7 professional monitoring. Bundled services have provided sector players with recurring revenue opportunities through subscription-based business models. Notably, Arlo Technologies (NYSE:ARLO) used its subscription-based security service to achieve 59% YOY growth in annual recurring revenue (ARR), according to its Q3 2023 investor presentation.⁷ Arlo’s all-in-one security service also accounted for 42% of its revenue mix in 2022, according to the investor presentation. Leading players in the Smart Home Security space are expected to continue prioritizing investments in the Consumer end market.

Security Solutions M&A Outperforms Prior Year Through Elevated Add-on Activity

The Security Solutions sector has seen healthy M&A activity in recent years and 2023 was no exception. There were 190 transactions announced or completed in the space, compared to 181 transactions last year— a 5% increase YOY. The Security Solutions sector outpaced the broader market, as M&A transactions decreased 25.2% YOY through Q3, according to Capstone’s Q3 2023 Capital Markets Update.

Although financial buyers accounted for the majority (54.2%) of transactions in 2023, private equity platform transactions accounted for only 6.3% of total deals. An elevated interest rate environment weakened private equity appetite for buyouts across all markets in 2023, however, sponsors were sitting on over $1.5 trillion in dry powder as of Q3 2023, according to PitchBook.⁸ Limited partners (LPs) will eventually expect this capital to be put to work, while private equity firms already increased their equity contributions for platform deals by 2.6% YOY to 52.6% through Q3 2023, according to GF Data®.⁹ While vast amounts of dry powder may provide a more favorable environment for platform acquisitions going forward, sponsors are likely to continue pursuing add-ons in 2024.

Fragmentation in the Fire & Life Safety segment made the space ripe for consolidation by private equity-backed companies. Buyers targeted the Fire & Life Safety segment at a high rate (38.9% of total transactions), with many private equity-backed businesses in the segment pursuing tuck-in acquisitions to enhance their market share. Private equity add-on acquisitions represented 48.0% of all deals in the broader sector in 2023, and 88.3% of all acquisitions by financial buyers. Of note, Pye-Barker Fire & Safety, a portfolio company of Atlas Partners, completed 13 tuck-in acquisitions in the Fire & Life Safety segment alone. The company completed 23 tuck-in acquisitions in the broader Security Solutions sector in 2023, nine more acquisitions than it completed in full-year 2022. Additionally, HGGC-backed Marmic Fire & Safety completed six tuck-in acquisitions in 2023, the second most in the Fire & Life Safety segment.

Valuation Outlook for Security Solutions M&A Looks Bright Heading into 2024

Valuations in the sector remained robust YOY, despite a lull in the broader M&A market. Purchase multiples in the Security Solutions sector averaged 13.0x EV/EBITDA in 2023, an improvement from the 2022 average of 8.1x EV/EBITDA. Comparatively, EBITDA multiples averaged 8.2x in the lower middle market ($10-$100 million), 12.3x in the core middle market ($100-$250 million), and 10.6x in the upper middle market ($250-$500 million) across all industries, through Q3 2023, according to Capstone’s Q3 2023 Capital Markets Update.

The median disclosed enterprise value for M&A deals in the sector amounted to $61.5 million, a 105% increase YOY from $30 million. Additionally, 2023 valuations outperformed the median enterprise value in full year 2021, which saw a high valuation environment across the majority of M&A markets. Valuations for Security Solutions transactions in the middle market also remained robust in 2023, averaging $70.3 million compared to $50.1 million in 2022. As the macroeconomic environment strengthens and valuations continue to increase, 2024 may prove to be a banner year for M&A in the Security Solutions sector.

Security Industry Stocks: Top Performers and Laggards

Public market performance among companies in the Security industry has provided an optimistic outlook for growth in 2024. Public companies in the Cybersecurity sector garnered healthy returns throughout 2023. Total return for the Hack ETF amounted to +33.6% through mid-December, compared to +20.9% for the S&P 500. Capstone’s Physical Security index underperformed the S&P 500, however, individual stocks among companies in the Physical Security space have experienced robust growth. Select equities in the Physical Security and Cybersecurity verticals are highlighted below.

Top Performers: Physical Security

• Arlo Technologies (NYSE:ARLO) – Home security system developer, Arlo Technologies, has seen its stock price improve 168.4% to $9.42 per share, as of December 12, 2023. The company improved its stock price by 27.2% from May 11 to May 12 to $8.97 per share following its Q1 2023 earnings release. Arlo reported $111 million in revenue for Q1, which was above the high end of the company’s guidance, according to an earnings transcript.¹⁰
• Alarm.com (Nasdaq:ALRM) – Alarm monitoring service provider, Alarm.com, has experienced a 18.7% year-to-date (YTD) increase in its stock price through December 12, 2023, to $57.93 per share. The company has increased its last-twelve-month (LTM) revenue by 4.1%. It reported strong Q2 2023 earnings, including a 46.3% YOY increase in net income for the quarter to $15.8 million, according to an earnings call.¹¹ Following the release on August 9, Alarm.com improved its stock price by 24.1% to $61.05 per share on August 10.

Laggards: Physical Security

• SoundThinking (Nasdaq:SSTI) – Public safety solutions provider, SoundThinking, has seen its stock price decrease by 26.5% YTD to $24.88 per share, as of December 12, 2023. The company has experienced turbulence in 2023 due to its controversial contract with the City of Chicago. Criticism of the company’s gunshot detection software sent its stock price down 22.3% to $29.41 per share on April 5, 2023. Additionally, SoundThinking reported $15.2 million in operating expenses in Q3 2023, according to an earnings release.¹² This accounted for 64% of revenue in the quarter, compared to 33% in the prior year period.

• ADT (NYSE:ADT) – The stock price for home security provider, ADT has decreased 29.1% through December 12, 2023. The stock dropped 14.3% to $5.71 per share following the release of the company’s Q1 2023 earnings on May 2. ADT reported an adjusted EBITDA loss of $11 million in its Solar segment in Q1, while additionally incurring a non-cash goodwill charge of $193 million associated with the Solar segment, according to an earnings release.¹³ The company has also reported interest rate pressures as a barrier to growth throughout 2023.

Top Performers: Cybersecurity

• Crowdstrike (Nasdaq:CRWD) – Crowdstrike, a cloud-delivered endpoint protection provider, has increased its stock price by 137.3% through YTD, ending December 12, 2023. Total revenue for the company has grown 35% YOY to $786 million in its fiscal Q3 2024, according to an earnings release.¹⁴ Crowdstrike’s adjusted net income has also doubled YOY to a record $199.2 million, according to its fiscal Q3 2024 earnings.

• Rapid7 (Nasdaq:RPD) – Cybersecurity solutions provider, Rapid7, has elevated its stock price by 67.5% through YTD, ending December 12, 2023. The company finished Q3 2023 with $777 million in AAR, an increase of 14% compared to the prior year period, according to an earnings release.¹⁵ The company also expanded its customer base by 6% YOY, according to its Q3 earnings. Following the release of its Q3 earnings on November 1, 2023, Rapid7’s stock price rose 11.8% to $51.35 per share on November 3, 2023.

Laggards: Cybersecurity

• Everbridge (Nasdaq:EVBG) – Software security manager, Everbridge, has experienced a 24.6% decrease in its stock price through YTD, ending December 12, 2023. In particular, the company reported a $15.1 million net loss in Q1, which sent the stock price down 21.8% between August 8 and 10, according to an earnings release.¹⁶ The stock has continued to drop, reaching a 2023 low of $19.34 per share on November 13.

• Tenable (Nasdaq:TENB) – Despite seeing its stock increase 11.7% through December 13, 2023, Tenable has underperformed the Cybersecurity market. Cybersecurity businesses with similar market capitalizations as Tenable ($4.8 billion), such as Varonis Systems (Nasdaq:VRNS) ($4.8 billion) and Rapid7 ($3.5 billion), have experienced YTD returns of 2% and 66.2%, respectively.

To discuss key trends driving top-line growth for sector players, provide an update on your business, or learn about Capstone's wide range of advisory services and Security Solutions M&A knowledge, please contact Tom McConnell at tmcconnell@capstonepartners.com.

Joe Collins, Analyst, was the lead Market Intelligence contributor to this article.

Endnotes

1. U.S. Bureau of Economic Analysis, “Personal Consumption Expenditures Price Index, Excluding Food and Energy,” https://www.bea.gov/data/personal-consumption-expenditures-price-index-excluding-food-and-energy, accessed December 5, 2023.

2. Allegion, “Q3 2023 Earnings Call,” https://investor.allegion.com/~/media/Files/A/Allegion-IR/reports-and-presentations/allegion-q3-2023-earnings-call-presentation.pdf, accessed December 5, 2023.

3. U.S. Census Bureau, “Value of Private Nonresidential Construction Put in Place - Seasonally Adjusted Annual Rate,” https://www.census.gov/construction/c30/pdf/nonresidentialsa.pdf, accessed December 5, 2023.

4. National Equipment Register, “Equipment Theft Report,” https://www.ner.net/wp-content/uploads/2017/10/Annual-Theft-Report-2016.pdf, accessed December 5, 2023.

5. Security.org, “2023 Package Theft Annual Statistics and Trends,” https://www.security.org/package-theft/annual-report/, accessed December 5, 2023.

6. Research and Markets, “Smart Home Security Camera Market Size,” https://www.researchandmarkets.com/reports/5786689/smart-home-security-camera-market-size-share-and#src-pos-3, accessed December 5, 2023.

7. Arlo, “Q3 2023 Investor Presentation,” https://s22.q4cdn.com/363130056/files/doc_financials/2023/q3/Arlo-Investor-Deck-Q3-2023-Final.pdf, accessed December 5, 2023.

8. PitchBook, “Q3 2023 Global Private Market Fundraising Report,” https://files.pitchbook.com/website/files/pdf/Q3_2023_Global_Private_Market_Fundraising_Report.pdf, accessed December 5, 2023.

9. GF Data, “GF Data Third Quarter 2023 Leverage Report,” https://gfdata.com/, accessed December 11, 2023.

10. Arlo Technologies, “Arlo Technologies First Quarter 2023 Earnings,” https://events.q4inc.com/attendee/360315514, accessed December 12, 2023.

11. Alarm.com, “Alarm.com Reports Second Quarter 2023 Results,” https://s24.q4cdn.com/652723797/files/doc_financials/2023/q2/Alarm-com-Q2-2023-Press-Release-FINAL.pdf, accessed December 12, 2023.

12. SoundThinking, “SoundThinking, Inc. Reports Third Quarter 2023 Financial Results,” https://ir.soundthinking.com/news-events/press-releases/detail/275/soundthinking-inc-reports-third-quarter-2023-financial, accessed December 12, 2023.

13. ADT, “ADT Reports First Quarter 2023 Results,” https://investor.adt.com/News--Events/news/news-details/2023/ADT-Reports-First-Quarter-2023-Results/default.aspx, accessed December 12, 2023.

14. Crowdstrike, “Crowdstrike Reports Third Quarter Fiscal Year 2024 Financial Results,” https://ir.crowdstrike.com/news-releases/news-release-details/crowdstrike-reports-third-quarter-fiscal-year-2024-financial, accessed December 12, 2023.

15. Rapid7, “Rapid7 Announces Third Quarter 2023 Financial Results,” https://s29.q4cdn.com/157304370/files/doc_financials/2023/q3/Q3-2023-Earnings-Release-Final-110123.pdf, accessed December 12, 2023.

16. Everbridge, “Everbridge Announces First Quarter 2023 Financial Results,” https://ir.everbridge.com/news-releases/news-release-details/everbridge-announces-first-quarter-2023-financial-results, accessed December 12, 2023.