Market realities spark changes to dealer funding
The short-term realities may be harsh, but in the long run, members of the security industryÃ¢â‚¬â„¢s financial community say, the recent changes in dealer programs and how they operate financially is having a positive impact on the alarm business.
The decision by ADT Security Services to reducing funding for its authorized alarm dealer program, combined with Leasecomm Corp.Ã¢â‚¬â„¢s announcement to cease new loan originations, brought to the forefront an industrywide move toward a more conservative economic stance.
Michael Barnes, who heads up the investment banking and consulting firm Barnes Associates in St. Louis, said the higher cost of capital brought about this market correction. Ã¢â‚¬Å“It had to happen. The outcomes of the first five to 10 years of heavy investing in this activity were clearly indicating that even many of the most successful programs werenÃ¢â‚¬â„¢t providing returns high enough to offset the risks. As a result, much of the capital funding the dealer channel pulled back, lowering the supply and increasing the effective cost,Ã¢â‚¬Â he said. Ã¢â‚¬Å“The full impact of this change was, unfortunately, very abrupt, and until a more consistent performance pattern emerges, will probably remain.Ã¢â‚¬Â
Barnes acknowledged that as a result of ADTÃ¢â‚¬â„¢s and LeasecommÃ¢â‚¬â„¢s decisions, as well as the general tightening of the capital markets, some independent security systems dealers will go out of business.
Ã¢â‚¬Å“If youÃ¢â‚¬â„¢re Darwin, you might say this is a good thing,Ã¢â‚¬Â he said, referring to Charles DarwinÃ¢â‚¬â„¢s Ã¢â‚¬Å“survival of the fittestÃ¢â‚¬Â theory. Ã¢â‚¬Å“The good players will adapt. The market is efficient and capital will find them, and the overall returns to everyone in the chain will settle in to the appropriate levelsÃ¢â‚¬Â
The downside, Barnes explained, is that, temporarily at least, the ability to reach potential alarm customers may decrease. Ã¢â‚¬Å“Middle America wants and needs alarms and will pay for them,Ã¢â‚¬Â he said. Ã¢â‚¬Å“But what will happen during the market adjustment is the capacity for the dealer channel to contact them and sell systems will contract.Ã¢â‚¬Â
Henry Edmonds, chief executive officer for St. Louis-based SLP Capital, said the paradox behind the recent industry shakeup Ã¢â‚¬Å“is that the alarm industry is performing better. We have data on attrition and it is lower. And the cost of creating a new customer is less.
Ã¢â‚¬Å“Operationally,Ã¢â‚¬Â Edmonds added, Ã¢â‚¬Å“the industry is much healthier because the terribly aggressive dealer model didnÃ¢â‚¬â„¢t work.Ã¢â‚¬Â
John Mack, co-founder and chief executive officer of USBX Advisory Services, Santa Monica, Calif., said Ã¢â‚¬Å“in the quest for growth,Ã¢â‚¬Â dealers such as ADT and others Ã¢â‚¬Å“lowered the quality criteria.Ã¢â‚¬Â
Ã¢â‚¬Å“The days of zero-down (for an alarm system) are gone, and thatÃ¢â‚¬â„¢s healthy,Ã¢â‚¬Â said Mack. Ã¢â‚¬Å“WeÃ¢â‚¬â„¢re back to finding customers who want security for the long-term.Ã¢â‚¬Â It is a return, Mack said, to a model based on lower multiples, higher credit scores and better customer relationships.
Paul Sargenti, president and chief executive officer of Security Alarm Financing Enterprises L.P., San Ramon, Calif., called the aggressive dealer programs of the past Ã¢â‚¬Å“worshipping at the altar of volume, which hurt quality.Ã¢â‚¬Â
He added that the recent moves by ADT and Leasecomm Ã¢â‚¬Å“are closer to the end of the line of shakeouts in dealer programs, rather than the beginning.Ã¢â‚¬Â
All of those contacted by Security Systems News said dealer programs in and of themselves are viable financial vehicles that offer incentives to independents while taking some of the risks and accounting-related penalties away from the acquiring company.
Ã¢â‚¬Å“The flawed model was the one based on growth over quality,Ã¢â‚¬Â said Sargenti.
So where then do the financial opportunities lie, and for whom?
Barnes said companies with successful fiscally conservative authorized dealer programs, such as Monitronics, Ã¢â‚¬Å“are in the catbird seat.Ã¢â‚¬Â
To a limited extent, some lenders and investors will also see some good opportunities arise from these market changes, Barnes noted, but it will be challenging.
Edmonds of SLP said recent events have started the phones ringing. Ã¢â‚¬Å“ItÃ¢â‚¬â„¢s been good for SLP -we finance people who are in it for the long haul.Ã¢â‚¬Â
And, he added, Ã¢â‚¬Å“weÃ¢â‚¬â„¢re finding a lot of good deals.Ã¢â‚¬Â Banks, Edmonds said, may still be leery about lending in the current economic climate, Ã¢â‚¬Å“but weÃ¢â‚¬â„¢re comfortable with lending money to (dealers with) good business plans.Ã¢â‚¬Â
Still, Edmonds warned times may continue to be difficult for start ups and those without a good financial track record. Ã¢â‚¬Å“WeÃ¢â‚¬â„¢re in a time when the capital markets are unforgiving,Ã¢â‚¬Â he said. Ã¢â‚¬Å“ItÃ¢â‚¬â„¢s difficult to come along and start a new dealer program. I donÃ¢â‚¬â„¢t see anything coming along to replace ADT.Ã¢â‚¬Â
Mack of USBX said opportunities exist for companies such as SLP and SAFE Ã¢â‚¬Å“to work with dealers who can generate accounts.Ã¢â‚¬Â
And, he added, Ã¢â‚¬Å“there are still organic growth opportunities.Ã¢â‚¬Â The alarm industry, he said, Ã¢â‚¬Å“can still grow, but just not as fast.Ã¢â‚¬Â Mack likened the correction to what took place in the cell phone industry, which also offered low prices to customers with shaky credit and suffered from high attrition rates.
Sargenti said dealersÃ¢â‚¬â„¢ perceptions that credit is tight is a correct one. Yet, he said, Ã¢â‚¬Å“there is plenty of capital in the pipeline to find good deals.
Ã¢â‚¬Å“I think the industry is robust. It has an enormous opportunity for growth,Ã¢â‚¬Â he said. Sargenti said he anticipates Ã¢â‚¬Å“other refinements to the process (of funding dealers), but the engine that drives the industry will focus on quality.Ã¢â‚¬Â
Barnes, who said he anticipates the industry would take six months to a year to work out the market correction, cautioned that observers not read too much into it. Ã¢â‚¬Å“The marketplace is simply digesting what it learned about the economics of the high-volume residential market,Ã¢â‚¬Â he said, with one of those key lessons being that Ã¢â‚¬Å“while you can move a lot of alarms through a standardized, low-price offering...the overall dynamic must yield an adequate return on the capital deployed in the process. Otherwise the offering isnÃ¢â‚¬â„¢t sustainable and a correction is inevitable.Ã¢â‚¬Â
Barnes pointed out the overall fundamentals of the alarm business remain very much intact. Ã¢â‚¬Å“Growth is strong, consumers value the services offered, and the industry is well-positioned to be a meaningful player in the Ã¢â‚¬Ëœwired-worldÃ¢â‚¬â„¢ economy. What should result from these changes is the emergence of a leaner, smarter residential Ã¢â‚¬Ëœmass marketingÃ¢â‚¬â„¢ segment, offering better financial returns to its participants.Ã¢â‚¬Â
Edmonds agreed the evidence now exists Ã¢â‚¬Å“on what works and doesnÃ¢â‚¬â„¢t on free systems.Ã¢â‚¬Â But time will tell, he added, whether someone will come along many years from now who lacks the historical perspective and repeat the pattern.
Ã¢â‚¬Å“If we havenÃ¢â‚¬â„¢t learned the lesson of zero-down systems and high volume and poor customer profiles, then weÃ¢â‚¬â„¢re doomed to repeat the problems of the past several years,Ã¢â‚¬Â said Sargenti. Ã¢â‚¬Å“As someone who finances dealer assets, I wonÃ¢â‚¬â„¢t be a force for financing under those terms,Ã¢â‚¬Â he said.
Ã¢â‚¬Å“YouÃ¢â‚¬â„¢d like to think youÃ¢â‚¬â„¢d learn from history,Ã¢â‚¬Â commented Mack. Ã¢â‚¬Å“If the market gets ebullient again, we could see excesses, but not at the same level.Ã¢â‚¬Â
In fact, Mack noted, what the industry is more likely to see now is renewed interest from the private equity community. Ã¢â‚¬Å“They got out in the 1990s because of the prices,Ã¢â‚¬Â he said. Ã¢â‚¬Å“But where we are now, with prices correcting -or even overcorrecting -thatÃ¢â‚¬â„¢s attractive to the private equity community.Ã¢â‚¬Â