Sneak peek of January's finance special report

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12/08/2008
As loyal readers know well, each January we publish in the paper our special report on the financial state of the industry. Lately, it's been targeted most at the availability of capital - while there are many ways to judge an industry's health, many of them don't apply well to the security market, since there are so few public companies with open books operating here. Especially on the integration and installation side, the books are particularly opaque. However, if lenders are still bullish on the market, that speaks to the overall health of things. Lenders are generally not in the business of making loans to companies they think will fail. As money gets more expensive and difficult to get, it says the industry is less of a clearly good investment. This year is a little different, of course, since money is more expensive and harder to get no matter what industry you're in. But the fact remains that the security industry (and here I mean the traditional RMR-based security industry most of all) is seen as something of a safe port during the storm. Take a look at last year's report. My headline was "Business as Usual." My sources accurately predicted that times were getting tight, but that well-run alarm companies should be unaffected, in terms of borrowing power. This was, to some extent, vindicated by the Pro One. They managed to add to a $275 million credit facility with Bear Stearns and Lehman Brothers, by taking on another $110 million to pay off some notes, back in March, just as Bear and Lehman were totally falling apart. To quote CEO Richard Ginsburg: The fact that Pro One was able to get the deal done at a time when "the debt market is effectively closed … says a lot for our industry and for Protection One." He said, "Market conditions are particularly harsh; existing debt is trading 70 to 80 cents on the dollar … A lot of companies are having a difficult time financing anything." Things are even more difficult now, and there was general agreement that even in the alarm industry, especially as the deals get bigger, it's going to be hard to find money. Both Capital Source and CIT, big traditional lenders to the industry, have had their difficulties, to different extents, and both companies told me they're having a harder time finding partners to go in with them on large deals. There just aren't as many big lenders around with any cash. That's why many of them, CIT and Capital Source included, are looking to become, or have already become, bank holding companies, which means they can take deposits. Problem solved, right? Deposits are the cheapest of all money - they give it to you for free! Unfortunately, those lenders now come under far more federal scrutiny and have less ability to get creative with the deals they make, so their prices and covenants will come to more closely resemble the traditional bank lenders (Bank of America (LaSalle), BankNorth, and CitiGroup), and there will be less variation in the deals that are done. This could be a good thing. Conservative deals are often successful deals for both parties. However, if you've got a shaky system for reporting your finances, or are not profitable, it's going to be majorly difficult now to find any money at all. That may have always been somewhat true, but it's the gospel now. Many different people have told me that a company's best investment for 2009 is in hiring, or giving a raise to, a top-notch CFO/accountant. Knowing exactly what your books and attrition look like is paramount in finding money. Due diligence is at its recent apex. I also heard that summer model contracts are not being valued very highly by some lenders, so don't think that's the way to go. But what about the commercial integrators? Well, the same rules apply, but everybody agreed that the less RMR you have, the harder it's going to be to find money. One lender told a story about a fire installation firm using its stored up RMR as an asset to sell to finance expansion in this down economy, making it possible to enter new rebuild markets instead of being dependent on new build. Smart move. But if you don't have RMR to sell off as an asset, you're not going to find it as easy to get money for that same expansion. Borrowing to create more revenue is possible, but what are you borrowing against if you're living job to job? You better own your building. Finally, what about this talk about manufacturers struggling and maybe facing extinction, like Steelbox? John Honovich posted a partial analysis recently talking about certain manufacturers being in trouble for 2009. I agreed with this slightly more before I did much of the reporting for this story. Basically, what I'm being told is that venture capital should still be available in roughly the same quantity as before. Yes, hedge funds and VC firms are going under or going away, but many of these venture firms have already raised money for funds and still need to put that money to work. They're not just going to sit on it. They're still going to be looking for good technology that needs a cash infusion and might be a good risk. They're willing to suffer nine bloodbaths if the 10th firm is the next Google. That's the game they play. So it might not be as hard as I thought for companies to raise their next funding round in 2009. What's going to be hard is for those companies that are a little more mature and would logically make the move from start-up capital to debt funding. Debt funding is going to be hard to come by for an unprofitable firm, and even more so for a manufacturer with no assets other than intellectual property. Patent protection is going to be even more paramount, as will be staying away from what are seen as dodgy markets: retail, municipal and state spending, new construction, anything to do with the auto industry, etc. So, if these are John's criteria for evaluating the risk of a manufacturer: Growth Rate of Segment the Company is in Profitability of Company Cash Position of Company Competitive Positioning of Company's products I might just add some nuance. It's all well and good to be in a high-growth segment like IP video, but if your IP video is targeted at the retail market, like, say, an Envysion, then that might not be the same as an IP video company like SightLogix, which is targeting the federal government and critical infrastructure. Profitability will be more important as a company ages. If you're new and unprofitable, that might be okay, as venture firms might be looking for a place to put their money on a good bet. If you're older and unprofitable, you won't be able to find a loan to keep you afloat. Cash is king. There's no doubt about that. Finally, competitive positioning. In an ideal world, how good your product is and how well it solves a problem would dictate how successful you are in making sales. But if you're not cash-positive enough to invest in marketing and getting your word out, you're going to get hammered by the bigger brands with better recognition, dealer channels, distribution relationships, and more cash in the bank. Further, I think a recession is as much psychological as it is economic. If people think things are bad, they are bad, and that makes them more conservative. A conservative mindset does not help a new technology make inroads; it helps an established technology keep its foothold. So, will we see a rash of IP camera and analytics makers go out of business in 2009? The lenders I spoke with thought there'd be some consolidation and culling of the herd, but didn't think it would be dramatic. More than one said the fears were overblown. We'll see.