Security industry: changing with the times
Security is in the news all over the world, and in particular in Europe. Migrant crisis, combined with terrorist events in Paris and Brussels means that safety and security is higher on the agenda of the public, the governments and the companies. It is natural to assume that security services industry would benefit from this trend. However, the industry itself has been problematic. Cash management and transportation business, a mainstay of many security services firms, is threatened in the long run by the rise of electronic payments. Man guarding business, other big revenue earner, is a low barriers to entry business, where a lot of competitors are smaller, regional and local players. Company management performance has been mixed, as well – for example issues surrounding G4S, one of the industry leaders, in the run-up and during London Olympics. As a result, the margins had been low, and topline growth modest.
Historically, the industry has not been a great investment, but our investment process is all about capturing positive change, not fully priced in by the market, and we see technological change in the industry which presents an opportunity. Technology in security means – for example - sensors, more automated access control, more high definition cameras, better communications, remote centralised monitoring facilities. This has material financial implications for the industry. Although this approach requires capital investment into client facilities, it brings substantial efficiencies. Guards are replaced by electronics, and security patrols can now cover wider area or more buildings, as they are helped by technology and coordinated by centralised monitoring team. This leads to a true win-win situation: saves costs, which enables companies to reduce the price that client pays, increase margin, maintain quality of service, and improve customer retention.
One company that is leading that change is Securitas AB, Swedish listed global leader in security services. Securitas aims to double the margin it earns on security contracts – from 5% to 10% on the operating level - as it transitions customers into technology-enabled contracts. Still early in this process, Securitas is showing real traction and real benefit of this transition. Since Securitas disposed of their cash management and transportation business, margin improvement should be very impactful on the group bottom line. It also improves competitive environment – such high tech solutions require expertise, scale and financial strength, which only larger, international players can provide. We see the prospect of market share gains, as larger clients give more business to the global top 3 – 4 companies, at the expense of smaller competitors. Securitas should be a beneficiary of this market share shift. This is not a theoretical assumption - there is a historic precedent to this transition. Japanese security company, Sohgo Security Services, had been implementing this transition for a while, and we have seen real inflection in its margins. Adoption of technological solutions helped improve Shogo margins from 3% to 9% between 2013 and 2015.
It is logical to look to supply chain companies to seek beneficiaries of this change. One such company is FLIR, a US-listed technology company specialising in infrared cameras. In our conversations with the company, commercial security sector is highlighted as a fast growing end-market for FLIR’s cameras. It is confirmatory to our view, but for FLIR itself it is still a smaller portion of its broad business, which includes cameras for defence and law enforcement agencies, diluting the overall impact of this change. This shows that even in unglamorous sectors, such as security industry, technological change may present real opportunities. Finding and analysing such change often requires to look across regions and sectors, but this is where we find our most compelling investment ideas.
Mikhail Zverev, Head of Global Equities, Standard Life Investments
First published in Hong Kong Economic Journal 27th April 2016