Investment Matters

Threat Protect: A secure future

As clients are aware, they have been invested in Threat Protect, a national security services company, since 2016.  The company has recently announced it will be acquiring OnWatch, a national security alarm monitoring business, which will significantly grow its size.

We thought it a good time to reflect on the security monitoring industry, its drivers and Threat Protect’s strategy.

Security and monitoring: resilient earnings with opportunity for further growth

The security monitoring industry is somewhat of an anomaly.  While we have seen consolidation in many 'scale-driven' industries such as telecommunications, the security monitoring industry remains highly fragmented.

Australia remains serviced largely by a collection of local security businesses.  These businesses generate revenue from the sale and installation of security systems and the ongoing monitoring of them ('connections').

Earnings in the industry have a low level of volatility, with relatively fixed costs and demand largely resilient to business and market cycles.

In the United States, monitoring revenue has continued to grow for the last two decades - in spite of volatile economic conditions, which includes during the Global Financial Crisis.

Main article 1

Source: First Samuel, Barnes Associates Feb 2018 security Alarm Industry overview. IRESS

Furthermore, the industry has solid prospects for growth on the horizon.

Growth in monitoring of non-residential premises will continue to be driven by broader economic activity (including spending by both the government and businesses) as well as insurance and increasing security requirements.

Residential monitoring remains significantly underpenetrated in Australia. Approximately 7% of households have their homes professionally monitored in Australia, compared to 20% in the US.

main article 2

Source: Parks Associates, Crime Stoppers (*US Figure at 2017, Australia at 2016)

 

Barriers to the adoption of home security systems include cost, a reluctance to enter lengthy contracts and an intermittent need for security.

Main article 3

Source: Budget Direct Home Insurance, 'Attributes and Behaviours towards Home Security' report

 

These barriers have been addressed internationally.  For instance, a large part of the growth in residential monitoring in the US is attributed to Do It Yourself (DIY) systems.  These systems can be self-installed, utilise wireless technology and thus carry no installation fees.

DIY installation coupled with affordable, flexible contracts (connected DIY) has increased practicality and affordability for a range of households (such as lower-income households and the rental market), spurring growth in the sector.

Main article 4

Source: Budget Direct Home Insurance, 'Attributes and Behaviours towards Home Security' report

The proliferation of the 'internet of things' and integrated security devices offered by large technology companies (such as Google’s Nest, Amazon’s Ring and Samsung SmartThings) has also driven demand for professional monitoring.

Threat Protects strategy: consolidation of a fragmented monitoring industry

Monitoring of connections is typically outsourced to one of 26 monitoring centres in Australia.  They effectively act as 'wholesalers', charging security companies (resellers) a fee for their services.  The reseller then charges the end customer a margin.  Under this model Threat Protect only captures a portion of the fees charged to the end user (approximately 30%).  

However, Threat Protect also provides connections directly to end customers.  And this is one of their key opportunities.  By acquiring smaller operators and integrating their customers it is able to provide services 'direct' to the end user, capturing 100% of customer revenue.

In acquiring these businesses, Threat Protect is able to offer the owners an attractive price and still grow their bottom line.  This is because it is able to earn more profit from each dollar of revenue generated.  This comes from economies of scale, as the costs to operate a monitoring centre are largely fixed and the incremental cost of monitoring additional connections small.

There remains considerable opportunity to further consolidate the industry in Australia, which is currently composed of over 6,000 businesses (source: Threat Protect)

The second opportunity for Threat Protect is to acquire security businesses that may have their own smaller, or geographically limited, monitoring centres.  These non-optimal centres can be closed and the connections integrated into Threat Protect’s own higher capacity centres – providing significant scale advantage.

main article 5

1. Direct Model, 2. Reseller Model
Source: Threat Protect

Threat Protect can take advantage of its national network of monitoring centres and operational experience.  Its latest acquisition (OnWatch) represents the fifteenth acquisition it has made since 2015.

With each acquisition, Threat Protect grows its bottom line by taking advantage of economies of scale from its monitoring centres.

Furthermore, while Threat Protect increases in value through growing its earnings, its value also increases as it grows in size.

As the business grows in size, it becomes more attractive to potential buyers, who are attracted to a large business with low earnings volatility that can be leveraged (purchased with a high proportion of debt) to produce higher returns.

Conclusion

There are several drivers underpinning our investment in Threat Protect: its opportunity to consolidate a fragmented industry, the increase in value that comes as it grows in size/scale, and overall prospects for the long-term growth of security monitoring.