Integrating the integrators
In my last column, I talked about buying alarm accounts from a buyer’s perspective. This time I will address some issues to be aware of if you want to buy an integration business.
Let’s define an integration business as one where the vast majority of the company’s revenue is driven by installation and spot service revenue. In short, recurring monthly revenue is not the dominant item of value. Most integration businesses are mainly driven by the installation of medium and large-sized camera, access control or intrusion systems or a combination of all three (producing an integrated system). There are security business that do smaller access control and camera system work; their value is not tied to their installation work but their monitored account base. I don’t consider these integration businesses.
There are not as many good integration businesses out there in Canada to be bought as there are alarm companies (and companies that do smaller access and camera work). Bidding on and successfully installing larger commercial, institutional or industrial security systems is a field requiring special skills. Your techs often need specialized training on the equipment they are working on. It is easy to “blow your brains out” on a large job by either underestimating the costs or not delivering on time or on budget.
Smaller integration businesses in Canada can range in size from just under $1 million to over $10 million in annual revenue, although what I see the bigger buyers of integration businesses buying are businesses with a minimum of $5 million in annual revenue. These are established businesses with systems and ongoing new business that does not depend on the owner. Often integration businesses are focused on a particular niche where they have developed expertise — access control, building automation or video monitoring — as in the last three businesses in Canada that Convergint has bought.
Although valuing and buying most businesses is about valuing the future stream of free cash flows that the target company produces, buying an integration business is very different than buying an RMR based business. With an integration business you should probably use a Multiple of Normalized Earnings method to get at the value of the company rather than a Multiple of RMR. What counts here the most is past Earnings before Taxes normalized for a normal owner’s salary and any one time revenue or expenses items. My experience is that although the future is important, the more experienced buyers will pay based mainly on past earnings.
There are other factors that affect the value of an integration business. Does the business have a well-developed niche in a segment of the market where there is lots of future business? This can definitely make the business more attractive. Businesses like this experience higher gross margins on each job. Following on from that, can that business be “scaled up” to double or several times its size?
I have found that most buyers of integration businesses will want to get an amount of “normal working capital,” included in the purchase price determined as a multiple of earnings. Determining normal working capital is an important calculation in the sale of any integration business. Deals can fall apart on this. In addition, some buyers expect that they will get some or most of the fixed assets used to produce the revenue streams in the business also included in the purchase price.
Considering payment terms for the target company, I would say this partly depends on how big and advanced the target business is. Will the business continue to operate successfully without the owner there? This is more likely to be the case with a $10 million integration business than $3-5 million business. With a $10 million business, I would expect to see a much higher proportion of the purchase price paid up front. As the business shrinks in size, be ready for smaller amounts up front and maybe even some kind of earn-out after the deal closes for a part of the total purchase price.
All in all, buying an integration business is a more difficult process to accomplish. First, finding a good one is more difficult. There aren’t that many that are really scalable out there to buy. I think this is partly because overall the Canadian market is just a smaller market. Then finding one that does not depend too much on the owner (or owners) is even more difficult. We have not talked about financing the buying of an integration business. Our chartered bank system is not really there yet in terms of financing deals to buy RMR (let alone deals where there is no RMR).
I am looking for more buyers of good integration businesses. Right now in Canada, for various reasons, not very many of the bigger names on the integration side — Tyco, Chubb Edwards and Johnson Controls — are actively buying. This has left an opportunity for companies like Convergint.
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