Description

Executive Summary:

I believe Securitas AB (SECU-B.ST) offers 70% upside in the next 2,5 years, for an IRR of 23%. At SEK 94, the shares trade at just over 10x normalized earnings, down from a 20x multiple five years ago despite solid underlying business performance. The opportunity exists due to a) an upcoming rights issue tied to a pricey acquisition discouraging investors and b) recent scandals plaguing the company’s reputation in its home market, Sweden. 

Securitas is a resilient business, pays a 4,7% dividend and should see topline growth of 4-5% for the foreseeable future (post-acquisition) with faster EPS and FCF per share growth due to incremental EBITDA contribution from the integration of the STANLEY Security acquisition, coupled with deleveraging efforts.

Business Description / Background:

Securitas is the 2nd largest security services company in the world with revenues of SEK 108B and over 300,000 employees worldwide (privately owned Allied Universal claims the #1 spot post its acquisition of G4S). The company offers on-site and mobile guarding services as well as electronic security solutions* consisting of alarms and remote monitoring services for security and fire safety. Security services are sold to residential, commercial and government clients through contracts (common structure includes yearly w/ renewals but high variability exists depending on the type of service provided) and sporadic one-time sales (guarding for single event, technical component sales, installation fees, etc.). 43% of revenues are generated in North America, 43% in Europe and the remaining portion in Latin America and others. North America has taken an increased share of total revenues over time, close to 100bps annually.

*Note that Securitas changed the segmentation of its operations during its Capital Markets Day on August 24th, renaming Security Solutions and Electronic Security to ‘Technology & Solutions’ as well as giving further breakdowns of the separate performance of ‘Technology’ and ‘Solutions’. I’ve opted to use the historical disclosure for consistency

Security service is not a hard business to understand. You hire security guards for X amount, contract them to clients for X plus 15-20%, then do your best to manage administrative costs (remote monitoring, customer service) and ensure working capital efficiency. Obviously, this is a simplistic view that doesn’t factor in the increased role of technology in the sector in the last decade, but the idea is generally applicable. 

It's also not a particularly attractive business from a returns standpoint: Securitas generates an after-tax ROIC of 8-9%, which already is higher than most of its peers, and an ROTCE of 50% due to the minimal amount of fixed assets involved. Customers do not switch their security service providers very often and the service does not offer much in terms of differentiation, hence organic market share gains are hard to come by, limiting the opportunity for reinvestment. As such, Securitas pays out 50-60% of its earnings as dividends and uses the remaining portion for acquisitions, on which it generates an average ROIC of ~10%.

The company is able to grow organically at a GDP-like rate of ~3-4% thanks to overall business growth (necessitating security services) and price increases that match inflation. More specifically, the electronic security part of Securitas has been growing organically at a 6% clip for the last 4 years as the industry is increasingly moving towards remote surveillance while the remaining biz (guarding services) has experienced annual growth of 3%. 

Industry:

Because of the inherently local nature of the service, the security service market is incredibly fragmented with the three largest players (Securitas, Allied Universal, and Prosegur)1 making up ~12% of the global market ($263B). It’s been a fertile ground for acquisitions with the top players purchasing dozens of companies every year. Yet, the operating leverage in security services is low due to its labor intensity, hence returns do not increase substantially with size. The large firms have proved to be content with earning the 10% ROIC that is generally achievable from acquisitions by purchasing at 7% earnings yields and growing at organic LSD. Let’s not kid ourselves: security service is not a great or sexy business.

1. Due to increased moves by Securitas into electronic security, companies like ADT (2021 revenue of USD 5,3B) can also be considered competitors

Ownership:

Swedish investment company Latour AB is the largest owner with a 10,9% stake in the company (29,6% of voting rights) and Melker Schörling’s investment company is the number 2 with 4,5% ownership (10,9% of voting rights). Insider ownership among management is small with the current CEO Magnus Ahlqvist’s holdings worth equal to that of his annual salary. Luckily, both Latour and Schörling are represented at the board level, bringing much-needed long-term focus. It should also be noted that Swedish corporate culture has proved to function successfully over the last decades despite a lack of insider ownership and professionalism has been high. Still, I view the lack of ownership as a slight negative.

Keys to the Thesis:

• Resilient performance over long periods: revenues have grown at 3-5% annually (3-4% organic excl. FX, 1% inorganic) for decades with very little variability; organic sales growth after the GFC was -1%, Securitas only year of negative growth in recent history.

• Organic growth in electronic security has been roughly 2x that of TotalCo growth

• GMs average 18,5% and have only dropped below 18% twice in the last 20yrs. Avg. EBITDA margins of 6,5%, only dropped below 6% twice in the last 20yrs

• Avg. & consistent net margins of 3% (200-300bps higher ex-amortization) thanks to diligent cost controls

• Days sales outstanding between 60-70 for >90% of the measured period

• Securitas is an acquisitive company, purchasing security service firms every year and integrating them into its corporate structure. Looking at the 10 latest years of data, they’ve acquired companies at an average of 0,5x sales and 15x earnings. This includes the announced acquisition of STANLEY Security.

• Share price plagued by temporary issues

• Securitas' upcoming rights issue (discussed below) to finance the acquisition of STANLEY security has spooked investors, as evidenced by the -30% decline in the share price since its announcement on December 8, 2021. 

• Dilution and restructuring costs will decrease earnings in 2022 but 2023E FCF of SEK 9,91 is on track to match adj. 2021A FCF (SEK 10,2 when excl. restructuring charges)

• Recent scandals involving high-level executives visiting brothels and thereby threatening national security through the brothels’ connections to the Russian State have had a negative headline effect in Securitas’ home market. In the same investigation, there have also been suggestions towards corruption taking place in a regional Swedish city to win government contracts. All employees involved in the scandals have since been fired: https://www.svt.se/nyheter/granskning/ug/bribes-and-brothels-scandal-at-headquarters-of-the-world-s-leading-security-firm. 

• Mitigant: Sweden is not a substantial market for Securitas; even in the case that Swedish revenue declines by 10% next year, the sales decline for the group would total just 0,5%. I see the scandals as a non-issue that will be taken care of sooner rather than later; the influential board has a lot of talking room and cares about their respective companies’ reputations.

• Best-of-breed in a mediocre industry: Security services is not a glamorous nor an economically prosperous industry. Growth is at GDP or GDP+ levels and the industry does not exhibit tremendous economies of scale; costs are predominantly variable and it’s difficult to improve the customer experience outside of maintaining reliability of service. 

• Securitas’ 12% pre-tax ROIC, 9% after-tax, make it one of the few security service businesses earning above-market returns (i.e the ROIC of S&P 500). Competitors Allied Universal and Prosegur do not do the same, mainly due to poor capital efficiency (e.g. Prosegur is family-owned and has historically held cash equal to 20% of revenue).

• Securitas’ track record of consistent positive organic growth is more than what can be said for competitors G4S (now Allied but more reliable data exists for the old G4S), Prosegur, or STANLEY Security for that matter, which all have seen negative growth in recent years.

• Lastly, Securitas has strengthened its suite of security services in recent years with an emphasis on tech-enabled solutions (security solutions and electronic security) that have a more recurring revenue stream than standard guarding services. Besides improving revenue quality, this sets the company up favorably from a competitive standpoint going forward as corporations move increasingly towards alarms and video surveillance. 

STANLEY Security and the Rights Issue:

On December 8th, 2021, Securitas announced its acquisition of STANLEY Security, the electronics security division of Stanley Black & Decker (“SWK”), for USD 3.2B. In 2021, STANLEY Security generated revenues of USD 1.7B and an 11.5% EBITDA margin. Since the announcement, Securitas’ shares have fallen 30%. While the acquisition has strategic rationale in bolstering Securitas’ share of electronic security services, a faster growing and higher margin segment of the market compared to guarding solutions, the purchase price is lofty at 1.9x sales and 16x adj. EBITDA (excludes cost synergies of USD 50M, otherwise 13x adj. EBITDA). 

The purchased assets incorporate SWK’s alarm monitoring, video surveillance, fire alarm and corporate system services as well as a range of healthcare solutions such as electronic protection wristbands, fall monitors, and emergency call products. SWK’s alarm and video surveillance business have a poor reputation, being known to gouge on pricing and force residential/SMB customers to stay in their contracts for longer than intended. Coupled with poor customer service and underinvestment in systems infrastructure, STANLEY Security has by any measure been poorly run and its financial performance reflects as much: In the four years leading up to the pandemic, annual price increases of 1% were more than offset by volume declines in every period, largely due to customer attrition, resulting in an average organic growth rate of 0% between 2016-2019.

In theory, there’s no reason why STANLEY Security could not achieve similar growth rates to that of Securitas’ electronic security segment, which has operated in the same markets as STANLEY for several years; Securitas generates 35% of its electronic security revenues from the U.S compared to STANLEY’s 57%.

Securitas’ Electronic Security segment:

Year: Real growth Real organic growth

2018: 21% 10,5%

2019: 10% 3,5%

2020: 5% (0,5%)

2021: 8% 3%

In short, I believe that Securitas can return STANLEY Security to growth: Securitas’ history of keeping client retention rates at above industry standards (>90% vs. 88-90% industry avg) and growing operations when its competitors are faltering speaks to their success. Furthermore, because of how STANLEY has been run in the past, it seems reasonable to assume that Securitas’ announced cost synergies with the acquisition (USD 50M) will be achievable. Consolidated back-office processes, increased purchasing power for electrical components and integrated customer service are all probable sources of reduced costs. Having STANLEY’s customer service traffic redirected to existing Securitas service centers would make all parties be better off, especially customers considering STANLEY’s poor history in that area. These benefits should help mitigate the impact of any restructuring programs tied with the acquisition (which are inevitable) and could boost margins. In 2019-2020, Securitas restructured parts of its North American division and increased margins by 50bps. I believe this to be repeatable with STANLEY NA business as well as Securitas’ European operations.

The STANLEY Security purchase is to be financed through USD 2.3B of debt and an equity rights issue of USD 915M, to be completed by the time of the acquisition. At 94 SEK per share, the rights issue is expected to dilute current shareholders by 20%. Net debt to EBITDA will increase from 1,5x to 4x, but interest coverage ratio will remain at a healthy 8x.

Not all is lost, however, as STANLEY Security’s high EBITDA margin (11.5%) will boost the combined company’s margins by close to 70bps to 7,26%. I pencil out pro-forma EPS of 7,6 (9,6 excl. restructuring charges), which puts the current earnings multiple at ~12x (10x normalized). EPS understates FCF to common shareholders a little due to non-cash amortization charges, which push FCF per share 10-15% higher than EPS. 

At the Capital Markets Day, Securitas disclosed that STANLEY’s adj. EBITDA margin for H1 2022 had dropped to 9%, attributable to inflationary cost increases and obsolete pricing processes. I expect this change to be temporary, with Securitas working through bad contracts at STANLEY and restructuring parts of the organization. 

Valuation:

I base my valuation on a 7% FCF yield in 2024 (see tables below), which equals 16x expected earnings due to non-cash amortization figures. In the last 5, 10 and 20 years, Securitas’ shares have traded for an average of 16x earnings and its growth & margin profile have been consistent throughout the period. Consider also how 1) small security service firms regularly get acquired at 15x earnings and 2) G4S was acquired in 2021 for 18x 2019 earnings (excl. goodwill impairment). 

Note that 2020 and 2021 earnings are impacted by higher than usual restructuring costs of SEK 640M and 923M, respectively, tied to cost reduction programs. As a result of these programs, Securitas exited 10 low-margin markets.

I assume all cash flow after capex, M&A and dividends go towards paying down debt in order to get to mgmt’s preferred leverage ratio of 3x.

The return profile is composed of a 4,7% dividend and 6% FCF per share growth, with the remaining difference coming from multiple expansion. If Securitas doesn’t revert to its historical traded multiple until 2026, the IRR compresses to 17% (projected FCFPS of SEK 11.7). I expect the economic profile penciled out in 2024 to be sustainable over time.

Risks:

• STANLEY Security integration fails, necessitating restructuring efforts and producing lower operating margins than expected

• Tight NA labor market reduces the quality of guard personnel available to Securitas, increasing employee churn and operating expenses

• Securitas is unable to pass along inflation-driven wage increases

• Mitigant: increased prices on par with cost increases in 2021 + Securitas should be able to flex SG&A costs more than small security firms

Catalyst

• Rights issue completed in September, 2022

• Successful USD 50M cost synergy program from STANLEY acquisition boosts EBITDA margins