Description

Security Associates is one of the largest independent alarm monitoring companies in the country with approximately 300,000 residential and business customers and state of the art monitoring centers in Illinois and Florida. It was a poorly run roll up of alarm monitoring companies but it has come under new management recently that claims it has brought it to a break even.

At present their business is strictly wholesale for the thousands of mom and pop alarm system installers around the country that don't want to give the monitoring contracts to people like ADT, Honeywell, or Brinks because they have their own installers who would take any future installation and repair work.

Security Associates net profit margins are very tight because their debt service eats up most of the money generated by their 40% gross margin. They only get about $5 out of the $25 to $30 per month that a residential customer would pay and even with the restructuring that they just completed their costs are more than $4. Prior to the new management coming in the billing was so disorganized that they weren't billing for huge amounts of services they were providing. They have identified the services dealers were getting which they weren't being billed for and charges for those services on a going forward basis have just been billed within the last month or so.

OPPORTUNITY FOR DRASTIC INCREASES IN PROFITS

They are going after two new markets which could increase their profits by a factor of more than 10. They found that while residential customers won't change monitoring companies for a discount of 20%, a very large number would change companies for a discount of 50%. As a result, they are going after the customers of their major competitors with a program called Fair Price Monitoring which they are selling directly to homeowners. If they get $15 per month instead of $5 and their costs are around $4 then they will net $11 per month per customer rather than just $1. Their state of the art monitoring centers in Illinois and Florida could handle 1 million customers (versus the current 300,000) without any increase in fixed overhead.

They are also going after the market for apartment alarms in the 20 million apartments in the United States. None of the majors alarm companies have gone after this market because they amortize the cost of installing their systems over many years and most apartment leases are only for one year. Security Associates has teamed up with an inventor who has designed a very user friendly system which can be sold through Home Depots for a price of something like $100. The customer follows simple instructions about how to place the motion detectors in each room and how to hook a wireless alarm monitoring device to his phone line and then calls Security Associates' 800 number with a credit card for the testing and hook up.

STRATEGIC SHAREHOLDERS

The prospect of installing alarm systems in aparts is one of the reasons Sam Zell invested $5 million in this company (making him the largest independent shareholder) through a personal vehicle called EGI Fund Investors LLC. Zell is the largest owner of apartments in the U.S. with approximately 400,000 under his control.

The largest shareholder is the Chairman, Tom Salvatore who manages a fund called TJS Partners. TJS Partners has provided Security Associates with substantial funds in the past and is in the process of finalizing the documentation for a $3 million loan which they recently provided.

While a microcap of this sort would normally be in jeopardy of running out of cash, I don't think that is likely given the financial strength of its backers.

MANAGEMENT

The company is now being run by Ray Gross and Paul Lucking who along with Vice Chairman, Stephen Ruzika were managing ADT prior to the Tyco acquisition. Both Gross and Lucking went to work for one of Sam Zell's companies after leaving ADT and were brought in to run Security Associates a little more than a year ago.

They consolidated it from six to two call centers and got G&A into line. They now have 2,400 customers per operator up from 1,300 when they came aboard.

STRENGTHS

Gross and Lucking have done four turnarounds together. The company has no trucks, technicians, insurance or employees in the field. They just want to market, sell, monitor and bill using partners to provide the installation and service. They have duplicate systems in both Illinois and Florida and each call center has a duplicabe system so that they have 4x redundancy hopefully ensuring their monitoring systems never go down.

PROBLEMS

Their bank line is too expensive at 12.5% and they want to replace it with something cheaper. They need $400,000 per month to service their debt and they believe they can quickly get to $300,000 to $400,000 per month of EBITDA.

OPPORTUNITY

The stock has been depressed by A) tax loss selling, B) private placements coming off lockup and C) being delisted by the Amex.

There is almost no dilution from employee stock options until the stock has increased by a factor of 16 (i.e., $2.50 per share). Management has been taking compensation in stock at $2.50 per share which is approximately where Sam Zell bought in.

Catalyst

Over the next few months we should see the results of A) the price increases they just put through on their existing wholesale business and B) the new programs they are starting which will give them the full retail monitoring fee ($15/month) rather than the wholesale rate ($5/month) while keeping the majority of their existing wholesale business.