Market watch: Homeland security takes center stage

Jerry Grossman

Four years after the Sept. 11, 2001, terrorist attacks, the concept of a sizable, coherent and identifiable market for homeland security products and services is approaching reality.

Emerging technologies such as biometric identity management tools and emergency communications systems are being tested and deployed in the field. The Homeland Security Department is making progress on some fundamental priorities, such as establishing an architecture and standards for an IT and communications infrastructure. The agency also is mobilizing technology assessment capabilities to analyze the myriad products being developed.

Issues identified in the wake of hurricanes Katrina and Rita have underlined the need to improve first-responder performance, especially in communications and coordination with the military.

The government is putting procurement vehicles in place to support a ramp-up in homeland security spending. The largest such vehicle is Eagle, the Enterprise Acquisition Gateway for Leading Edge solutions. This $45 billion, agencywide contract consolidates DHS IT services and solutions acquisition. For small businesses providing IT commodities, DHS created FirstSource, a $3 billion, five-year vehicle.

The performance of publicly traded, homeland security stocks over the past four years also highlights the evolving perception of investors. A group of 12 public homeland security stocks was used to calculate a price index. The group, which includes Armor Holdings Inc., Cogent Inc., Identix Inc., OSI Systems Inc. and Verint Systems Inc., had aggregate revenue of about $3 billion in the latest 12-month period.

From third quarter 2001 to third quarter 2004, the pricing index grew at a compounded annual rate of more than 100 percent. During this period, perception trumped performance, as homeland security spending lagged expectations. In the 12 months through September, the index grew by 5 percent as investors took a wait-and-see attitude.

Pending initial public offerings for Colt Defense Inc. and Global Secure Corp., with target proceeds approaching $200 million, will add to the capital capacity of public companies. Special purpose acquisition corporations, which have no operating businesses, such as Fortress Acquisition Corp., are raising equity in the public market with homeland security as their core acquisition strategy. In addition, several private equity groups are seeking to build businesses around a homeland security theme.

Merger and acquisition activity is another indicator of expected growth and investor interest in the homeland security sector. From 2001 to 2003, there were 28 announced acquisitions, with pricing reflecting enterprise value to revenue ratios of about 1.0 times. In 2004 alone, there were 37 announced transactions, and this pace continues in 2005 and at similar valuation levels.

In the aggregate, from 2001 to 2005, more than $10 billion was paid in nearly 90 transactions. The median-size deal was between $40 million and $50 million.

Large deals included the purchase of Novar plc by Honeywell International Inc., Marsh and McLellan Companies Inc.'s deal for Kroll Inc. and General Electric Co.'s acquisitions of Edwards Systems Technology Inc. and InVision Technologies Inc. The aggregate value in these transactions was about $6 billion. Armor Holdings and London-based Smiths Group plc also were active, spending more than $600 million in six deals.

It's likely that successful companies will emerge as key players in one or more segments of the market: detection, protection, infrastructure, response and recovery. Events domestically and globally suggest that over the foreseeable future, priority funding will be dedicated to homeland security at all levels of government.

Jerry Grossman is managing director at Houlihan Lokey Howard & Zukin in McLean, Va. He can be reached at jgrossman@hhlz.com.

About the Author

Jerry Grossman is managing director at Houlihan Lokey Howard and Zukin.

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