Investment Trends With...
Brian W. Ruttenbur
Morgan Keegan & Co, Inc.
Brian, please give us an overview of your background.
Brian W. Ruttenbur: I am an equity research analyst with Morgan
Keegan, covering Homeland Security Technologies with 14 stocks under coverage.
I have been an analyst since 1994 with over 10 years of experience in
equity research on the sell side.
2. SecurityStockWatch.com: You recently published a 2004 Homeland Security
Technologies Industry Overview. Frankly speaking, this 180+ page report
of yours is one of the best, and most comprehensive, studies that we have
seen. Would you kindly give our audience an overview of Homeland Security
Opportunities and Drivers at the present time.
Brian W. Ruttenbur: Thank you, this summer we did published a
Morgan Keegan Homeland Security Technology Industry Overview Book. The
Book provides thorough analysis of the security industry trends, drivers,
funding, growth prospects, and main players. We offer detailed information
of our three coverage segments including descriptions of the macro environment,
legislation, federal funding, overview of available technologies and products,
competitive analysis, and operational and financial analysis on major
competitors in each sector.
Our three coverage segments that represent significant business and investment
1. Tracking and Identifying Individuals & Equipment (current market
size of approximately $4.8 billion; estimated to grow to approximately
$10.7 billion in 2007): Smart cards: chip-based (contact and contactless),
optical memory, others; Hardware (readers) and software used for smart
card solutions and tracking transportation equipment; Biometrics: finger/hand,
2. Physical Security Technology (current market size of approximately
$20.0 billion; estimated to grow to approximately $36.3 billion in 2007)
A. Physical Security Products (current market size of approximately $7.0
billion; estimated to grow to approximately $10.0 billion in 2007): Body
armoring: protective gear, forensic gear, etc.; Vehicle armoring: military
and commercial; Ballistic and blast protection equipment: doors, windows,
other hardware; Non-lethal munitions: Beanbag rounds, rubber batons, conducted
energy weapons, etc.
B. Detection and screening technologies and products (current market size
of approximately $8.5 billion; estimated to grow to approximately $15.3
billion in 2007): Individual screening: explosives, metal and contraband;
Cargo/baggage screening: parcel and checked-in luggage, large cargo screening;
Air, food and water screening and detection (includes bioterrorism)
C. Surveillance and Monitoring (current market size of approximately $4.5
billion; estimated to grow to approximately $11.0 billion in 2007): Communication
interception; Digital video surveillance; Infrared systems
3. Risk Mitigation (current market size of approximately $9.6 billion;
estimated to grow to approximately $14.6 billion in 2007): Investigation
and intelligence; Background screening; Executive protection; Restructuring
and bankruptcy consulting
Our investment thesis for the Homeland Security sector is as follows:
• Large, fragmented industry with attractive growth prospects
- Total global security spending in excess of $100 billion
- Over $35 billion in estimated 2003 revenue within our specific coverage
- Compounded annual growth rate for our coverage over the next four to
six years of 16%, growing to $64.6 billion in 2007
- Significant consolidation activity and opportunities
• Large funding expected for Homeland Security
- Federal spending on Homeland Security is expected to be $27 billion
(plus another $20 billion from other agencies) in FY 2005
- Approximately 30% of federal funding is estimated to go to the private
sector; however, we believe the long-term trend will decrease this portion
- The Federal Homeland Security Budget is expected to grow in line (or
at a faster rate) with Department of Defense funding over the next five
to eight years
• Underlying industry drivers remain solid
- Fear of additional terrorists attacks and therefore a focus on security
- Legislative mandates requiring increased security
- Increasing globalization of business has heightened corporate concerns
regarding security issues both domestically and abroad.
- Technological advances continue to spawn innovative security solutions
and introduce new security threats.
• Several growth areas are beginning to emerge
- Security technology hardware and software products show strong signs
of rapid growth as the need to secure our physical surroundings becomes
- Tracking and identifying individuals, as well as enterprise/government
equipment, shows long term promise as governments and corporate clients
increase acceptance of this technology.
- Need to screen people, parcels, cargo and air, water, and food is growing
- Market for decision enabling software and hardware is growing rapidly
- Fraud prevention and risk mitigation providers are demonstrating positive
momentum, especially background checking and investigative services.
3. SecurityStockWatch.com: Now that the election is over, what does
a 2nd term for President Bush with and a Republican House and Senate mean
for the security industry?
Brian W. Ruttenbur: The overall sentiment brought with the election
of President Bush for the second term is that the federal government will
continue funding security initiatives as well as defense and war-related
programs. We continue to see a strong and growing budget for both Departments
- Homeland Security and Defense. Last month President Bush signed the
2005 Homeland Security Appropriations Act, which provides $28.0 billion
in net discretionary spending for the DHS ($1.8 billion, or 6.6%, above
2004 level). The bill is primarily focused on border and port security
and biodefense. The 2005 Department of Defense Appropriations Act provides
$417.5 billion in funding. This legislation funds both core defense programs
in the U.S. as well as ongoing operations in Iraq.
4. SecurityStockWatch.com: Which companies are you presently covering
and may we have a brief overview of the strength of each company.
Brian W. Ruttenbur: As we mentioned earlier we cover 14 companies
in this sector. It is important to note that we have three basic ratings:
Outperform (O), Market Perform (M), and Under Perform (U). We also have
three risk ratings, Speculative Risk (S), Market Risk (M), and Conservative
(C). Below is a list of our Outperform rated coverage companies:
• American Science and Engineering (ASEI - O/S, $37.70) develops and manufactures
inspection systems for detection and security applications that include
drug and weapons smuggling, trade fraud, trafficking of illegal aliens,
and anti-terrorism purposes. The company's product line includes 12 models
that can be broadly categorized into three groups: CargoSearch systems,
ParcelSearch systems, and a third division that provides services and
support. The company's products utilize the company’s patented Z Backscatter
technology and vary in price from $60,000 to $6 million. The company has
deployed its systems around the world in high-threat and high-risk facilities
including: the White House, U.S. Congress and Supreme Court, and 90 U.S.
embassies. We would like to point out one of AS&E's products that
has been driving growth recently - Z Backscatter Van. It was introduced
to the market last year and since then the company sold over 50 Vans worldwide.
Vans are adopted to screen cargo and vehicles at ports and borders as
well as for anti-terrorism efforts by police and military forces.
• First Advantage (FADV- O/S, $16.52) is a provider of enterprise and
consumer screening and risk management solutions to corporations and consumers
globally. The company’s three operating segments – Enterprise Screening,
Risk Mitigation, and Consumer Direct – serve an extensive clientele of
employers, property managers, insurers, and consumers. Using its Web-based
technology, proprietary systems and national data resources, First Advantage
offers industry-leading information products and services, including:
criminal record checks, drug-free workplace programs and other occupational
health testing, investigative and digital data services, employment and
education verification, credit reports, social security number verification,
and motor vehicle records. Through the recent acquisition of CIC Enterprises,
First Advantage has added the identification and processing of tax and
incentive credits to its inventory of available services. First Advantage
was formed in June 2003 when the First American Corporation’s Screening
Technology Division merged with US SEARCH.com’s employment screening subsidiary.
First Advantage has broadened its customer base and expanded business
operations through many acquisitions, resulting in substantial growth
for this maturing company. Since 1998, the company's formation, development,
and growth have been significantly enhanced by 32 acquisitions.
• LaserCard (LCRD- O/S, $10.64), formerly Drexler Technology, is a provider
of optical data storage products and systems, featuring its LaserCard
optical memory cards and chip-ready Smart/Optical cards. The company's
LaserCard optical memory cards are used for digital governance applications,
such as immigration, border crossing visas, cargo manifests, motor vehicle
registration, multi-biometric identification (ID) cards and other digital
read/write card applications. The company's wholly owned subsidiary, LaserCard
Systems Corporation (LSC), makes optical card read/write drives, develops
optical card software and markets optical cards, read/write drives and
related systems. We would like to highlight that LaserCard supplies its
optical memory cards to several large programs including the following:
green cards and border crossing cards for the U.S. government, cargo manifest
cards for the U.S. military, permanent resident cards to Canadian government,
national ID cards to the Italian and Saudi Arabian governments, and vehicle
registration cards for the government of India. The company has no direct
competition in optical memory card segment. It offers a broad portfolio
of smart card products including a hybrid optical memory and chip (contact
or contactless) card. LaserCard faces significant opportunities from both
current secure ID programs that the company is already working on deploying
and new business opportunities as many entities, primarily governments,
are considering deploying secure ID programs like national ID card.
• OSI Systems (OSIS - O/S, $20.28) is a provider of security and inspection
systems, medical monitoring and imaging products, and optoelectronic devices
and value added subsystems, as well as engineering and manufacturing services.
On the security side, OSI Systems is the leading provider of X-ray and
metal detectors used to scan and inspect people, baggage, cargo and other
objects for weapons, explosives, drugs, and contraband. The company, through
its four brand names, Rapiscan, Aracor, Ancore, and Metor, are the cost
leaders in the security sector. Optoelectric technology, the technology
found in security devices of Rapiscan and Metor, has been used by the
company in various other applications. Through its subsidiary Dolphin
Medical, the technology is used to detect the amount of oxygen in the
blood. Another medical application of optoelectric technology is detection
of bone density to prevent the onset of osteoporosis, which the company
does through its subsidiary Osteometer MediTech. In addition to the medical
field, the company utilizes this technology in the military, telecommunications
and various other applications. As of March 19, 2004, OSI Systems closed
its acquisition of Spacelabs Medical, a manufacturer and distributor of
patient monitoring and clinical information systems based in Issaquah,
Washington. Spacelabs was integrated into OSI' healthcare/medical segment.
OSI's management has been evaluating strategic restructuring alternatives
for the company, one of which is two break security and healthcare segments
into stand alone entities. On the security side, we are expecting the
launch of operational PFNA screening systems at the U.S. - Mexico border
in El Paso, Texas (expected early next year).
Below is a list of other stocks that we cover:
• ActivCard (ACTI - M/S, $7.75) - provider of software for smart card
deployments (CAC deployment)
• Armor Holdings (AH - M/S, $42.18) - provider of body and vehicle armoring
for law enforcement, military, and commercial customers (up-armors HMMWVs
at a record rate of 450 vehicles per month)
• CompuDyne (CDCY - M/S, $7.23) - provider of physical security products
including blast resistant windows and doors, attack resistant equipment,
products for corrections industry, and public security and safety systems
• Digimarc (DMRCE - M/S, $9.48) - provider of secure identification products
and watermarking solutions (over 60% market share in the U.S. drivers'
• FLIR Systems (FLIR - M/S, $59.78) - provider of infrared solutions for
imaging and thermography applications
• Identix (IDNX - M/S, $7.46) - provider of finger/hand, face, and skin
biometric solutions (US-VISIT program)
• I.D. Systems (IDSY - M/S, $17.51) - provider of smart RF wireless systems
for asset management for industrial vehicles, airports' and ports' equipment,
and rental car fleet management
• InVision Technologies (INVN - NR, $48.25) - provider of computed tomography-based
detection products used by the aviation industry to screen baggage
• TASER International (TASR - M/S, $59.66) - provider of less-lethal conducted
energy weapons (M-26 and X-26 models; military products)
• Verint Systems (VRNT - M/S, $39.09) - provider of communication interception,
digital video security surveillance, and digital video and communication
business intelligence platforms
5. SecurityStockWatch.com: We have seen some consolidation in the security
industry….do you expect that trend to continue?
Brian W. Ruttenbur: The Homeland Security technologies market
remains highly fragmented, even amidst continuing consolidation. This
industry has experienced a great deal of M&A activity over the past
several years. Based on transactions involving companies monitored by
Morgan Keegan, approximately $13 billion in aggregate consideration has
been paid in over 100 transactions since 1997, excluding the IT security
products and services sector.
Customers’ increasing demands for global and integrated security solutions
have encouraged industry participants to expand their capabilities and
pursue strategic alliances. According to the Hallcrest Report, there are
30,000 security companies worldwide. Given the fragmented nature of the
security industry, we anticipate numerous acquisition opportunities for
leaders in these sectors. Meanwhile, we believe that increasing demand
within the security industry will spur internal growth for the leading
Examples of the most recent acquisitions in our sector are: GE acquiring
InVision Technologies for $900 million, Marsh & McLennan acquired
Kroll for $1.9 billion, Verint Systems acquired ECTel for $35 million,
FLIR Systems acquired Indigo Systems for $190 million, and Armor Holdings
acquired Simula for $110.5 million, among other examples. We would like
to highlight that most companies under our research coverage represent
attractive opportunities for acquirers as they offer various venues to
get exposure in homeland security efforts. These opportunities have been
especially attractive to large defense contractors and system integrators.
6. SecurityStockWatch.com: Brian, many thanks for your time today. Are
there any closing comments you would like to make?
Thank you for the time. We believe the Homeland Security sector outlook
remains positive and will remain one of the focal agenda items in the
Federal government. We would like to mention that Morgan Keegan will host
its annual Homeland Security Conference in NYC on May 23, 2005. If you
are interested in attending this event, please contact a Morgan Keegan
institutional sales person for more details.
Please see the disclosures below
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