Is the Video Surveillance Business Starting to Improve?

In the last month, a renewed sense of optimism has emerged in the video surveillance industry - mirroring the rise of the global stock markets and culminating in a better than expected turnout at ISC West.  What does this mean?

The 4th quarter was fairly bad for video surveillance. We predicted major long term changes for the security industry, argued that the stimulus package would be a minor force for the industry and that 2010 would be worse than 2009 for the business.

• Q1 Sales growth was slightly lower to even with last quarter's sales growth
• Government intervention was the key to stopping sales declines
• Such intervention may bolster economy this year but creates future risks
• Companies must factor in risk of new crisis in the short or mid term
• Expect more companies to fail/acquired in fire sales by the end of the year

Q1 Sales Trends

The general consensus in the industry was that January and February were weak but that March was stronger. Many vendors referenced sales picking up towards the middle of the quarter. Only a few companies (mostly megapixel) indicated that sales were strong throughout the quarter. 

Towards the end of quarter some projects that were delayed from the 4th quarter were approved, however a substantial portion of projects are still being delayed.

Whereas in Q4 2008 very few companies cited shifting to lower cost options, in Q1 2009, this became a more common refrain. Common buying activity observed was buyers selecting less expensive products from a manufacturer, shifting to lower cost providers and staying with analog systems rather than going forward with previous IP plans. Whether this trend will continue is heavily dependent on buyer's economic confidence and how the economy changes in the near future.

I would estimate industry growth rates to be even to slightly down from last quarter. While I did not receive many reports on growth falling fast, I only had a few companies report accelerating growth. On balance, it appears that downward pressure on the industry continued but at much smaller pace than the 4th Quarter 2008.

The question, then, is why is the fall of growth rates dropping? Is the recession run its course or has the government intervened?

Impact of US Government Action Bolster Short Term Economy

I believe the massive impact of the US government has bolstered the short term global economy, helping many organizations relax and move forward with projects. Between the bank bailouts, continued AIG bailouts, rapid expansion of the money supply, massive purchases of treasuries [link no longer available] and the commitment to subsidize bad bank assets, the US Government has already poured in more than $1 Trillion into the economy to substitute for private sector spending. This has had a global impact as the subsidies has benefited trading partners and banking partners to the US institutions being assisted.

This has increased business confidence and provided some immediate relief to large organizations. The positive impact of this is reflected in many new leading indicators.

Mid and Long Term Tradeoffs

The big trade-off is that this short term benefit leverages future benefits either by increasing the risk of inflation or by adding in debt that constrains future spending. Whether or not this is the right path is irrelevant since we are already committed. The only practical question is what type of trade-off this produce and when will it be produced.

Risk of Major Economic Crisis in Mid-Term

The risk is now real that a secondary recession/crisis could occur in the next few years if the government spending and monetary expansion creates problems of its own. While greater short term confidence may be warranted, companies need to be careful about their longer term plans so that they are not over-exposed to a potential future crisis.

Lower Future Growth

Even if no future crisis occurs, the sheer drop in the economy and the massive disruption in industry, will require years for full recovery. This still makes a return to pre-crisis industry growths very unlikely to occur.

Companies Running out of Funds

Whereas 6 months ago when the crisis began, most manufacturers were concerned about the theoretical possibility of running out of funds, this is now starting to become a practical problem as many have less than 6 months of cash in the bank and are dependent on new funding or an acquisition. Even in a best case scenario with the economy improving, funding availability will likely remain challenging for many.

Little Consolidation . . . Publicly Yet

The only semi-public deal in video surveillance yet resulting from the economy crisis is the Mango DSP / MATE merger. This merger was able to be executed quickly because of the common investors in both companies.

Nonetheless, it is likely that a few dozen companies globally are actively looking for funding and are having challenges finding that funding (I have heard from some of them and some potential acquirers doing due diligence).  These company's challenge comes from ongoing losses (the 'burn rate') with constraints on new investments.

I would expect a number of bankruptcies and fire sales of smaller video surveillance companies by the end of the year. 

Expectation for Rest of Year

Looking out towards the rest of the year, it is likely that the US and other government will continue to intervene and help hold up the economy. This may create a floor and allow sales to level off or growth to start increase.

Nonetheless, the risk of new bad debt writeoffs is very real. I attended a presentation by the Chairman of Citigroup tonight and his core message was that the current crisis is driven by a lack of liquidity and confidence. Specifically, he argued that mark to market was a mistake because people are under-valuing assets. If he is wrong, as many believe, and the low price of assets is genuine and is eventually acknowledged, this could damage the recovery and the financial system. The current rebound implies that further bad debt will not be a serious factor - this is a risky point.

Conclusion

While government interventions have helped stabilize business, significant risks remain in (1) further bad debts and (2) longer term problems from government debt/monetary expansion. 

Companies should remain cautious for these two significant risks for the rest of 2009.