KEN KIRSCHENBAUM, ESQ
ALARM - SECURITY INDUSTRY LEGAL EMAIL NEWSLETTER / THE ALARM EXCHANGE
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comment on Multiple for inspection and service contracts / ISC meeting
April 11, 2024
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comment on Multiple for inspection and service contracts from article on March 26, 2024
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Ken,
I wanted to respond to the March 26, 2024 inquiry from our old buddy Anon, who asked if the “multiple for inspection and service RMR is the same for monitoring, and how would it be calculated?”
Valuation is a profession. My firm does 20 – 30 valuations of alarm companies each year. Many times the valuation is for parties to a divorce or a partner dispute. Both sides have hired an expert to value the company and they are so far apart that we are called in to break the stalemate. Other times it we are simply valuing the company in connection with it being transferred to a trust, to value a probate estate, or for tax purposes. In these cases, the users are looking for expert opinions, not guesses (educated or otherwise). There are Professional Standards that must be followed when performing a valuation. We follow the American Institute of Certified Public Accountants’ Statements on Standards for Valuation Services (SSVS).
Many times we encounter a situation in which one party has retained a Valuation Professional who doesn’t understand the Alarm Business and the other side has retained a Broker or other person who understands Alarms but not the Standards. They are hundreds of thousands, even millions apart and deadlocked.
The alarm business is somewhat unique in that Recurring Monthly Revenue (RMR) provides high margin cash flow and alarm companies can many times buy it and enjoy a future stream of cash flows. Many companies Aggregate RMR, that is they purchase the cash flow stream for a price and consider the future cash flows to be a return on investment. For example, a base of 800 monitoring accounts, that represent $30,000 per month represents $360,000 per year of monitoring revenue (assuming no attrition). If that account base costs the alarm company $3,600 per month to bill and monitor it is providing that cash flow at an 88% margin. Few revenue sources enjoy margins of more than 50% let alone nearly 90%. The theory behind aggregation is that the $30,000 of RMR, produces $316,000 of annual net cash flow. If the aggregator simply bills and collects the RMR they can add this net cash flow to their bottom line. Sophisticated aggregators use a Discounted Cash Flow Model to determine the value of the RMR base that they are considering purchasing. For example, if this $30,000 of RMR has a 12% cost and a 9% attrition rate the aggregator will apply a “discount rate” (which accounts for the time value of money), typically 10% to 15% to account for the fact that the RMR will be received in the future and that there is some risk that not all of it will be received. In this case, the $30,000 of RMR would yield $253,224 during the first year. Attrition will reduce this amount to $23,351 in the second year, and, after 10 years, only $112,306. If the aggregator discounts the cash flows by 15% per year the Net Present Value of the cash flows would be around $1 million dollars or 33X. This is how sophisticated Buyers determine “Base” Multiples. The Base Multiples are then adjusted by other factors, for example, if a Buyer is forced to re contract the customer base due to deficiencies in the monitoring agreements, the Multiple will be reduced by the expense of re contracting.
Getting back to Anon’s question about multiples for service and inspection agreements, I would refer you to the Margin component in the calculation above. Monitoring cost is low compared to Monitoring Revenue. It is also stable and predictable. Service cost is not. Let’s look at the above model and its monitoring cost of 12%. Each month the Alarm Company bills out $30,000 of RMR and has $3,600 of monitoring cost (central station, communicators, billing expense, etc…). If the Company also has $30,000 of service contract revenue chances are it is not at an 88% margin. Let’s say that the service contracts are at a 35% margin. If we substitute this into our Discounted Cash Flow Model our first year net cash flow is now $40,000. The total discounted cash flows are only $158,747, or 5X, much lower than the cash flow from monitoring. Of course this is a Base Multiple and is many times adjusted. Inspections are a different animal. Some companies have turned inspections into a high margin business segment by automating the process and charging time and materials for any repairs or upgrades. Other companies don’t make much from inspections, and for many, there is some doubt as to whether their annual inspections are contracted RMR at all.
Victor Harding has weighed in many times about the importance of margin to the valuation equation. For example our company above is realizing 88% margins. If the company monitors at a lower rate, or includes extra services (interactive, cellular, supervision, etc…) without getting a corresponding increase in rates, its net cash flow will be lower and its value will be less.
Mitch Reitman
817 698 9999 x 101
Reitman Consulting Group
Fort Worth, TX
http://www.reitman.us
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Response
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WOW, I asked for a milk shake, not all the ingredients and how to make it ….. Of course Mitch, when wearing the bean counter hat, is correct. You can’t really do a proper analysis of service and inspection RMR without considering cost of service. Unfortunately that analysis depends on historical data and then some guess work, at least for the repair service RMR. Where have we heard this one: “past performance is no guarantee of future results”. Well that’s the story with guessing on future costs for repair service, along with “the best laid plans of mice and men …”
Monitoring RMR is the easiest to predict and inspection is next, especially if it doesn’t include any repair service [and the K&K contracts do not include repair with inspection and testing].
You have to start with a few assumptions and work from there when doing a valuation. The assumptions can be wrong. For example, a buyer can assume a seller priced its RMR so that it had a profit on all RMR services, yet closer examination may reveal that the seller made grave error and takes a loss on many levels. That account may have little or no value, and the bean counters can spend hours doing calculations coming up with the reason that’s the case.
Here’s a reliable tip: use K&K contracts and command at least 5 point more for your RMR multiple, no matter what the RMR is for.
Also unfortunately, but alas the case, expert valuation is required in many situations. I’ve noticed that judges don’t seem too enthusiastic accepting my statements backed up by “because I said so”. I’ve had to hire Mitch as bean counter more than once for matters. Go figure.
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Group Meetings: See schedule below. Last minute changes: call: Stacy Spector at 516 987 8428.
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Group Meetings: Topics and Schedule
Thursday April 11. Group Meeting: 10:00 am to 11:00 am - Insurance for your alarm business – best options; availability, pricing and claims. Group meeting conducted by Shawn Iverson of The Insurance Center.
Thursday April 11. Group Meeting: 11:00 am to 12:00 pm – Contracts – which ones you need and why you need them. Group meeting conducted by Ken Kirschenbaum.
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The Corporate Transparency Act. Group meeting conducted by Mitch Reitman of Reitman Consulting Group.
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Schedule a private meeting with Rory Russell of Acquisition and Funding Services (AFS) to discuss buying or selling security, fire and integration business. Available times to meet with Rory Russell are as follows: Wednesday April 10 and Thursday April 11 between 7:30 am and 11:00 am and 12:30 pm and 4:00 pm. Contact Stacy Spector to schedule a private meeting with Rory. Call 516 987 8428
ALL TIMES ARE PACIFIC STANDARD TIME.
Contact Stacy Spector, Esq. for all scheduling at Sspector@kirschenbaumesq.com or 516-987-8428.
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Ken Kirschenbaum,Esq
Kirschenbaum & Kirschenbaum PC
Attorneys at Law
200 Garden City Plaza
Garden City, NY 11530
516 747 6700 x 301
ken@kirschenbaumesq.com
www.KirschenbaumEsq.com
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