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What are the implications for Allied/G4S, and also the broader manned guarding industry as a whole?

Tony Dong

Remember G4S? The global UK based security firm who bungled the 2012 London Olympics badly enough that:

  1. The British government was forced to call in 17,000 soldiers to assume security duties after G4S fell short in staffing by 3500 guards;
  2. G4S market value tanked, dropping $938 million in just 4 days (Moral hazard much, management screws up, shareholders pay the price);
  3. The G4S chief executive at the time (picture below) had to testify before Parliament, admitting the fiasco was "a humiliating shambles" and their reputation "was in tatters".

Well, it turns out that US security firm Allied Universal is now poised to take over for a bigly sum of $5.1 billion USD. If successful, the resulting G4S/Allied entity will generate up to $18 billion annual recurring revenue and comprise over 750,000 employees. For the "leaders and influencers" in the manned guarding industry unaware of these developments because they've been too busy focusing on excessively high NBOT as a result of COVID related staffing issues, its time to take note. I'll get into the reasons why later, but for now, here’s a brief timeline of the events.

Previously, G4S fended off two offers from Fleming Capital Securities LLC (a wholly owned subsidiary of Canadian security firm GardaWorld). The first one occurred on September 15th, 2020, an unsolicited cash offer to the tune of 190 pence per share. The G4S board unanimously rejected the offer and essentially told them to "GTFO", citing that the offer significantly undervalued the company and its prospects, was highly opportunistic during a global pandemic and recession, and not in the best interests of shareholders. The shareholders agreed, and no murmurs of dissent were raised.

GardaWorld tucked its tail between its legs, slunk away to do some more financial engineering, and came back with a revised offer of 235 pence per share on December 2nd, 2020. The G4S board deliberated for only 6 days before unanimously recommending again that shareholders reject it, citing that it still undervalued the company. I imagined the face of the G4S Board Chairman looked something like this upon reviewing the revised GardaWorld offer:

Hilariously enough, in that same announcement the G4S board recommended that shareholders accept a 245 pence per share competing offer from Allied Universal. They "strongly urged" shareholders to take no action in response to the GardaWorld revised offer, which is polite corporate speak for "blow it out your a**". In response, on December 9th GardaWorld went back on its word, swallowed what was left of their pride, and struck the "No Increase" statement from their revised Final Offer of December 2nd, perhaps hoping to counter with another bid. The G4S board then published an announcement informing shareholders that GardaWorld's recession of their "No Increase" statement did not change their intention unanimously to recommend the cash offer from Allied Universal.

So where do we go from here? What are the implications for Allied/G4S, and also the broader manned guarding industry as a whole?

The first question is how Allied Universal plans to fund this takeover. In simple terms, Allied Universal has to acquire a controlling majority of the outstanding G4S common shares. Because of the size of G4S, the large amount of shares outstanding, and their relatively high market value (which Allied Universal is already paying a premium over for), it is unlikely that Allied has the capital to finance this takeover single-handily. Allied Universal will likely, or already has secured financing from an investment bank or other institutional lender who can provide the capital to complete the takeover.

The deal will likely be heavily leveraged, with the goal being that once acquired, G4S's operating cash flow is sufficient to pay off the debt used to make the takeover possible. If the operating cash flow of G4S post-take over remains strong, the remainder after interest payments and the investment banks management / underwriting fees can be returned towards investors as income, with a likely capital gain if the shares appreciate in value.

The second question is whether Allied Universal will continue to operate G4S as a publically traded organization, or delist and take it private. There are advantages and disadvantages to each. Operating G4S as a public company increases investor interests, as the buying and selling of public company shares is a relatively straightforward transaction holding good liquidity. There is also a certain degree of prestige to being a publicly traded company, implying a level of operational and financial size and success.

However, there are also tremendous regulatory, administrative, financial reporting, and corporate governance requirements to which public companies must comply with. These activities can shift management's focus away from operating and growing a company and toward a compliance focus, which saps strategic planning capabilities and resources. Public companies must also devote a significant amount of time and resources to conducting operational, accounting, and financial engineering to meet investor's quarterly earnings expectations. This short-term focus on the the vaunted quarterly earnings report can reduce prioritization of longer-term functions and goals, such as R&D and debt funding.

The third question is what the outlook for G4S common shareholders will look like (I don't really care about preferred / bond holders for the purpose of this discussion). In my opinion, the recommendation of the G4S board to the shareholders to accept the Allied Universal bid was calculated to anticipate their likely response. Why? During a takeover attempt, common shareholders who have voting rights will often pressure the board of directors and senior management to complete a pending deal. Many common shareholders of public companies are also short-term institutional and retail investors, and realizing premiums over the going market value from a takeover or take-private (if G4S gets delisted) represents a low-risk way of securing solid returns. The G4S board maintains shareholder confidence by issuing a recommendation that aligns with their expectations.

Finally, I mentioned earlier that Allied Universal's bid will likely be heavily leveraged, possibly on G4S's balance sheet. If the leverage used is excessive (I'll need to do a comparison of G4S's current debt-to-equity ratio to industry benchmarks, if any, to determine this), serious credit risk could result if adverse events or conditions occur. The prospect of a economic downturn, competition from GardaWorld and Securitas, or the loss of key revenue generating contact awards could put G4S in financial distress. If strong growth occurs, the use of leverage will deliver exponentially higher results that what would happen without the use of debt financing. However, if the cost of servicing the debt with interest payments outweighs the income generated during times of crisis, share value and earnings-per-share will decline.

The costs of debt financing are heavily correlated with market conditions, meaning that the profitability and risk of leverage may not be readily apparent at the time of transaction. Should G4S's have difficulty servicing its debt post-takeover in the event of adverse market or economic conditions, the credit ratings on their bonds and debentures will likely suffer, rendering it difficult for them to raise further debt capital. This will have a limiting effect on their capital expenditure, expansion, and R&D goals, which are all crucial activities to achieving a long-term strategic plan. This could cripple G4S's competitive advantage in the saturated and stagnant manned guarding industry, where every company's service and product offerings are nearly identical and have few strategic differentiators.

What about the manned guarding industry in general though? I think the 2020's will be characterized by a frenzy of hostile takeovers and heavily leveraged management buyouts, fueled by an influx of private equity. The result? The rise of the global security super-conglomerate - one "too big to fail". The implications of that for an industry tasked with protecting other's assets makes me deeply uneasy. By 2030 there will be 2 types of security providers - subprime small local business, and global conglomerates. The mid-tier enterprises will become uncompetitive in the face of the low bill rates afforded by the former and the vast resources of the latter. The net result? Diminished service quality for clients, and increasing lack of regulation from industry authorities reluctant to disturb the status quo of those who grow to comprise a larger sector of the economy and workforce.

If manned guarding gets more regulated (or even regulated at all) at the federal level in the U.S. and at the provincial level in Canada, these super-conglomerates stand to have great influence in setting selection, vetting, and training requirements. I imagine that they would argue that they are best placed to set up programs to meet compliance levels. I disagree strongly. Lobbying from industry giants such as G4S and Allied Universal will almost never be in the best interests of clients or service quality - it'll likely revolve around tax breaks and licensing standards designed to minimize their overhead. I almost think we need an independent industry watchdog and neutral observer like IPVM, but for manned guarding as opposed to surveillance products.

I also envision a foreseeable antitrust inquiry in the distant future. Should this takeover suceed (and my guess is Securitas or Brinks their next target), Allied Universal stands to dominate a sizable portion of the $102.9 billion global physical security market in terms of manpower, but not valuation - the combined assets of both companies only total $18 billion. Should they get any larger, the whispers of "monopoly" will begin flying around inside legislator's heads, especially if another publically-funded debacle like the 2012 London Olympics occurs. I'm definitely against monopolies and especially so when both companies have a history of sub-par performance on large contracts and numerous ethics violations. Hell, G4S has an entire Wikipedia page dedicated to controversies.

That being said, security has been a defensive industry enjoying steady, but modest growth. I think this new M&A trend will buckle the market, create needed volatility for bears & bulls alike, invigorate interest in investors, and spawn capital for future growth. Regardless, you can bet I'm buying put options on G4S in the coming weeks.

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