Protection One Is No. 2 Through Acquisitions

Culver City-based Protection One Inc. has quietly become the second-largest burglar alarm company in the U.S. in the last year, as a strategy of growth by acquisition has made it a dominant force in the fragmented security industry.

Largely through purchases funded by secondary stock sales and other financings, including last month’s sale of $350 million in high-yield “junk” bonds, Protection One has grown from a regional alarm company to one that serves more than 1.5 million residential and commercial customers in the United States, Canada, Britain and Western Europe.

The company, with 4,500 employees, has seen its stock market capitalization balloon to more than $1.3 billion, from just $55 million in 1994.

“I think we’ve snuck up on Los Angeles and become one of the larger companies here,” said John Mack, the company’s chief strategic officer. “We’re a real growth story.”

But its multiple stock offerings and rapid acquisition pace also have soured some investors, who fear that Protection One may have stretched itself too thin--and heavily diluted future earnings for shareholders.

The basic business, however, appears to have strong growth potential. Security services are used by only about 14% of households nationwide but are growing by about 15% a year in household penetration, according to recent data.

Even though statistics show crime at its lowest level in decades, people are still buying home alarm systems. Increasingly, they consider them part of a home’s cost, like a cable bill, specialists say.

“We offer a peace-of-mind product,” said David Barnes, spokesman for Protection One. “We have seen no reduction of demand for our product, even with the numbers showing crime in decline.”

Protection One was formed in 1991, when three Westec Security executives left that company and used venture capital to buy the Protection One division of Oregon-based utility PacifiCorp.

Since then, Protection One has grown rapidly and diversified its business lines through acquisitions. In October, the company agreed to buy medical-alert company Lifeline Systems Inc. for $179 million in cash and stock, its first move into the medical monitoring business. Lifeline, based in Cambridge, Mass., makes devices that alert hospitals when its clients need assistance.

“We had a rare opportunity to become one of the top three companies in America in a certain industry,” Protecion One Chief Executive James Mackenzie said. “Now we want to take advantage of our size to grow.”

Much of the firm’s growth occurred in July 1997, when Western Resources Inc. agreed to acquire an 84% stake for $320 million in cash and debt. Western Resources, a Topeka, Kan.-based utility, merged its security company subsidiary with Protection One to create the nation’s second-largest burglar alarm firm.

Western Resources had made a failed hostile bid for Bermuda-based ADT Ltd., the largest provider of burglar- and fire-alarm monitoring. Tyco International Ltd. bought ADT for $7 billion in mid-1997.

Utility companies are moving into services such as home security in hopes that offering a broader range of home-related services will help them attract and keep customers as their industry is opened to competition.

For its part, Protection One has expanded from home alarms into the apartment alarm systems business, as well as alarm-monitoring systems for automobiles.

“Protection One is definitely an industry consolidator,” said analyst David Staples of Fitch IBCA Inc., a New York credit-rating service that analyzed the company’s latest high-yield bond offering, which was sold in December by a team led by Morgan Stanley Dean Witter.

“For a long time, people didn’t think they would be able to pull it off at Protection One,” said Jason Knott, publisher of Security Sales, an industry magazine in Torrance. “But to their credit they were able to do it, and the deal with Western Resources has really helped them.”

After losing money from 1995 through 1997, Protection One turned profitable last year. In the third quarter ended Sept. 30 the company earned $2.8 million or 2 cents a share, on revenue of $103.3 million, compared with a loss of $6.8 million, or 10 cents a share, on revenue of $32.8 million a year earlier.

Despite the revenue growth and new profitability, the stock, which moved from Nasdaq to the New York Stock Exchange in November, has hardly been a stellar performer. Shares reached a 52-week high of $13.13 in April before dropping to a low of $6.94 during September’s market slump. The stock has languished in recent months at $8 to $9 a share, closing Friday at $9.06.

“Management has lost sight of what it takes to create shareholder value,” said Jeff Bronchick, a portfolio manager of a $1-billion investment fund with Reed, Conner, Birdwell in Los Angeles. He said he sold his fund’s less-than-1% stake in Protection One late last year after holding shares for three years.

“By overpaying for the last 18 months of acquisitions, they have increased shares outstanding more than they have increased subscribers, which is not the way to create value,” Bronchick said.

The company’s shares outstanding have soared to 127 million from 9 million in 1995.

Current shareholders include Capital Research and Fidelity and Vanguard mutual funds.

“We haven’t had an opportunity to get out and talk to equity investors and tell our story,” Mack said. “We’ve been so busy growing.”

Despite industry consolidation, the home security business remains dominated by smaller companies. In fact, 1,829 alarm companies are based in California, and about 1,025 of them are headquartered in Southern California, according to the state Department of Consumer Affairs, which oversees the industry. Los Angeles County dominates the state, with at least 524 alarm companies based here, the department said.

“It tends to be a highly personalized, customized business,” said Jerry Lenander, executive director of the California Alarm Assn., a statewide trade group. “But there are also these large companies, like Protection One, Westec and ADT that do well.”

Protection One has more residential and commercial customers than Westec Security of Newport Beach, which last year sold its residential accounts to Edison Select, but fewer than Bermuda-based ADT Ltd.

Southern California is expected to increasingly become a battleground, industry watchers say, as Westec’s new owner, Edison, and Protection One seek to corner the lucrative local market for home alarm systems.

Protection One is betting on future growth through acquisitions in Western Europe next year, as well as by expanding its network of dealers. Instead of a commissioned sales force, the company has a network of 400 dealers who sell Protection One contracts, and it then buys those contracts from the dealers.

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At a Glance

Company: Protection One Inc.

Headquarters: Culver City

Employees: 4,500

CEO: James M. Mackenzie

Year founded: 1988

Clients: 1.5 million residential and commercial

Market capitalization: $1.3 billion

Majority owner: Western Resources, with 84%

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Debora Vrana covers investment banking and the securities industry for The Times. She can be reached by e-mail at debora.vrana@latimes.com.