Investing in ITS: Show us the money

The ITS industry is currently attracting a lot of interest from private equity and venture capital providers. Adam Hill asks some of the people who have their eyes on the market what makes it such a good bet
UTC / April 8, 2022
© Iwan Zeller |
© Iwan Zeller |

There is a ‘red carpet’ vibe to the ITS sector at present. Whisper it, but companies are basking in a warm financial glow; there is a lot of money around and the industry, its products and its services are all in the spotlight. ITS is attractive.

PTV Group’s owners have just announced they are buying a majority stake in Econolite for an undisclosed sum, while Siemens Mobility’s deal to spin off Yunex Traffic to international road traffic business Atlantia for €950 million is due to complete later this year. These are just the latest in a line of big, and not so big, deals over the last 18 months or so. To name a few: Teledyne spent $8bn on Flir; Verra Mobility bought Redflex Holdings for $113m; Rekor Systems bought Waycare Technologies ($61m); Iteris purchased software developer TrafficCast ($16m). Quarterhill has reiterated its desire to be a global leader in ITS through its acquisition of various brands, primarily Electronic Transaction Consultants (tolling) and International Road Dynamics (enforcement technologies). Cubic Corporation, owner of Cubic Transportation Systems, was sold for $2.8bn last year to private equity companies Veritas Capital Fund Management and Evergreen Coast Capital Corp.

This is all good news for ITS. Smart money does not tend to chase indifferent companies in low-growth industries and recent research suggests the sector will be worth anything between $90bn and $120bn by 2025. It’s worth pointing out that ITS is also not an undiscovered country when it comes to outside investment - Trafficware and Eberle Design, to name but two, were owned by private equity firms at one time, for instance, well before Cubic (although Trafficware is now a Cubic company, of course).

‘Tailwinds’ and ‘confluence’

There are a few reasons why the sector is appealing right now. The market dynamics are complex but several of the investors ITS International spoke to mention two words: ‘tailwinds’ and ‘confluence’. The industry has a strong breeze behind it at present and various factors are coming together in its favour.

The need to ease urban congestion is one reason why ITS is attracting interest © Sergey Novikov |
The need to ease urban congestion is one reason why ITS is attracting interest © Sergey Novikov |

While it may be something of a niche industry in and of itself, the sorts of things that ITS can do are increasingly an important part of the mainstream. For instance, the world’s population is inexorably migrating to expanding urban areas, where traffic congestion and air quality are often poor. At the same time, the planet is getting hotter and traffic technology is seen as one of the possible mitigators of climate change through more efficient, less congested and less polluting transportation.

The widespread adoption of Vision Zero principles confirms road safety is a major issue for city, regional and national governments worldwide, and sustainability is near the top of policymakers’ agendas; ITS can help with both. Covid has sparked renewed interest in different transport modes – in particular active ones such as walking and cycling; meanwhile the rise of micromobility is reshaping the look and feel of cities everywhere. It doesn’t hurt, either, that there is a renewed emphasis on the importance of mobility for successful economies (Exhibit A: the US bipartisan Infrastructure Investment and Jobs Act) and a broader recognition that the roll-out of electric vehicles - and connected and autonomous ones - will require new infrastructure as communication and connectivity become more important. Frequent mentions of artificial intelligence, machine learning and ‘smart cities’ all create the impression of a sector which has a buzz about it – ITS is (literally) going places.

“I think it’s a few things,” one anonymous investor tells ITS International. “One is the proliferation of the connected economy. As technology improves, as people think about how to make cities more efficient, this is going to be one huge area that can really help, whether that’s traffic patterns, or safety or data on who’s going where, as efficiencies around cities become more of an important element of public policy.”

This brings us to a third word after ‘tailwinds’ and ‘confluence’: technology. ITS is a tech-led sector and it is this which often interests potential investors which want market leadership or differentiation.

“It’s a bifurcated market: you have mature players providing legacy technologies and innovating incrementally along the way,” explains Chris Toussaint of investment bank Harris Williams (which was M&A advisor on the recent PTV/Econolite deal). “Within the US, you have established players like Trafficware, Econolite, Q-Free, Parsons, McCain and others that have been in the space for a very long time. And then you have a whole host of innovative, newer companies, attacking problems like traffic congestion, public transportation, parking and connected vehicles from a different angle. So you have both: you have companies that are evolving into it in the middle and creating new markets. The connected vehicle market, five to 10 years ago, was a dream. And now that’s evolving very quickly.”

Cultural fit of a company with its investors can be an important factor © Rawpixelimages |
Cultural fit of a company with its investors can be an important factor © Rawpixelimages |

This wide range is attractive for all sorts of investors - so who are they? They fall broadly into three groups: venture capital (VC) providers get involved in early-stage companies – such as the geeks in the basement who have discovered an algorithm that’s going to change the world but who at present don’t have the money for a cappuccino. Private equity (PE) tends to be interested in companies which are already turning over millions of dollars but want to expand. Investment bankers are essentially the deal brokers: “Think of them as real estate agents for companies, looking to align buyers and sellers,” suggests ITS veteran Greg McKhann. In a 30-year career in the sector McKhann has held a variety of senior roles, including at Iteris and, most recently, as chief operating officer at McCain. He now advises investors looking to make deals in the ITS space.

“The way these deals work is, typically, a seller will hire an investment banker to help them put together a PowerPoint deck that lays out the opportunity and then the investment bankers promote it to the private equity firms and strategic buyers,” he says.

This can be an expensive undertaking: it would be entirely possible to spend six-figure sums in preparation for making a healthy bid for the company that is up for sale – and then not make the shortlist. Having said that, in ITS the big companies do not tend to be particularly big when put alongside firms from other sectors. Investors tend to be too polite to call the ITS sector ‘immature’, preferring instead to use words such as ‘emerging’ or ‘white space’.

Yet just as there are all sizes of company in the ITS sector, so there are all sizes of investors looking at opportunities in it. “It’s not just the big guys that sniff around when a company goes on the market – there are players up and down the various price points,” says McKhann.

Tangible value

Valuations are generally high right now as stock markets and asset prices are high. People will pay for quality companies where they can see growth and a return but there’s no blueprint for a single deal: every company is going to have to be treated on its own merits. Companies may also be seen through the prism of how they might dovetail with another entity in a similar or complementary area.

Sensor technology, connectivity technology and computing power are converging © Juan Ignacio Polo |
Sensor technology, connectivity technology and computing power are converging © Juan Ignacio Polo |

“Sensor technology, connectivity technology and computing power have evolved to a point of cost-effectiveness such that one can bring them to bear in a number of markets,” points out Eric Logue of Harris Williams. “Can I put this together with that? Maybe this company does AI; this company has great camera technology; another sophisticated sensors capturing data. By combining effective emerging technologies, providers can deliver tangible value to constituents and in turn build companies of scale. The potential has always been there and it is unfolding now.”

So a deal is a deal, is a deal. To use McKhann’s real estate agent analogy: “If you’re buying one of 100 homes on the same street and they’re all built at the same time, and they’ve got the same floor plan, give or take, the range of price variation is going to be pretty small. But with a company, beauty is in the eye of the beholder: are they well-positioned? Do we like the market segment they serve? Do we like the technology? Do we like the people? How good or not good is the balance sheet? Every company is different - so there’s a much wider range of perceived value on the part of buyers.”

An entrenched image of the typical PE investor is of someone who is more interested in a quick win than in the health of the company in five to 10 years’ time. In short, they turn up, slashing and burning, cutting headcount by 15%, getting rid of engineers, marketers and accountants and working the remaining employees to death. This means the numbers will look good for six quarters or so, allowing them to flip the company and move onto something else.

It’s a grim vision – but McKhann says this is not his experience. “In my dealing with private equity firms, they all kind of assume a four- to six-year hold period and that the company is going to be bigger and stronger in that time, and that sophisticated investors like themselves - but bigger - are going to be the buyers. And the buyers are sophisticated enough to poke around, say: ‘Wait, what the hell, you had this CTO? Where did he go?’ And if you say: ‘Well, he was expensive, we cut him loose’ they’re going to frown on that if the move was strictly to cut cost. So it’s not that ‘slash and burn’ mentality, it’s more they want to grow things. That’s not to say they wouldn’t trim fat - but they’re not going to cut muscle and bone. That’s my sense: they want companies to be lean and efficient but to have good people doing the right things with good processes - because they are more valuable in five years when the investors are thinking about selling the business.”

Human resources

Another point to remember, especially in the smaller businesses of which ITS has many, is that a company founder who has built up a successful firm is likely to care deeply about employees and their welfare – and also about the company’s legacy. You’re unlikely to let just anyone in – instead you will want a two-way dialogue: money is important but so is human resources. PE is there to bring money but also to add value – perhaps in terms of enterprise resource planning (ERP) systems, improving process flow and manufacturing, or just being prepared (and able) to wait a little longer for a return on a new product or system than an owner whose house might well be mortgaged on the outcome.

Recent research suggests the ITS sector will be worth anything between $90bn and $120bn by 2025 © Piksel |
Recent research suggests the ITS sector will be worth anything between $90bn and $120bn by 2025 © Piksel |

Steve Sandbo, partner at Vance Street Capital in Los Angeles, has heard the stories. His firm specialises in investing in smaller, family-owned businesses so definitely does not take the ‘slash and burn’ approach, he insists. “I think for us, that is critically important - probably a bit of a differentiator. We’ll go in and say 90% of the deals that we do are with families and founders and management teams - and you can call every single one and ask ‘how have we done, did we do what we say?’ I think that’s really important for families because there are a lot of horror stories. But there’s a lot of success stories too: I think it can be a little bit polarising when you just listen to the rumour mill of how private equity works.”

Sandbo sees this as an “interesting time” within ITS, especially when it comes to M&A and growth equity activity. “If you look at the technology and the innovation in the market over the past 20 years relative to where we sit now, it’s an interesting inflection point: you see a lot more VC money coming into this market, more private equity interest, and those tend to converge,” he explains. “In many cases, it’s a partnership with some of the VC-backed businesses where we can leverage their technology and provide them access into our hardware in real estate within the intersections. Even before the US Infrastructure Bill went through, this was a market that we felt had a lot of tailwinds and it’s just going to have continued investment. It seems like there’s more openness when it comes to the adoption cycle of some of this new technology. We want to find markets where the innovation, the engineering, the quality which you’re able to produce is why people choose you - not because you’re 10 cents cheaper making the t-shirt.”

Whitespace chessboard

People love investing in businesses that have high growth and an appealing software element to them but there are other ways to do it. Lower-growth, steadier businesses that generate a ton of cashflow can be interesting as well, points out another investor: “And sometimes if they have a really good market position where they are in lots of different intersections or they’re a number one provider, or even if they do one thing really, really well - even if it’s less sexy than controlling the cabinet - you may be able to have leverage for new product sales through that channel. And so even less sexy businesses, or even some of the hybrid distributors that are out there, could be interesting areas of investment because they have an ability to go to market in a way that is hard to replicate.”

So whichever way you cut it, ITS is spending some time in the sun for good reason. “For a market potential of this size, it’s a very rare instance where you have such an open, whitespace chessboard,” concludes Eric Logue. “What is happening now is a realisation that there’s a large opportunity to create value with technology.”

So what do ITS companies need to do to attract investment?

Have good technology, demonstrate decent margins and prove that your product is being adopted by customers. Knowing this in your bones is not enough: an investor wants to see this demonstrated in some fashion. Data tracking such as return on investment, contract wins, customer retention and growth is important. And while demonstrating, say, double-digit growth can be impressive, investors may want reassurance that this progress is smooth rather than bumpy. For instance, the increasing prevalence of Software as a Service business models may be attractive exactly because of the visibility of revenue - and its consistency. If you can identify points of differentiation or market leadership in a particular sector or sub-sector then so much the better. Investors may also be interested because of the secondary opportunities that larger companies in particular create – for instance, in repackaging their data in different ways to find other ways to monetise it. Companies may also be attractive targets if investors think they might be put together with another business to strengthen the offering. Also, don’t underestimate the power of cultural fit: people with money want to know that your management team will use it in the right way. At the core are good sales channels, close and preferably long-standing customer relationships and the ability to grow both organically and through acquisition. A high-margin business which is on its last legs won’t get anyone particularly excited. High-growth markets will allow investment in your business or product portfolio and offer room to build out sales channels. And finally, remember that it is possible to be a good business and yet not be the right fit for a particular investor. There are plenty of others out there at the moment.

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