General Electric’s planned acquisition to reshape detection market

General Electric, headquartered in Easton,
Conn., announced March 15 that it would pay $50 per share for the
Newark, Calif.-based InVision Technologies, adding up to a total price
of approximately $900 million for the manufacturer of explosive
detection systems for airports. InVision reported a net profit of $56.9
million on sales of $416.5 million in 2003.

InVision has been growing rapidly. With the
current focus on upgrading aviation security, the company’s revenues
have increased at a compound annual growth rate of 37.4 percent from
1997 to 2003. Net income increased even faster, at a 43.1 percent
compound annually over the same period.

GE Infrastructure, the unit of General
Electric acquiring the business, is composed of some of General
Electric’s fastest-growing divisions. Now General Electric sees the
potential to broaden from its leadership in commercial aircraft
manufacturing into another air travel-related specialty.

GE Infrastructure plans to combine InVision’s
x-ray detection business with its own complementary ion track business
that detects traces of explosives and narcotics. The result will be an
ability to provide higher technology systems using both x-ray and trace
detection of explosives for airports, railways, border checkpoints,
chemical plants and military bases.

Smiths’ competition

Until General Electric announced the
acquisition in mid-March, Smiths Detection, a unit of UK-based Smiths
Group PLC, had the advantage of offering both trace and x-ray
technologies detection equipment, making it unique among detection
competitors. In trace technology, Smiths faced General Electric’s
InTrack while in x-ray it faced InVision Technologies, L3
Communications, and Science Applications International Corp.

Until now, Smiths Detection’s presence in
both segments of the market also made it the largest player in the
detection market. Merrill Lynch Global Securities Research estimates
that Smiths Industries’ detection and protection business will bring in
$632 million of revenue in 2004 alone. By comparison, InVision will
have only $300 million in detection revenue and L3 Communications, only
$225 million in the same.

Smiths Detection was also considerably more
globally focused than its competitors, deriving only about a quarter of
its sales from the United States and giving it strong potential for
growth as systems are upgraded in other areas, particularly Europe.

Now the competitive dynamic of the market
will fundamentally change. General Electric has a strong manufacturing
capability through its extremely successful Six Sigma program to
improve quality and cut costs. Its strong research capabilities and
corporate resources promise to give it a strong position in developing
future detection systems. Moreover, it has a broader marketing reach
worldwide than the Smiths Group, despite Smiths Industries’ ownership
of significant detection assets in both the United States and Germany.

The InVision logic

InVision Technologies’ leadership’s decision
to sell reflects not just the potential to create a stronger market
position with General Electric, but also the immaturity of the homeland
security market.

Despite strong long-term prospects, the
detection market has entered a period of weakness. The decline reflects
a need for a year or two for US airports to complete construction
projects that would enable in-line screening of baggage. In-line
electronic detection systems will integrate high-speed explosive
detection systems into an automated baggage handling system that will
be behind the scenes rather than in the lobby of airports as is
currently done.

The result has been an uneven growth rate for
InVision, reflecting an immature market almost entirely reliant on
large US government sales. Revenues peaked in 2002 at $439 million and
have slid since then to $416 million in 2003. This year sales will drop
further to $310 million. Only in 2005 does InVision see growth resuming.

Profit margins also have been under pressure,
declining from 30 percent in 2002 to 24 percent in 2003. This year the
company projects margins will be from 18 to 20 percent.

Merging with General Electric gives InVision
Technologies the ability to deal with the current downturn and
uncertainties in the future market, which still promises to be quite
strong over the longer term.

Despite the installation of basic detection
systems at US airports, InVision sees growth in improved screening
technology in the United States. There is a need for $2 to $3 billion
for automated in-line systems in airports rather than existing
stand-alone detection systems.

Additionally, there is the potential for the
aviation market to serve as a test bed, enabling technologies developed
there to be used in the significantly larger market, such as cargo
shipping, outside of aviation. This has the potential even to surpass
aviation as a market, further justifying General Electric’s interest in
InVision Technologies.  HST

Philip Finnegan is
director of corporate analysis at the Teal Group, a firm based in
Fairfax, Va., that provides strategic and market analysis to major
corporations.

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