Britain’s Smiths Group has agreed to acquire the California-based detection business of France’s Safran Group for $710 million, a deal which would give it a marquis position globally for automated checked baggage screening systems and consolidate a large portion of the international market for trace detection products.

The deal is subject to regulatory approvals and the companies expect it to close in early 2017.

The only potential regulatory hurdle would seem to be in the area of trace detection where both Smith Group’s Smiths Detection business and Safran’s Morpho Detection unit are market leaders with their respective explosive trace detection products, mainly for aviation security applications.

However, more than a year ago Implant Science Corp. [IMSC] won the latest ETD contract from the Transportation Security Administration (TSA), and has followed up that milestone win with additional contracts with aviation security authorities in Europe, staking out a position has a viable competitor in trace detection. With Implant Sciences’ success of late, regulatory authorities in the U.S. and in Europe are less likely to have any qualms about the pending acquisition of Morpho Detection by Smiths, one industry official says.

Deepak Chopra, chairman and CEO of OSI Systems [OSIS], believes the acquisition does face antitrust hurdles, although he didn’t elaborate as to the specific obstacles on his company’s third quarter earnings call.

Another industry expert also suggests that there could be regulatory issues based on the “commanding” presence that Morpho and Smiths have in the explosives trace detection market.

TSA declined to comment on a query about any regulatory concerns.

The pending acquisition would provide Smiths with a comprehensive portfolio of airport checked-baggage screening systems for explosives detection.

In the airport checked baggage screening market Morpho Detection enjoys a strong position globally, including in the U.S., with its computed tomography (CT)-based explosive detection systems (EDS). The company’s main competitor in this space is L-3 Communications [LLL] and to a lesser degree Leidos [LDOS].

Smiths Detection has developed a high-speed EDS system, the HI-SCAN 10080 XCT, but has had limited success selling the product. Morpho Detection supplies EDS systems in three market categories, reduced-size, medium-speed and high-speed.

Emerging Opportunities

At one time Smiths Group was shopping around Smiths Detection with no luck finding a buyer. Now with the Morpho Detection deal pending, the company may be taking a “double down” approach to the market as Europe gears up to buy new CT-based systems to meet new regulatory requirements for checked baggage screening and the TSA readies to recapitalize its installed base of EDS systems beginning in the next two to three years, Steve Wolff, an independent aviation security consultant, tells HSR.

Wolff said that with its existing product portfolio and the coming demand for CT-based EDS systems, Smiths may have decided that it wasn’t in a good position to compete and win a substantial amount of business.

Smiths said it expects annual cost savings synergies of $30 million to be reached by the third full-year of the combination with one-time integration costs of $30 million to achieve these savings. The company also said it expects mid-single digit per share earnings accretion in the first full year of the acquisition.

Smiths said the acquisition strengthens its position in the global threat detection market segments, which are expected to grow in the mid-single digits annually in the medium to long-term. It also said the deal provides it with complementary businesses offering a broad product offering and services to detect threats and illegal activities in air transportation, ports and borders, critical infrastructure, military, and emergency response.

“The threat environment for people and critical infrastructure around the world is constantly evolving and becoming more complex and sophisticated,” says Andy Reynolds Smith, chief executive of Smiths Group. “Morpho Detection is a high quality business with a strong management team, and I am convinced that his combination provides a compelling competitive platform for product, service and technology leadership.”

Chopra says the deal will make Smiths Group’s Smiths Detection business a “formidable player” and a “stronger competitor” in the overall detection market but points out that his company’s Rapiscan Systems division has all the same products—with the exception of an installed base with trace systems—as well as an installed base and sales channels and so is “ready for the challenge.”

Rapiscan has begun selling a medium-speed EDS system into international airports. The system, called RTT, is a CT-based machine with a fixed gantry that the company can also provide in a high-speed configuration. Most of the global installed base of CT-based EDS systems today has rotating gantries.

In the U.S., Canada and Japan CT EDS systems must be used in airports for screening checked baggage and the European Union requires all installed EDS systems be CT-based by 2022.

Smiths Detection offers a range of Advanced Technology X-Ray systems it sells internationally for screening carry-on bags and hold-baggage. Some of the systems have automated threat detection capabilities but not at the level of CT-based systems. Morpho Detection has some advanced X-Ray screening technology based on diffraction techniques but it isn’t widely deployed.

In the X-Ray systems space at airport checkpoints, Smiths main competitor is Rapiscan Systems. SureScan, another U.S. company, has also developed an EDS system it hopes to sell internationally.

Morpho Detection had $320 million in sales in 2015, with aftermarket services, including software, accounting for more than 50 percent of revenue, which Smiths said helps position it for long-term recurring business. Operating margin at the business was 18 percent and it posted $56 million in operating profit.

Smith also said the software engineering capabilities it will acquire will help in offering future networked solutions and integration of remote monitoring systems and diagnostics.

The checked baggage screening environment is largely networked between the various EDS systems in an airport, allowing for a level of centralized command and control. Morpho Detection brings a strong networking background that Smiths Detection may be lacking, at least to the degree Morpho has.

Wolf said that there is increasing interest in having more networked technology at passenger checkpoints, adding that with the Morpho acquisition Smiths would be able to improve its capabilities here.

Slides that Smiths used in an investor call put the threat detection market at around $4.7 billion annually, growing to $6.7 billion in 2021, with the air transportation segment consisting of 40 percent of the future market followed by ports and borders at 28 percent, critical infrastructure 19 percent, and military and emergency response 13 percent.

Smiths will pay for the acquisition from existing cash and available financing.

Of Morpho Detection’s current sales, 61 percent are in North America, 19 percent in Europe, and 20 percent in the rest of the world.

A Lumpy Business

Safran Group in March said it planned to divest its detection business and explore options for its identity solutions business as it focuses on its core commercial aviation and defense businesses. The company acquired a majority of the detection business in 2009 from General Electric [GE] and completed the rest of the acquisition in 2012 for a total deal size of $698 million.

Smiths Group and GE in 2007 attempted to form a joint venture between their respective security screening businesses but that hook-up fell through. Smiths would have owned a 64 percent share in the joint venture.

The detection market is a lumpy one in terms of annual revenue for just about every company competing here. When GE and Smiths Detection attempted to form their joint venture, GE’s Homeland Protection business had $330 million in sales in 2006. In 2008, that unit had $260 million in sales.

GE entered the detection business in 2002 when it acquired Ion Track, which developed and produced explosives trace detection systems. In 2004 GE purchased InVision Technologies, which made CT-based EDS systems. At that time InVision had more than $400 million in sales.