When the last section of Boston’s Central Artery/Tunnel project, more commonly known as the “Big Dig,” opened last December, it marked a milestone for the intelligent transportation systems (ITS) industry— completion of the most ambitious city-based ITS project to date. At the same time, it very much reflected the industry’s advancement in that much progress had been made, but much remained to be done.
On the one hand, an astonishing amount of technology had been installed underneath Boston’s downtown core designed to speed traffic and enhance safety including 2.6 million ft of fiber-optic cable, 430 closed-circuit color pan-tilt-zoom television cameras, 130 electronic messaging signs, 300 lane-control signs and 25 infrared height detectors.
On the other hand, integration of the whole system had not been achieved as originally envisioned and certain incident detection techniques had been left out altogether. Delays, change orders and demands to work faster had driven the prime contractor, Honeywell Technology Solutions Inc., to substantially increase the price tag of the project from the original $104 million to $234 million and the resulting claim against the project ended up going to mediation. Such growing pains have been life for many private-sector ITS participants. As an emerging industry, many ITS projects extend the state of the art and, thus, it is not surprising that problems crop up along the way.
Once just a concept some 20 years ago, ITS has moved to demonstration and test projects and eventually to real-world deployments like the Big Dig. See Exhibit 1 for a depiction of the information flows involved. Today, many private-sector firms are engaged in a variety of ITS projects around the world. While revenues and profits have been lumpy, it is clear that the ITS industry has established a foothold and is no longer just something that is talked about. A recent report from the Texas Transportation Institute indicates that congestion in the U.S. costs the nation $70 billion in economic cost and lost productivity annually. Such a staggering figure suggests that fundamentally, the ITS market is here for the long term.
The ITS industry in the U.S. was driven by landmark federal government legislation beginning in 1991 when the Intermodal Surface Transportation Efficiency Act funded studies for the deployment of ITS technologies in the largest 75 metropolitan areas and 30 highway corridors. Funding was continued in 1998 as part of the Transportation Equity Act for the 21st Century (TEA-21) to the tune of $220 million per year through 2003 to the state and local level for the execution of the deployment plans. State and local governments also put up their own matching funds and thus provide a multiplier effect to the federal money. Renewal of the TEA-21 legislation for another six-year term is set to take place in 2004.
While government was the primary driver of infrastructure-related technology, the private sector began seeking in-vehicle solutions. Automakers and fleet operators considered technology for their vehicles and fleets that could improve the performance and began investing in such technology.
Growing strong
According to market research firm Freedonia Group, the ITS market in North America is expected to grow from $3.7 billion in 2003 to $7 billion in 2008, a 14% compound annual growth rate, exclusive of planning and design revenues. The market consists of infrastructure systems ($2.5 billion in 2003, growing at 12%) and in-vehicle systems ($1.2 billion in 2003, growing at 17%). Roughly half of the infrastructure market is electronic toll collection (ETC) while the other half is advanced traffic management systems and public vehicle traffic management systems. In-vehicle systems consist primarily of commercial vehicle operations and advanced vehicle security systems.
The market is highly fragmented with approximately 50 serious players in North America of which 30-40 firms have annual ITS revenues greater than $10 million. There are scores of other firms that are either smaller niche players or touch ITS tangentially but do not concentrate on it as a core market. Competitors for design and deployment of ITS systems can be categorized as consultants, systems integrators and product vendors. Exhibit 2 shows some key players, most of whom have more than $10 million in annual ITS sales. Generally, firms participate in one niche area although TransCore and Iteris are two companies that have presence in several segments.
Infrastructure deployment projects generally follow a path of design-build-operate and sometimes transfer to the client. Due to the complexity of the systems, consultants and system integrators often form alliances and consortia to undertake these projects. Alliance building is important because it is rare for one company to be able to do everything itself. Besides private-private alliances, there also are many private-public partnerships at play. In addition to deployment projects, the government funds planning studies and research and development activities for the purpose of developing new technologies that can be deployed in the future.
While the market opportunity for infrastructure systems is large, private-sector participants have and continue to face challenging issues. For example, state and local budgets are fixed annually and can vary considerably. At present, many state budgets are running in deficit and because of this transportation budgets suffer. California, which has been very progressive to date regarding ITS, is currently suffering from severe budget problems.
At the federal level, ITS is funded in six-year periods which means that the funding is predictable, but from period to period there is some uncertainty, as there is now.
Two other issues that companies face when dealing with government clients are that often there is no incentive for clients to move fast and, secondly, government regulations can make technologies obsolete. On the second point, the use of standards has gained significant momentum in the last few years, thereby reducing the risk of companies spending on R&D.
By contrast, automakers and commercial vehicle operators are much more adept at incorporating technology into their vehicle if they see the value of it. One downside with automakers, however, is the low-cost environment that one must sell into. As well, education of consumers on the value of ITS is an ongoing and long-lasting process and is necessary if ITS technologies are going to find their way into passenger cars.
The largest player in the ITS market today is Navteq (formerly Navigation Technologies), which is 83% owned by Philips Electronics and had 2003 revenues of $272.6 million. Two other large players are Mark IV and TransCore which have approximately $100 million and $200 million in ITS revenue, respectively. Both are large players in the ETC market, while Mark IV also has an information display systems division and TransCore serves a variety of other ITS markets. Other large players include Quixote’s Peek Traffic Systems division (ATMS products, $75 million), ATX Group (telematics, $49.4 million) and Iteris (a broad-based player, $41.4 million).
Typically, product vendors make very high gross margins on products that are specified in contracts. Transponder vendors have earned gross margins as high as 50%. Lucrative ETC contracts that require tens of thousands or even millions of transponders have led to lawsuits over the fairness of specifications due to the high stakes. Licensing is another option. Image Sensing Systems licenses its products for the North American and Latin American market through its distributor, Econolite, so it can focus more on product development.
System integrators and consultants by contrast normally bid on contracts that are either fixed price or cost plus. For fixed-price contracts, the bidder will build in a profit of roughly 10-20%, while cost-plus contracts involve full disclosure of costs and the contractor receiving an agreed-upon profit above and beyond costs. Although bidders assume certain margins for fixed-price contracts, cost overruns or savings can have significant impacts on the ultimate margin realized. In the case that the contractor is asked to do additional work, or given change orders to the originally agreed-upon work, they are able to make a claim to be reimbursed for such work.
For in-vehicle technologies, independent ITS companies can have their products and services installed in new vehicles or sell them into the aftermarket. For new vehicles, the ITS company works with either the automaker itself (referred to as an original equipment manufacturer, or OEM) or through an equipment supplier, whereas the channels to the aftermarket include fleet operators, distributors or direct to consumers. Systems can either be stand-alone or involve two-way wireless communications with response centers. Revenue models typically involve licensing agreements, subscription fees for services or a combination of the two. It should be noted that most, if not all, OEMs have a plan for in-vehicle technologies. Some are developing the technologies internally while others are partnering with outside firms. In-vehicle technologies represent a fast growing market by virtue of the fact that more and more vehicles are being technology-enabled and technology-serviced (i.e., a service is being provided). Telematics Research Group estimated the cumulative number of telematics-serviced light vehicles on the road in North America and Western Europe to be approximately 4 million and is projected to increase to approximately 12.6 million light vehicles by 2007, an annual growth rate of 33.2%.
Fantastic five
While most competitors in the ITS marketplace are either privately held or derive just a small percentage of their revenue from ITS, there are five North America-based publicly traded companies that derive 100% of their revenues from ITS: Iteris, International Road Dynamics, SIRIT, XATA and Image Sensing Systems. A sixth, Quixote Corp., recently consolidated six ITS companies and now derives 50% of its revenue from ITS through its Peek Traffic Division. These companies represent some $172 million of ITS revenues (roughly 5% of the North American market) and presence in all the major ITS markets.
Over the past several years these companies have generally underperformed the S&P 500 by a large margin. In fact, if you look at the performance from 1996 through the end of 2002, a seven-year period during which all five pure play companies were traded, on average, they lost 8.8% annually while the S&P gained 5.1% annually. However, in 2003 these stocks gained an average of 109.4%, far in excess of the S&P’s 27% increase. Quixote is included in the 2003 data but not in the 1996-2002 data because it only recently entered the ITS market.
Certainly, this group of companies and its performance represents a small percentage of the overall ITS market. However, at a minimum it indicates that currently there are some attractive opportunities for investment in ITS.
It should be noted that 2003 was actually a challenging year in that the market for government-funded projects was lower than normal. Thus, investors believe that despite the difficult market conditions in 2003 the market for future years looks strong. In another indication of support for the industry in 2003, venture capital investors put up $9 million of investment for Maptuit, a company whose main product provides on-demand truck-to-door directions to operators of heavy trucks.
While not publicly traded yet, Navteq and ATX Group both disclosed that they turned an annual profit for the first time in their history in 2003 and both filed with the Securities and Exchange Commission to conduct an initial public offering of shares of their companies. Navteq was founded in 1985 while ATX Group was founded in 1994.
Seeing a pattern
As the ITS market evolves, there are some key trends that have emerged as follows:
The market is consolidating: Three companies including TransCore (six acquisitions since 2000), Quixote (six acquisitions since 1998) and Iteris (three acquisitions since 1997) have accounted for 15 ITS acquisitions in the past few years. ETC leaders TransCore and Mark IV IVHS (Mark IV’s ETC business unit) entered into merger discussions in 2002 but broke them off in early 2003. International Road Dynamics has indicated that its goal is to make acquisitions and reach $100 million (Canadian) in revenue by FY2005 from its FY2002 revenue of $29 million (Canadian). In 2003, it backed off on the timetable but still aims to reach the $100 million (Canadian) mark. It acquired the traffic and telematics business of PAT GmbH in 2003. As these companies gain larger mass, they gain efficiencies.
The need to create the market is lessening: In the past, companies have had to spend considerable amounts of money on sales, general and administration (SG&A) and research and development (R&D) in order to help create the market. However, as the market matures, and revenues increase, those costs are lessening as a percentage of revenue and additional revenue is dropping to the bottom line more easily. For example, SG&A for Image Sensing Systems decreased from 63.4% in 2001 to 46.8% in 2002. R&D for Iteris decreased from 12.1% in 2001 to 8.9% in 2003. For International Road Dynamics, SG&A and R&D expense as a percentage of revenue both decreased from 2002 to 2003 on flat revenue.
TEA-21 reauthorization, while not yet completed, will likely give a significant boost to ITS: To date, federal money has been the catalyst for the ITS industry. Federal money has been transferred to state and local governments who often add money of their own to augment their programs. As of May 2004, funding for the six-year period had still not been decided upon, although an appropriation of $232 million had been made for 2004, roughly equivalent to the 2003 appropriation. The House proposal included some $4.1 billion of funds over six years for ITS while the Senate proposal included just $1 billion. This compares against $1.3 billion from the TEA-21 funding. Even though deficit concerns arose as the bill was to be debated, it still appeared that ITS funding would be at least flat, but with the possibility for a significant boost. For example, if an average of the Senate and House proposals were taken, ITS funding would jump to $2.6 billion, a doubling of the previous six-year period.
Private-sector promise
By no means is the ITS marketplace a sure bet for private-sector participants. However, in comparison with the first 20 years of its existence, the opportunities are the greatest that they have ever been and momentum is in the industry’s favor. Certain sectors of the market can be extremely lucrative. It appears that growth of the market will be steady, buoyed by the federal funding and increased interest on the part of automakers and fleet operators. Fundamentally, the market to relieve traffic congestion and improve safety remains sound.
It appears almost certain that the market will continue to consolidate and that market leadership will mean not only double-digit top-line growth but also improved cost structure.
Just how fast the ITS market will grow depends in large part on how systems like the Big Dig’s and others across the U.S. and the world perform and are deemed to have value by their customers and end users.
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