How Debt Purchasing Companies are Being Valued in Today’s Market

There has been a lot of press in the past few years about M&A transactions involving debt purchasing companies. Since buyers – and owners of these companies for that matter – remain highly interested in exploring merger and acquisition discussions, many have questions about how buyers are determining fair market value. Although there are no absolutes, there are some generally accepted methodologies being employed in the valuation of debt purchasing companies.

While most buyers agree that contingency collection agencies should be valued as a multiple of adjusted or normalized EBITDA (The Earnings Before Interest, Taxes, Depreciation and Amortization amount adjusted for owner expenses that will not exist post-transaction), more and more buyers of debt purchasing companies are utilizing a different measurement in addition to a multiple of adjusted EBITDA to determine value. This other measurement determines the value of the purchased portfolios under management – what we refer to as the “base value” of the debt purchasing company – and then applies a premium, if warranted, to this base value that takes into account the existence of certain tangible and intangible factors, including:

• The existence of additional established and recurring revenue streams (e.g., contingency collections)
• The liquidation capability of the servicing platform or servicing strategy
• The company’s future growth potential
• The growth opportunities within the company’s market specializations
• Management’s pricing and sourcing expertise and existing business relationships

Buyers will calculate the base value by 1) applying a multiple to the average gross monthly cash flows generated during the most recent twelve month period; 2) calculating the net present value of the portfolio’s future expected cash flows under its existing liquidation strategy (also referred to as the discounted cash flow analysis); and, 3) assessing the resale value of the portfolio in the market.

The multiple applied in the first option typically falls between 18 and 22 depending on a variety of factors including the quality and status of the accounts within the portfolio, but we have seen it go as low as 12 and as high as 24 - 25 in rare situations. For the discounted cash flow analysis, buyers will typically project out four to five years worth of future cash flows, strip out all expenses that are not necessary for liquidating the portfolios, then apply an annual discount rate to the net cash flows that can range between 15 percent and 25 percent depending on how secured the cash flows are and the buyer’s investment criteria.