Would the Real Unemployment Rate Please Stand Up
I love how the government and media quietly announced the unemployment statistics for August last Friday as many of us were either out of the office or rushing to get an early start to the Labor Day weekend.
I enjoyed even more the subtle way in which the news acknowledged the fact that the unemployment rate jumped to 9.7 percent, only 30 days after we had heard that it had declined in July to 9.4 percent from 9.5 percent in June, a trend which was heralded as evidence that the U.S. had reached or was near the bottom of this recession. Of course we learned last Friday that the unemployment figures for July were “upwardly revised” and as a result we didn’t experience a decline in the first place, a side effect of what I term “premature calculation”!
We also were told that the unemployment increase in August was “less bad” because the rise was less than what the economic analysts had originally forecasted. Tell that to the 216,000 workers who lost their jobs and the thousands of businesses impacted as a result.
So, the question I’ve been asked to address is which unemployment rate is the most relevant to the ARM industry. My answer: the one that represents the biggest impact to an ARM company’s liquidation performance.
After reviewing the various unemployment calculations maintained by the Bureau of Labor Statistics, I have come to the conclusion that the U6 calculation (Unemployed, discouraged and underemployed workers) is the most relevant, which increased 0.5 percentage points in August to a whopping 16.8 percent, representing a total of roughly 20 million people in the U.S. And remember, this is “less bad”. I like that the U6 number includes underemployed workers, because these are people that have jobs but aren't making as much money as they are accustomed; they have been forced into part time work. This can impact payments to ARM companies.
So, what should ARM companies do with this information? Our recommendation is that executives of ARM companies, particularly consumer focused ARM companies, keep track of the unemployment rate because it can help them assess future changes in liquidation performance. If the unemployment rate is rising chances are that the future liquidation performance may decline.
Whether you believe the unemployment rate is 9.7 percent, 16.8 percent or something else the important thing to know is how it is changing over time. Feel free to give us a call and we will keep you apprised of changes in the unemployment rate and other key economic and market statistics that we believe are most relevant to the ARM industry.
Mark Russell manages M&A transactions for Kaulkin Ginsberg. To confidentially discuss your business interests, please contact Mark Russell at 240-499-3804, or by email.
Creative Financing for Debt Buyers
I just returned from the DBA Executive Retreat, where I participated in a panel discussion regarding creative ways in which debt purchasing companies can access debt and equity financing to purchase portfolios. Here are some common themes that were discussed regarding the best types of financing and how to go about accessing it:
Financing options are not the same for everyone – Small and/or first time debt buyers do not have the same accessibility to debt and equity financing as more established/larger debt buyers. However with the right business plan and purchasing opportunities, money is still available. Small and first time debt buyers should focus on family, friends and other high net worth individuals within their business networks for equity financing, and also leverage their local and regional banking relationships for debt financing. However, when raising equity capital from individuals, debt buyers will want to make sure that they are doing so in compliance with securities regulations.
In addition, certain small and large hedge funds may also be willing to finance a majority of the purchase price (up to 80-90%) if the debt buyer can finance the rest. Larger, more established debt buyers may have existing bank lines and equity relationships that they can tap into for future portfolio acquisitions or leverage their historical purchasing performance to secure new debt and equity financiers. Senior debt lines are much harder to come by in today’s market even for the largest and most successful debt buyers, but mezzanine lenders, hedge funds and special situation funds could be viable alternatives (albeit more expensive options).
Most financiers will want to crawl before they walk – For new financing relationships, most debt and equity providers will want to test the relationship first with a few purchases before offering a line of credit or equity for the business. Debt buyers will need to get the financiers comfortable not only with the purchasing methodology and sourcing capabilities (strong preference made toward direct access) but also their analytics and underwriting procedures, all of which will need to be maintained in written form for the financiers to review. Once financiers become comfortable, the debt buyers will likely not have to provide them with as much due diligence information.
Debt buyers need to create a business plan – Particularly when seeking equity capital, debt buyers will be required to create a business plan that details the company’s history and performance to date, the background and expertise of the management team members, the core competencies and key investment considerations of the company, and management’s expectations of the company’s future financial performance in the form of a three to five year financial projection with detailed assumptions. The business plan should show investors how the debt buyers are leveraging their previous experience to build a growing and financially rewarding platform going forward.
Some non-traditional financing alternatives – Larger debt buyers, international lenders and other accounts receivable management companies (e.g. collection agencies, debt collection law firms, etc.) were also discussed as viable sources of financing particularly for portfolios that they have experience purchasing/collecting. As prices have declined over the past 18 months more of these types of players have expressed interest in purchasing debt in the U.S. International lenders are particularly attractive particularly those in Europe due to the exchange rate benefits. However, they are difficult to access and require U.S. debt buyers to travel to see them.
Overall, the lending and equity markets are still accessible but require debt buyers to work harder to obtain financing than three years ago. However, debt buyers with proven management teams, defensible business plans and attractive purchasing opportunities should be able to source the financing they need in today’s market.
Mark Russell manages M&A transactions for Kaulkin Ginsberg. To confidentially discuss your business interests, please contact Mark Russell at 240-499-3804, or by email.
Follow Mark Russell on Twitter at DBA Retreat
Mark Russell, Director at ARM advisory firm Kaulkin Ginsberg, is at DBA International’s Executive Retreat this week in Napa Valley, Calif. He will be providing updates from the meeting via Twitter.
You can follow Mark directly from his Twitter feed (http://twitter.com/mrussellkgc) or check back here for live updates as prominent members of the debt buying community discuss matters of critical importance to their industry.
Q1 2009 Credit Card Sector Performance
Two weeks ago I discussed in detail the credit card sector’s liquidation performance and portfolio pricing ranges in the first quarter of 2009 during KGC’s Executive Conference Call.
In Q1 2009 the credit card sector experienced a liquidation decline between 25% and 50% compared with Q1 2008 results, with the earlier stage paper (fresh and prime) generating greater liquidation declines (30% to 50%) than later stage paper (tert and quads), and smaller balance accounts producing lower liquidation declines (15% to 25%) than larger balance accounts. Collection agencies and debt buyers confirmed that fresh portfolios experienced the largest declines in liquidation performance, and felt that this trend was occurring because credit issuers were generating better liquidation results at the pre charge-off stage due to better internal collection strategies and a higher level of first party outsourcing.
Debt portfolio prices also continued to drop as a result of the liquidation declines coupled with increases in unemployment and continued uncertainty surrounding the economy and market conditions. In Q1 2009, portfolio prices declined between 20% and 50% over the past year, with the most significant declines occurring at the fresh and prime stages of delinquency.
Debt buyers speculate that fresh portfolio liquidations dropped due to credit issuers improving their liquidation performance pre charge-off by outsourcing the portfolios to collection agencies on a first party basis and/or upgrading their internal collections operations. While the decreasing pricing trend has caused a reduction in debt purchasing activity, it has also led to a change in the debt purchasing process. Instead of portfolios typically trading via a public auction process, several credit issuers are focusing more on private transactions, and some are starting to consider structured deals with debt buyers whereby the buyer and seller agree to an upfront cash component along with a fee sharing arrangement based on future liquidation performance. I believe private transactions and structured deals will become more common in the debt purchasing sector throughout the rest of 2009.
I expect liquidation performance to continue to decline throughout ’09 as compared to ’08 due to ongoing increases in the unemployment rate and concerns regarding the economy, which will also continue to apply downward pressure on pricing with fresh portfolio prices most likely bottoming out in the $.04 to $.06 range.
How does this feedback compare to your performance in the credit card sector? Please let us know!
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Industry M&A Deals in 2009; Fasten Your Seat Belts!
2008 ended with a bang when Audax Group, a private equity firm, announced its recapitalization of United Recovery Systems, a market leader within the third party bankcard/credit card receivables management industry.
This deal bucked a couple of the M&A developments that had been unfolding in the second half of ’08 – reduced activity from private equity sponsors due to an inability to access debt financing for transactions, and reduced activity from other buyers because of uncertainty surrounding future liquidation performance within the receivables management consumer markets.
The URS transaction has raised a number of questions from company owners who are wondering what’s in store for M&A in the ARM industry in 2009. While more details will be provided in our Executive Conference Call on January 21st (click here for further details), here are a few predictions to set the stage for our upcoming discussion:
Greater deal volume, less total deal value in 2009 vs. 2008 – 2008 produced just over $2 billion in total deal value from 36 transactions, but over 80% of the deal value was generated by only 5 of the transactions, three of which were private-equity sponsored deals. In 2009, we do not anticipate as many large, private-equity sponsored transactions but we do expect more than 36 completed transactions -- mainly because industry buyers are stepping in to fill the void made by private equity and strategic buyers, many of whom are currently sitting on the sidelines to see how the market and economic conditions play out before pursuing acquisition opportunities.
Acquisition multiples will be down slightly from the peak value ranges – We started to see the range of acquisition multiples drop slightly in the second half of ’08 and believe this trend will continue throughout 2009. In Q3 2008, acquisition multiples for large platform companies (those that attract private equity and strategic buyer interest) fell slightly from 6 to 8 times normalized EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) to 5 to 7 times normalized EBITDA depending upon the deal’s structure and terms. This drop was primarily driven by reduced access/increased cost of debt financing and concerns surrounding future account liquidation and financial performance in 2009 and 2010. As we saw with the URS transaction, platform acquisitions are still getting done but they are experiencing greater financing challenges. Add-on acquisitions have basically retained their acquisition multiple ranges – 3 to 6 times normalized EBITDA, depending on the company’s size and the attractiveness of the company’s growth trends, profitability, operational and technological platform, and client base.
Cash will be king – There are still buyers with access to cash and a willingness to purchase companies with all or a vast majority of cash at closing. Sellers should be willing to consider some deal structure (use of earn outs, seller notes, retained equity, etc.), particularly if part of the deal value is predicated on achieving future performance, or be willing to accept a slightly lower valuation in exchange for an all-cash or predominantly cash deal structure.
Turn around and distressed opportunities will increase – This is a very typical theme as we head into the deepening part of a recession; the percent of turn around and distressed M&A opportunities will increase as a result of bad timing on previous investments into growth initiatives, loss of client business, and/or simply bad luck. While there are several buyers who will express an interest in purchasing distressed companies, make sure that you choose one who understands the inherent value within the client base and infrastructure in order to maximize your value potential.
There is no doubt that 2009 will be filled with uncertainty and change, but these conditions produce great business opportunities for those buyers with smart and patient capital, and for those sellers who are either willing to share the risk in exchange for higher rewards down the road, or take a slight reduction in valuation up front in exchange for all or a vast majority of the value paid in cash at closing.
We will continue to keep you updated on the evolving economic and market conditions, and how they impact M&A activity. We also look forward to sharing more M&A and other industry related information with you during our Conference Call on the 21st.
