Outlook for M&A for Small and Mid-Sized Agencies
Despite the economic volatility, M&A activity is alive and well in the accounts receivable management (ARM) industry. A few weeks back, our M&A team hosted a teleseminar about current M&A and valuation trends in the ARM industry. We will be hosting these on a quarterly basis.
Michael Lamm covered how small- and mid-size collection agencies are being valued in today’s market and shared his predictions for the remainder of 2008. Here are some of his observations:
Small Collection Agencies – Up to $3M in annual net fees
- Multiples tend to peak at 4 to 5 times adjusted EBITDA. The value of smaller agencies is in this range because they have not reached economies of scale, rely on one individual who is typically the owner, and tend to have a localized client base. Buyers tend to focus on prior year financial performance as the agency most likely hasn’t created a budget or forecast for the current or future fiscal years.
- Deal Structure: We are seeing a combination of cash and structure, which could consist of an earn-out, retained equity, or a seller’s note. Because the owner is typically intimately involved in the business, his involvement post-transaction is usually critical to transition the personnel and clients.
- Buyers for these companies tend to be industry players, for example, a collection agency buying another agency as a geographic add-on to expand itsthe client base. We are also seeing agencies targeted by former owners and executives looking to re-enter the industry after a sale. Often these types of deals involve a seller who may want to retire or has fallen ill and needs to sell.
- Deals: Most of the deals occurring in this revenue range are not publicly announced, but Kaulkin Ginsberg identified 2 of the 9 deals in Q1 fell at or below $2M in revenue.
Mid-Size Collection Agencies – $2M - $20M in annual net fees
- Multiples between 4 to 6 times adjusted EBITDA, sometimes even higher depending upon the fit and terms.
- Deal structure: we are seeing 80% to 100% cash transactions, with the non-cash component in the form of an earn-out, retained equity, or a seller’s note.
- Buyers in this revenue range have been strategic and industry players. Some financial players (very small private equity firms or investment groups) are doing deals in these ranges, but they will likely need to see at least $2 million in adjusted EBITDA to get motivated.
- Deals: In this revenue range, we expect continued interest from private equity backed agencies looking to grow their platforms via acquisition in certain vertical markets to round out their client base and services.
In terms of recent deal activity, this revenue range continues to be very active for both strategic and industry players. We expect a significant amount of deal activity in this revenue range in 2008. In Q1 2008, 6 out of the 9 completed transactions fell into that range.
Predictions for Q2 – Q4 2008
- Kaulkin Ginsberg anticipates the ARM industry will produce well north of $1 billion in total value in 2008, and may exceed 2007’s deal value total depending on pending transactions in Europe.
- We expect the volume of activity to pick up by the second half, and the total for 2008 should exceed 2007’s results.
- The buyer pool will continue to include strategic and financial players seeking platforms. The largest number will represent sizable ARM industry companies, particularly those that are private equity backed, seeking strategic add-on opportunities in the mid-size revenue range that allow them to enter new geographic markets, expand their service offerings and/or increase their client base.
- We also predict that the strategic buyer pool will start to include Canadian and European ARM companies seeking platform acquisition opportunities within the U.S. market to leverage value from the differential in the currency exchange rates.
As always, we want to know what you think. Comments and questions are always welcome.
Mike's Take: The Challenge for Student Loan Collections: Thoughts from NCHELP
I’m fortunate to work with a team of advisors who are constantly participating in industry conferences and events – sharing their knowledge and keeping abreast of what’s going on across all sectors of the ARM industry.
Paul Legrady was at the National Council of Higher Education Loan Programs (NCHELP ) Debt Management Conference last week at Walt Disney World, and I asked him to relate his thoughts from the conference:
“As the credit crunch expands throughout the U.S. economy in the second quarter of 2008, no company that extends credit to consumers seems to be going unscathed. Some recent examples include Washington Mutual’s recapitalization in response to bad bets on loans to consumers, Health Management Associates’ disclosure that bad debt accounted for a whopping 24% of revenues, and the downgrading of GMAC’s bond ratings. And, that’s not even mentioning residential mortgages. And, we’re not even officially in a recession, at least not yet. For many credit issuers, it should get worse before it gets better.
“It was against this backdrop that roughly 300 experts in the field of student loan collections gathered in Walt Disney World last week. The NCHELP Debt Management Conference attracted leaders of the country’s guaranty agencies – organizations created by law to extend student loans and keep these loans from going into default – as well as the collection agencies that help them execute this increasingly challenging mission. The saccharin-sweet Disney staff constantly saying, “Have a Magical Day!” could not mask market conditions.
“At the conference, guaranty agency (GA) officials described troubling statistics affecting the market for student loans. For example, guaranty agencies track “re-delinquency” rates, which describe the percentage of their student loans that go into delinquency, come back out through default prevention techniques, and then go back into delinquency. One official described how this figure had increased recently from 50 to 65 percent. With NCHELP officials suggesting more change afoot on the legislative front with the upcoming reauthorization of the Higher Education Act, GAs are challenged on a number of fronts.
“Private student loans, once thought to be the free-market solution to a shortfall of federal education funding, are also taking a beating as the market for securitization of these loans has dried up. For example, shares of First Marblehead, a student loan provider, have dropped about 80% in the past 6 months as its insurance provider went into bankruptcy. One panelist forecaste “giant waves of reform” starting in Congress, reshaping the private student loan market in coming years.
"Like credit grantors in other industries, GAs have different strategies to avert default and collect on defaulted loans. Interestingly, Maine had the best performance on collections in the fourth quarter of 2007, and New Jersey ranked worst. What makes the difference? In part, at least, it’s due to collection agencies.
“While some GAs such as the state of Kentucky operate their own call centers quite successfully, and place no accounts with collection agencies, most of the successful GAs do use agencies. As any agency owner or executive would tell any prospective client, collection agencies that specialize in the recovery of delinquent debt tend to do better in this field than their clients. Don Taylor of Account Control Technology, an industry veteran, told a room full of GAs, “you have a lot to learn from your agencies.”
“For the most part, he is right. A good collection agency will not solve every credit-related problem faced by credit issuing companies. But, as the consumer credit crisis worsens, the credit issuers that can extract the most value from their networks of service providers will be the ones most capable of promoting shareholder value. This is true for collections in all market segments – not just student loans.”
Mike’s Take: Good News on M&A in the ARM Industry
It is no secret that the US economy is having a significant impact on mergers and acquisitions overall. But the ARM industry is showing remarkable signs of resilience. Let’s take a look:
Worldwide, M&A was beaten down considerably in the 1st quarter of 2008. In fact, it suffered the biggest quarterly decline in 6 years, falling nearly 25% compared to the 1st quarter of 2007. Much of this decline was due to particularly low M&A activity in the U.S., which was down more than 50% from Q1 2007. By comparison, Europe’s M&A activity was virtually the same as last year.
Private equity-sponsored M&A deals were off some 70% from Q1 2007 overall and over 85% in the U.S., its lowest mark since Q4 2003. Down stock prices are negatively impacting some corporate buyers’ ability to pay market prices for acquisitions. The Dow Jones is down 7.6% from where it started ’08, its worst quarter since the dot com bust. If stock prices continue to drop, more publicly-traded corporate buyers will be forced to lower valuations or risk transactions that are dilutive.
However, I am happy to report that M&A is alive and well in ARM. In fact, the first quarter produced the same number of M&A transactions that occurred in Q1 of 2007. Nine transactions were completed in Q1 2008, totaling $461M in deal value (of which $325M was generated by the NCO-OSI deal). The important note is that deals are still getting done despite the current economic conditions.
Several key points came out of this recent quarter’s M&A activity:
1. Buyers are continuing to secure debt financing for their transactions. Lenders are financing up to 4.5X the adjusted EBITDA value for top performing ARM servicers.
2. Buyers are successfully structuring deals with sellers to take into account any perceived risk in the transaction.
3. Sellers sustained their financial performance despite the economic conditions. While liquidation rates for some ARM servicers are still being impacted by the reduction in PIFs and SIFs, the successful ARM servicers quickly converted their collection strategies from large payments to recurring payment plans that debtors can afford. The low unemployment rate supports the notion that debtors can still make monthly payments; they just can’t tap their home equity lines to make larger payments.
4. Starting at the end of January, the positive effects of tax season kicked into gear and resolved some concerns that the ARM industry was being severely impacted by the economic conditions.
5. Credit issuers and debt buyers increased their outsourcing and debt sales volumes, and in some cases increased commission rates and incentive fees to motivate their top servicers.
6. And finally, while the public markets have been extremely volatile throughout the quarter, stocks have started to rebound recently enabling some strategic buyers to begin looking at deals again.
The ARM industry tends to be more recession proof than most industries, and while recoveries in some market segments may be off, placements mount during down times. Buyers continue to be attracted to the ARM industry because it still possesses the characteristics of an attractive investment. It is a sizeable and growing industry, still highly fragmented, naturally competitive and profitable. The bottom line is that we are not seeing any noticeable changes in the number of deals completed or in purchase price levels.
Mike’s Take: How are economic times affecting your ARM business?
You can’t pick up a newspaper these days without reading about the problems we’re experiencing in the U.S. economy. The ongoing effects of the sub-prime mortgage crisis, decreasing home sales and prices, the credit crunch, and a rising unemployment rate are all taking their toll on the economy in general and thus on credit and collections.
Even though by definition we are not officially in a recession, the reality is that many consumers have been behaving as if we were. The U.S. Labor Department this morning reported the unemployment rate for March rose to 5.1%, the highest level since September.
The raw numbers only paint part of the picture. An increasing number of people want full-time work but are only able to find part-time jobs. There is also an increase in the number of people who have stopped looking for work altogether because they have become discouraged by the weak market.
If a growing percentage of people are not working, or are only working part time, they will not be able to pay all of their bills on time and past due accounts receivable are piling up. At this stage, we are seeing that a majority of credit grantors are not yet changing their recovery strategies – taking a wait-and-see approach rather than implementing any abrupt changes. After all, this is not the first time that the US economy has moved toward recession.
As economic conditions are worsening, some credit grantors are starting to place or sell off more accounts, sometimes earlier in their receivable lifecycle, recognizing that as companies they are simply not equipped to manage collection efforts the way third-party experts in ARM can. Some ARM companies are already feeling the effects through increased placement volumes, larger portfolios for sale, and noticeably lower purchase prices.
We recognize this is only part of the story. In a down economy, account volumes tend to increase but recovery rates may go down. This depends in large part on the age of the receivable placed, the type of credit, the geographic location of the debtor and the sophistication of the collector.
One thing is certain. The impact is different from credit grantor to credit grantor, collection agency to collection agency and debt buyer to debt buyer. What affect is the economy having on your ARM business? Do tell. We all want to hear from all of you. (If you don’t want to respond to this blog I understand. Just contact me directly at 301-907-0840).
Fooling Around with Fees
There are bad apples in every industry. The collection industry is certainly not immune to schemes such as this one, where unscrupulous individuals prey on vulnerable small businesses that are seeking to recover past due accounts at potentially attractive rates. The rates don’t matter to the dishonest collectors, because they never intend to remit back to the client anyway.
If you’re a credit grantor, you’re probably thinking this can’t happen to you. Many credit card issuers have developed a bullet-proof on-boarding process for collection vendors, believing that prevents unscrupulous agencies from getting in. The reality is that creditors can be their own worst offender when it comes to letting the “bad guys” in through the back door – by cutting rates down so low that it is impossible for reputable agencies to generate enough revenues and profits to properly capitalize their business and maximize recoveries for their clients.
What do you think is the number one concern among senior executives who are in charge of recoveries for their company? If your answer is maximizing net-back performance you’re dead wrong. The number one concern among recover managers is waking up one morning and finding their company on the front page of USA Today because of extreme cases like the one above – or more commonly, from aggressive collection tactics that violate FDCPA. Front line news about their collection vendors may cost a recovery executive his or her job. That is a risk they simply can’t take.
In short, you get what you pay for. If the creditor works with their collection agencies to keep fee rates at appropriate levels, the agency can generate profits without sacrificing performance, and everyone wins. The client will maximize recoveries while staying out of the headlines. The agency will grow a profitable and sustainable business. We just might keep the bad guys out of the industry once and for all.
Is the FTC Acting More Fairly Toward Collectors?
For those of us who have been in the ARM industry for a while, it does not seem imaginable, but it happened twice in the past week; the FTC acted favorably toward bill collectors.
Yesterday, insideARM Editor Patrick Lunsford reported that the FTC quickly ruled that it is not a violation of the FDCPA for mortgage collectors, in their initial consumer communication, to inform a debtor of settlement options that could prevent foreclosure (See the actual letter at http://www.ftc.gov/os/2008/03/P084801fdcpa.pdf).
This is big. The FTC is rarely quick to react to anything – especially in favor of bill collectors. In this particular case, the FTC not only moved quickly but also acted in a way that is a win-win for collectors and debtors alike. Wow! Kudos to Babara Sinsley and Manny Newburger for taking a stand against the FTC and, as a result, eliminating one circumstance where consumer lawyers file frivolous lawsuits against agencies.
While I am on the topic of the FTC, you may not be aware that they filed their annual report to Congress on the FDCPA last week. I realize that most bill collectors are not jumping up and down for joy at this news, as the report is notorious for pointing out the rise in the number of consumer complaints against collection agencies. Maybe you will get excited though, when you learn that, for the first time, the FTC actually provided context for understanding the nature of its data. Did you ever try to sift through the FTC’s annual report on FDCPA? Providing context is not a small accomplishment.
The report also noted that complaints against collectors do not mean that laws were actually violated or that the complaints were even valid. It is about time! The ACA has been fighting this fight on behalf of the collection industry for quite some time. Kudos to Rozanne Anderson, the ACA’s executive vice president and general counsel, and to the ACA for their efforts on this front.
Now that NCO Acquired OSI, Who’s Next?
For anyone who has followed NCO over the past 15 years, it comes as no surprise that they were able to close and fund the OSI acquisition. I can’t recall a transaction that Mike Barrist and his team announced that they were not able to close and fund. Since then, I’ve been asked the same two questions repeatedly: “Are deals still getting done in the ARM industry?” and “Who’s next”?
M&A transactions continue to get done in the ARM industry in spite of the tough lending environment. While cheap debt is harder to come by, it is the billion dollar plus leverage buy-out transactions that are consistently falling apart, not the deals in the lower to middle-market range (Less than $250 million in value). Let me remind everyone that the vast majority of ARM transactions fall into this lower to middle range of the market.
Yes, some transactions are being priced lower or structured differently so the risk is shared between the buyer and the seller. Reductions in purchase price or changes in deal terms are occurring for two primary reasons. Either the seller experienced a major performance change, such as a loss of a major client that forced the buyer to reconsider their initial proposal, or the buyer is not able to secure financing from its lenders. If the buyer is a public company, their stock price may have slipped to a point where the price is no longer accretive.
I believe the majority of ARM M&A transactions over the next 12-24 months will involve sellers that fall into one of the following categories:
Large Independents – We define a large independent as a company that is at the top of its particular market segment and is not a division of a larger company or majority owned by a private equity firm. By definition, large independents are specialists and not generalists. They are relatively large by ARM standards, generating revenues of $20 million or more a year. Private equity firms and corporate buyers from outside the industry are still attracted to these players because they are profitable, have significant growth potential, and typically employ a strong executive team that can lead the company post sale. Due to the limited number of these opportunities, coupled with certain competitive advantages that they enjoy as successful market leaders, we anticipate these companies to continue to generate substantial buyer attention, resulting in premium values in today’s marketplace.
Healthcare ARM – This sector has already generated a relatively large number of M&A transactions involving small to mid-size healthcare ARM companies, and we expect this trend to continue as buyers in this market segment seek to expand their footprint geographically.
Debt Buyers – A consolidation is inevitable in the U.S. debt purchase industry and this will drive a considerable amount of M&A activity over the next 12-24 months. The time for the debt buying industry to consolidate is now. Let’s face facts. Some debt buyers purchased portfolios over the past few years at high prices and now they are struggling to generate expected returns. They can only stretch out their curves so far before they are forced to sell. A larger, well funded debt buyer is a logical acquirer of these businesses.
Also, large credit card issuers still control over 80% of debt sold in the market. These issuers want to work with large, well capitalized and reputable debt buyers. They are willing to sacrifice on price if they feel the debt buyer is able to protect their image in the market. Issuers will force a consolidation through their actions -- selling their debt to established buyers that demonstrate rock-solid credentials.
So what are you seeing in the world of mergers and acquisitions in the ARM industry? Do tell.
What’s In Store for Commercial Collections? Thoughts from the IACC Conference
In late January, we let Associate Michael Lamm escape a Northeast snow storm to attend the 37th annual International Association of Commercial Collectors (IACC) conference in Ft. Lauderdale, Fla,
He was able to catch up with many owners of commercial agencies and law firms to learn how the economy and market conditions were impacting their businesses. Most were in good sprits, seeing increased placement volumes with little impact to overall liquidation results. Michael was surprised (and happy) to hear that liquidation rates have been minimally impacted by the ongoing economic turbulence.
After the show, Michael had some predictions for what lies ahead for the commercial collections market:
- Placement volumes are expected to continue to increase throughout the year as more companies seek to reduce financial stress by outsourcing collections.
- Commercial creditors will seek to offset expected increased bad debt expense by outsourcing the collection of their delinquent commercial accounts earlier in the recovery cycle.
- Recovery rates are expected to decline at some point during the year as recessionary conditions and tight lending markets force more companies to seek Ch. 11 protection or liquidate altogether; however, this effect should be offset by the increase in placement volumes.
- M&A activity is expected to continue as buyers seek to establish platforms in the commercial market to take advantage of cross sell and growth opportunities. Since very few sizeable platform acquisition targets exist, prices will remain at desirable levels for sellers.
- Strategic buyers including the commercial trade re-insurance companies will continue to pursue acquisitions.
- Commercial debt buyers will garner significant attention, provided that they have a true niche specialization, a strong flow of new purchase opportunities and an effective debt liquidation capability.
What are you seeing in commercial collections? We’d like to know how you are fairing in the market and what opportunities you are seeing. Feel free to contact Michael Lamm by email or call 240-499-3808. Or, weigh in with your comments to this blog below.
Is Your Firm an All-Star Performer? Strong Fundamentals Drive its Market Value
Like some of you, I curled up on my comfortable chair this past weekend and watched the best that the NBA had to offer. Every player on the court during Sunday night’s All-Star Game worked extremely hard to advance to the top of their profession. Yes, all of these players are gifted athletes who can do amazing things with a basketball. Some are blessed with the height gene. Others like Chris Paul practiced countless hours to master the fundamentals of their trade and positioned themselves to be ready when their time came.
If you're a business owner, is your firm an "all-star?" Are you going to be positioned to achieve the maximize price when it comes time for you to sell? Like the stars of the NBA, strong fundamentals and preparation will drive business value. Here are the star qualities that buyers look for:
Positive top line and bottom line trends
Buyers place a higher value on companies that demonstrate a consistent track record of annual revenue and net income growth. Twenty percent growth is optimal.
Sustainable levels of profitability
An average efficiently-run ARM business should be able to demonstrate a sustainable bottom-line operating income of at least 20% of revenue. Of course most privately held businesses will have to “normalize” their bottom line to account for any one-time and extraordinary operating expenses.
Diversified client base
Ideally, buyers prefer to acquire businesses with a diverse client base, so no client makes up more than 15 percent to 20 percent of revenues. Too much concentration in too few clients is generally perceived negatively. Of course exceptions exist, including the US Department of Education, some large issuers, and state government contracts. Knowledgeable buyers understand that higher levels of concentration risk could exist in certain market segments, but this risk could be reduced due to segmentation.
Management strength
Buyers seek comfort that after the owner cashes out, qualified senior-level management is in place to run the business and service the clients. An experienced buyer will try to incorporate more structure to a deal if they perceive that the owner is integral to the business.
A financial house that is in order
Reviewed or audited financial statements by a reputable CPA firm give a buyer a great deal of comfort in the financial integrity of the selling business. Also, prepare a current year budget and 2-3 year projection (no hockey sticks!) with a solid growth plan that management supports.
All of us can shoot a basketball, but it takes skill and dedication to make it to the NBA All-Star Game. As a business owner, with preparation and commitment, you can reach the top of your game when it comes time to for you to sell.
Thoughts from the DBA: The Game Plan is Changing
The theme for this year's DBA International conference was the "World Championship of Debt Buying" and the agenda was full of great baseball analogies. As for me, I missed the conference for the first time this year. I was on the "Disabled List" with a bad back and ended up spending the time in my office with a heating pad.
Luckily, several directors of our advisory team were at the show to pinch hit for me. Which is good, because all kidding aside, it is a very pivotal year for the industry. I asked Paul Legrady to share his observations from the event:
"The Debt Buyers Association returned to Las Vegas again this year, albeit as a different industry. Debt buyers, contingency agencies, vendors, and credit issuers all seemed to agree that the frothy debt buying market of past years had given way to a more moderate environment for buying and selling debt. This recent change in the market is affecting companies throughout our industry.
"First and foremost, credit issuers are selling more debt and receiving lower prices for these portfolios. We heard of pricing degradation of 20 to 40 percent year over year, depending on the type of portfolio being sold, from a number of credit issuers. While prices were at historical highs in 2006 and early 2007, these recent pricing changes are remarkable -- a sign of a restraint in bidding on the part of buyers, and of fewer expected recoveries based on changing economic conditions.
"We heard that pricing reductions in the secondary market are even greater. Of course, when debt buyers are unable to "buy and flip" portfolios, the prices they can pay for original debt purchases must decline. With a few exceptions, we see this ripple effect taking place throughout the market, and many companies are seeing their revenues and profits decline as a result.
"As the debt buying market changes, cash is king. Debt buyers that can take down portfolios can find bargains at today's prices. If these companies bid intelligently on these portfolios and utilize a tested liquidation strategy, these companies will turn a profit over time, as successful debt buyers have done since Bud Reitzel began buying loans from small banks in Michigan in the 1960's.
"The heady days of 3 times purchase price in 3 years are past. The rising tide in this market is no longer lifting all boats. More moderate days of 20 percent internal rates of return (IRR) are here, at least for the foreseeable future. Profits in this market will, more and more, be reserved for the smart."
Did you come to the same conclusions as Paul? What was your take-away from the conference? Was Johnny Bench entertaining? Do tell!
