The Green Sheet Online Edition
January 25, 2016 • Issue 16:01:02
The M&A market 2016: 10 things to know to best position your business
As the payments industry looks ahead in 2016, there is much to be optimistic about on the mergers and acquisitions front. 2015 was a banner year for buyers and sellers, with deals continuing right through the December holidays and into this January.
The turning of the year is always a particularly active time for mergers and acquisitions, as many owners set out to chart the future course of their businesses. The basic questions asked by many owners at this time are whether or not to exit, or how to best invest in growth. To fully address these questions requires an understanding of the current market conditions, ongoing trends, and the consequences of future events that may impact a payment company's ability to transact in 2016.
Takeaways from 2015
Following are three major takeaways regarding last year's valuations, buyers and sellers:
- Valuations: 2015 exhibited a divergence in valuations between high-quality payment properties and poorly performing ones. Fetching record valuations were ISOs with quality distribution (writing large numbers of high-quality accounts with highly trained sales staff and/or referral/affiliate channels), technology, niche vertical penetration, and exceptionally low attrition. Other ISOs that benefited from record high valuations were full liability First Data and TSYS shops, for which the market continues to sustain a high level of demand. Conversely, the valuations for ISOs and portfolios with lackluster production, no technology and no vertical specificity saw valuations slide.
- Buyers: 2015 exemplified why M&A activity in payments has become so active, as the continued conflation of payments and software-as-a-service–based solutions has drawn in non-payments industry buyers who recognize the value of payment processors' books of business. Many of the new buyers are technology companies looking to benefit from cross-sell opportunities afforded by ISOs' merchant bases. These companies are well funded, and when they find the right book of business, they will pay premium valuations.
- Sellers: It has never been more important for sellers to find the buyer best suited to acquire their businesses. 2015 proved that sellers who didn't properly market their property for sale, and consequently wound up selling to a friend, a friend of a friend or someone referred by their ISO relationship officer, left money on the table. With all the new types of buyers out there, it is critical today for sellers to find ways to market their properties to companies other than large merchant acquirers.
Things to watch in 2016
Following are three things to keep an eye on in 2016:
- Interest rates: 2015 brought us the first interest rate hike since 2008, albeit a miniscule .25 percent. Nonetheless, the Fed articulated a course of incremental rate hikes moving forward, which one can only assume means more to come in 2016. Both buyers and sellers need to be aware of these rate increases, because higher costs of capital lower valuations. This shouldn't instill fear in business owners who have already made the decision to sell their properties in 2016. However, it must be considered in any decision to sell in the future, whether 2017 or beyond, as the trend will continue.
- EMV conversion percentage: 2015 brought us the much-touted Europay, MasterCard and Visa (EMV) deadline. It came and went, and only now are we beginning to see the consequences of EMV compliance trickle into the M&A market with measurable effect. Deals that went under agreement or were on track to close toward the end of 2015 were the first transactions for which buyers formally implemented EMV assessment into their due diligence. As the race to EMV has officially started, buyers must be aware of this key metric, as a low conversion percentage reflects questionable operational sense, and it injects risk into the transaction resulting from increased exposure to losses from competitors using EMV as a "break-in" issue to sell their processing services.
- Bad buyers: A final admonition for 2016 is to beware of "false" buyers. As 2015 showed, the payments space is bringing a whole suite of new buyers; it is also attracting bad ones. False buyers present very well. They are polished, have good background stories and dazzle sellers with big valuations, but they can't execute. Be circumspect with who you deal with in 2016, and make sure you have the resources available to suss out buyers, whether through your adviser or network of trusted industry professionals.
10 ways to best position your business in 2016
Following are 10 pointers for business growth in the coming year:
- Grow, grow, and grow. Don't ever take your foot off the gas. Whether you are selling your business this year, in five years or in ten years, the most highly weighted driver of valuation in any business, payments technology or otherwise, is growth. Always chart you growth, and make sure you keep it on a steady, upward trajectory.
- Write quality, not quantity. Through the eyes of a buyer, when assessing your growth and new business potential, the preference is quality over quantity of accounts. Don't pat yourself on the back when in one month you sign 10 small businesses that, collectively, process less than $50,000. Sign up one account that processes $100,000 that you sold through your expertise and technology offering, and that will not leave you in three months.
- Assess you sales channel. Independent sales (Form 1099) channels are difficult to manage and inject significant risk into a potential transaction. Endeavor to figure out a practical, cost-effective way to assemble a direct sales channel you can manage internally. Direct channels command higher valuations, and agent referral channels even more. Find me an ISO where the majority of new business comes in from an agent bank channel, and I'll find you a buyer who will pay top dollar for your property.
- Find a hook. Every owner/operator in the payment processing space should have a hook: a specialty that allows them to successfully sell into niche market verticals. If your target merchant account is generic small to midsize enterprises, you will not get as high a valuation on your ISO or portfolio as your peers who have niche vertical penetration.
- Monitor your portfolio. Understand how your portfolio performs over time. It's the only way you can change the way you operate to address deficiencies in your portfolio and business. Don't wait until you decide to sell to take your first glance at your portfolio's attrition rate or revenue concentration. Fix and maintain these attributes now so when you decide to go to market, your portfolio or ISO will benchmark well against the top properties out there.
- Go EMV. Get it done. Owners who don't have the majority of their merchants switched over in 2016 will get penalized for it in a transaction.
- Go OptBlue. Again, get it done. Buyers will look at the EMV and OptBlue conversion rates as a measure of how well a particular ISO manages its business.
- Know your contract. Renegotiate your contract. I can't stress this enough. Some basic contractual provisions in every ISO agreement will affect the valuation given to a particular property in a transaction, and sometimes, determine whether a transaction can be consummated at all. Have a consultant or an attorney review your agreement for you so you can renegotiate any provisions that may be problematic down the road.
- Keep your eye on charge volume. Sellers should be aware that when buyers are evaluating portfolio attrition (a top driver of valuation), many will weigh the charge volume attrition more than revenue attrition. This is because today, fee revenue and pricing fluctuations constantly muddy the revenue number. Because the charge volume number is less susceptible to financial engineering, it is a better metric for gauging a portfolio's true performance. So when tracking your portfolio's attrition, pay closer attention to the volume.
- Have a plan. Have a plan to exit. Have a plan to grow organically. Have a plan to grow through acquisition. Regardless of which, have a well thought out plan to accomplish your strategic objectives. It's a great time of year to lay out your annual goals. Owner/operators who do this will always do better than those who don't. And if you need help, feel free to shoot me a call.
Adam Hark is co-founder of MerchantPortfolios.com, a dba of Preston Todd Advisors Inc. With over a decade of experience in the payments industry, Adam specializes in mergers and acquisitions, growth and exit strategies, and asset and enterprise valuation for payment processing and payment technology companies. He can be reached at firstname.lastname@example.org or 617-340-8779.
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