By Adam Hark
Preston Todd Advisors and MerchantPortfolios.com
Over the years, an interesting phenomenon related to payment processing portfolio valuations has arisen: the fair market value of a merchant portfolio has, more often than not, been equal to or greater than the fair market value of the payment processing company, or enterprise, itself. My proprietary database revealed that across a spectrum of ISOs with roughly 2,500 to 15,000 merchant identification numbers, approximately eight out of 10 portfolios displayed this characteristic from 2008 through 2015.
The notion that a merchant portfolio asset can be worth more than the entirety of the company that built it is counterintuitive. After all, it's human nature to intuit that a part of something cannot have a greater value than the whole. But when you take a closer look at the cost structure of a traditional ISO, the explanation for why this has proven to be true comes to light.
Traditional ISOs were designed to sell payment processing. The ability to process the transaction itself was the value proposition ISOs provided to merchants. Transaction processing was sold to merchants via 1099 agents, W-2 salespeople or a combination of both.
From a market valuation perspective, the costs associated with revenue derived from an ISO's merchant processing portfolio would be tied, in many instances, directly to the costs of the sales channel. This is because a portfolio acquisition typically contemplated carving out the processing portfolio and the sales channel assets only: the deal structure and valuation were based on a buyer being able to "pull" the portfolio and sales channel and "plug" them into its own ISO platform, leaving the selling ISO's remaining operational costs behind.
Thus, the valuation of the merchant portfolio asset often exceeded that of the entire ISO because ISO valuations, for their part, were based on a more traditional valuation methodology, whereby a company's valuation, or enterprise valuation, was based on a multiple of its earnings, before interest, taxes, depreciation, and amortization were calculated out.
Because enterprise valuations were based on a company's entire cost structure, which included all the general and administrative costs in addition to the sales channel expenses, the valuations often came in lower than the merchant portfolio itself. (The principle in play being that netting down a business' cash flows by all of its operational expenses further reduces its future cash flows and pushes the valuation downward.)
The basic ISO business model has changed. ISOs are no longer just in the payment processing business. They're in the technology business. ISOs provide value-added products and services that go well beyond payment processing. Integrated POS, end-to-end business management solutions, and new infrastructure schemes are part and parcel of today's ISO business model and the merchant portfolios included therein.
The sale, implementation and servicing of these new technologies doesn't come without a price. Whether an ISO elects to build, develop or acquire these new technologies, or leverage someone else's technology in some form of joint venture or strategic relationship, the ISO is necessarily accruing new costs, which have a direct impact on the ISO's portfolio valuation.
The merchant portfolios being built today are the products of the sale, installation and support of customizable, sophisticated technology platforms that provide operational efficiencies, robust reporting, and frictionless, multichannel consumer shopping experiences to businesses. Because of this, additional expenses are directly tied to the portfolio assets that didn't exist before.
A merchant portfolio and attendant sales channel can no longer be pulled as a stand-alone asset. Payment processing is only part of the value ISOs are selling to businesses. As such, all the costs associated with the technologies and transaction processing that ISOs are selling need to be factored into the projected future cash flows of the portfolio, in addition to the costs of the sales channel, which ties directly to valuation.
Thus, it is imperative that buyers model portfolio acquisitions as they would enterprise acquisitions; as the methodologies for portfolio and enterprise valuations become comparable, so do the valuations themselves. 
Adam T. Hark is co-founder of Preston Todd Advisors and MerchantPortfolios.com. With over a decade of experience in payments, payments technology, and fintech, Adam advises clients in mergers and acquisitions, growth strategy, exits, and business and portfolio valuations. He can be reached at adam.hark@prestontoddadvisors.com, adam@merchantportfolios.com or 617-340-8779.
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