By Daniel Federgreen
Analyst
A primary issue that must be addressed when acquiring a portfolio of merchant service accounts is merchant retention. Valuation of an acquisition target clearly is driven by the "quality" of the accounts contained in the portfolio. And by quality, many experts mean the likelihood of retention. On average, approximately 50 percent of merchants obtained during an acquisition remain with the new acquirer after one year.
In addition to standard issues, such as the type of accounts within a given portfolio, purchasers must consider what factors will influence a merchant's willingness to remain in a portfolio during and after it is acquired. These include resolution of consumer complaints, pricing, reaction to merchant needs, product offerings, transparency of statements, complexity of conversion and "local" touch.
An area that has not been specifically addressed in the electronic transaction literature - and that the author believes can add significantly to the long-term success and valuation of an acquisition - is the successful integration of the various business operating units of the acquired and acquiring entities.
Hidden value can be won or lost, depending on the success or failure of integration. And if you realize that ease of integration is the key factor in retaining merchant accounts, you can exercise control to avoid disruption and make the transition smooth.
The principal mission of every merger and acquisition integration is orderly control of the process to guide it toward success. Neglecting to control the process may lead to failure or worse - an ongoing, expensive failure. Parameters and milestones must be understood and agreed to before the acquisition is completed.
Indeed, the cost of the target must include the cost of its integration. Therefore, from a modeling view, the cost of integration management and guidance must be added to the overall cost of the project. It should be calculated as the monthly imposed management burn rate multiplied by the time, in months, to full integration.
An additional factor of cost acceleration should be added to the equation in recognition of the fact that the total value of the target will be reduced through the inevitable consequence of merchant attrition.
Bain & Co.'s merger and acquisition group, led by Ted Rouse, conducted research on more than 24,000 integration transactions during a 10-year period from 1996 to 2006. They developed a list of 10 key actions required to create the highest rate of success. These are:
Of equal interest is an article written by Gerri Knilans for the winter 2009 issue of Employment Relations Today, in which she identified seven key levers associated with a positive merger outcome. These levers are:
Going hand-in-hand with the key integration levers are the three components of a successful integration: processes, tools and measurement.
How does all of this affect a deal between an acquirer and seller of a small or midsize portfolio? In far too many cases, deals are struck without adequate forethought about the post-purchase integration process. Many deals in the small ISO marketplace are based upon the judgment of individuals who have little or no prior experience with mergers and acquisitions. This means no expert hand is brought to the table.
Existing third-party firms within the electronic payments space can represent the multiple sides of an ISO portfolio acquisition, but they tend to act more as brokers than as integrators.
Once the deal has been consummated, the real work of bringing the portfolios into alignment is left to individuals with, in many cases, minimal experience and inadequate skill sets. Valuation of portfolios is therefore market-driven as a multiple of some x net value. This is a far cry from a reasoned approach to the true cost of integration.
For example, in the current environment, the multiplier value is driven almost solely by the feeding frenzy of purchasers, rather than the true cost of integration. Success or failure is defined by the retention percentage, which is almost entirely based upon antecedent predictors, rather than the subtle endpoint of integration cost and success. The missing variable in the analysis may be the previous success rate of the portfolio's acquirer in similar activities, as stated by Rouse and Knilans.
It is highly unusual to find within the merchant services literature a discussion about how to successfully integrate a target acquisition into a purchasing entity.
The retention percentage of acquired merchants can be positively affected by the correct plan of action; therefore, what might appear to be a "dog" in terms of a traditional evaluation may turn out to be a performance star if a managed approach to integration is employed. I believe strongly that proper team integration, and the positive role it can play in merchant retention, cannot be underestimated when considering an acquisition's value. As Ralph Waldo Emerson said, "Commerce is a game of skill which everyone cannot play and few can play well."
(I wish to thank Ross Federgreen of CSRSI for his guidance and critical review of this article.)
Daniel Federgreen can be reached at exvala@gmail.com. He currently is employed in the corporate financial group of a Fortune 500 company.
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