Valuing a Collection Agency in a Hot M&A Market

September 1st, 2006

The M&A “perfect storm” of activity in 2006 has been driven by three converging forces: first, the economy is growing and debt levels are increasing; second, there are abundant sources of capital and cheap debt available to fund acquisitions; and third, there are too many financial and strategic buyers chasing too few deals. These forces have created a perfect opportunity for contingency collection agency owners with a compelling story to tell.

The announcements in 2006 by NCO Group (NASDAQ: NCOG), West Corporation (NASDAQ: WSTC), and Encore Capital Group (NASDAQ: ECPG) have prompted many agency owners to call me and ask: How much is my business worth in today’s market? It may be frustrating, but there is no quick answer to that question: typically – it depends on what you are selling. However, I want to share some of the general guidelines used when assessing a company’s value.

How to calculate Adjusted EBITDA?

Here are the fundamentals:
Buyers valuing a collection agency typically first determine the multiple applied to Adjusted EBITDA, which is Earnings Before Interest Expense, Taxes, Depreciation and Amortization. EBITDA is normally “adjusted” to reflect the removal of certain non-recurring income and expenses (e.g. sale of equipment, owner perks and benefits not existing post-transaction, moving expenses, certain consulting fees, etc.), changes in owner and personnel compensation, and any other business-related adjustments that both parties agree to during negotiations.

Buyers tend to focus on historical financial performance and generally evaluate the prior fiscal year, or trailing twelve month Adjusted EBITDA results, to determine fair market value. However, based on the motivation and synergistic fit between the buyer and a seller – as well as a competitive M&A market – a buyer may be willing to apply current year Adjusted EBITDA performance to calculate the purchase price.

I have provided a Fundamentals 101 calculation to illustrate the process of determining Adjusted EBITDA:

Adjusted EBITDA Calculation –
Contingency Collection Agency

Revenues (Net Fees) $5,000,000
Operating Expenses ($4,500,000)
Net Income $500,000
Interest Expense $25,000
Income Taxes $20,000
Depreciation & Amortization $25,000
Other Adjustments:
Excess Salary (Owner) $50,000
Perks (Owner) $15,000
One-Time Expense (Moving) $10,000
Adjusted EBITDA $645,000

What are buyers looking for?

Every buyer is different.
The multiple applied to Adjusted EBITDA is driven by the fit of the agency with the buyer, the current financial market, and the agency’s value drivers such as:

  1. Sustainable Earnings – Typically, well-run agencies produce at least a 15% to 20% EBITDA margin consistently, year-over year.
  2. Consistent Year Over Year Revenue (Net Fees) Growth – A trend of 20% to 25% historical annual growth with no “bumps in the road” is ideal.
  3. Seasoned Management Team – Essential to achieving maximum value – high tenure in industry and with current company, and led by a CEO with a vision of how best to grow the agency; well-versed in managing the operations, sales and marketing, technology and human resources aspects of the company; M&A and international experience are considered a plus.
  4. Clients Served – Existence of blue-chip clients with tenure and minimal revenue concentration – no one client generates 10% or more of annual revenues; if client concentration does exist – which is typical for agencies – it is better to have it with the more attractive, long-term clients
  5. Scalable Infrastructure With Minimal Capital Expenditures Required – Scalability of an existing facility and IT systems for new business and additional staff (collectors) is important.
  6. Growth Opportunities – Options that require minimal capital expenditures to implement are preferred (e.g. entering new markets, obtaining additional clients in existing markets, obtaining additional business from existing clients); however, well capitalized buyers may also see growth opportunities via add-on acquisitions.

What multiple typically applies to an agency
my size
?

Well, it depends…
Contingency agencies, meeting the criteria just described, are trading on a multiple between 4 to 6 times Adjusted EBITDA, a range that applies to agencies generating roughly $2 million to $20 million in revenue annually. Large agencies that are recognized by buyers as “platforms,” typically above $20 million in revenue, trade for as much as 8 times or more Adjusted EBITDA.

However, no rules of thumb exist and there are always exceptions to the multiple ranges applied to any size agency.

Where is the M&A market headed?

Multiples are peaking, but the market remains strong.
Financial and strategic buyers continue to aggressively seek acquisition opportunities in the ARM industry. Well-run, growing contingency agencies are generating the most interest and the highest values. We anticipate that non-industry buyers will continue to view the contingency collections arena as an attractive investment as long as debt levels rise, businesses outsource or sell receivables, and the lending markets remain favorable.

Now my question to you: Are you ready to sell?

It depends – maybe for the right price.

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