There has been a lot of press in the past few years about M&A transactions involving debt purchasing companies. Since buyers – and owners of these companies for that matter – remain highly interested in exploring merger and acquisition discussions, many have questions about how buyers are determining fair market value. Although there are no absolutes, there are some generally accepted methodologies being employed in the valuation of debt purchasing companies.
While most buyers agree that contingency collection agencies should be valued as a multiple of adjusted or normalized EBITDA (The Earnings Before Interest, Taxes, Depreciation and Amortization amount adjusted for owner expenses that will not exist post-transaction), more and more buyers of debt purchasing companies are utilizing a different measurement in addition to a multiple of adjusted EBITDA to determine value. This other measurement determines the value of the purchased portfolios under management – what we refer to as the “base value” of the debt purchasing company – and then applies a premium, if warranted, to this base value that takes into account the existence of certain tangible and intangible factors, including:
- The existence of additional established and recurring revenue streams (e.g., contingency collections)
- The liquidation capability of the servicing platform or servicing strategy
- The company’s future growth potential
- The growth opportunities within the company’s market specializations
- Management’s pricing and sourcing expertise and existing business relationships
Buyers will calculate the base value by 1) applying a multiple to the average gross monthly cash flows generated during the most recent twelve month period; 2) calculating the net present value of the portfolio’s future expected cash flows under its existing liquidation strategy (also referred to as the discounted cash flow analysis); and, 3) assessing the resale value of the portfolio in the market.
The multiple applied in the first option typically falls between 18 and 22 depending on a variety of factors including the quality and status of the accounts within the portfolio, but we have seen it go as low as 12 and as high as 24 – 25 in rare situations. For the discounted cash flow analysis, buyers will typically project out four to five years worth of future cash flows, strip out all expenses that are not necessary for liquidating the portfolios, then apply an annual discount rate to the net cash flows that can range between 15 percent and 25 percent depending on how secured the cash flows are and the buyer’s investment criteria.
The type of accounts under management and how they liquidate will determine which calculation will have the most impact in determining the base value.
Once the base value is derived, the buyer will determine if a premium is warranted, and if so, apply a multiple to this base value. In the current market, the multiple has ranged from 1.25 to 2; a multiple of 1.5 or higher, however, has been assessed for debt purchasing companies that have one or more of the following characteristics:
- A specialization within a niche market that is poised for substantial growth (e.g., healthcare and commercial)
- A superior liquidation strategy that provides a competitive advantage in the marketplace (e.g., intensive litigation strategy)
- A blue chip management team committed to remaining post-transaction that includes the individuals with the debt purchasing expertise and client relationships.
Certain buyers, including many private equity firms, are still basing the value of debt purchasing companies as ongoing concerns on a multiple of adjusted EBITDA, but other buyers are assessing the base value of the debt purchasing company and applying a premium to it. One measurement of value is not necessarily better or worse than the other. What counts in a competitive M&A market is whether the buyer and seller can mutually agree upon value and the best way to structure the transaction to satisfy both parties.
If you have specific interest in understanding how your debt purchasing firm may be valued in today’s market, please feel free to contact me directly.
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