2007 M&A in the ARM Industry Still Active But Market Turn May Be Ahead

January 16th, 2008

Merger and acquisition activity remained high in the accounts receivable management industry (ARM) in 2007, but economic forces and market conditions may slow down activity in 2008.

We calculate the total deal value in 2007 at $1.65 billion from 48 completed transactions. The year was characterized by fewer transactions involving comparatively larger deal values, bringing total value on par with prior years. In 2006 there were 72 deals at $3.10 billion in total deal value, but this was largely due to three private equity-led transactions which represented roughly two-thirds of the total value for the year.*

Deal Volume vs. Deal Value

Significant announced deals of 2007 include:

  1. The purchase of 37 percent of the equity of Sherman Financial Corp. by its management team for $518.8 million.
  2. West Corporation’s purchase of one of the largest privately-owned ARM firms, Omnium Worldwide, for $150 million.
  3. AllianceOne was acquired by France-based Teleperformance, enabling the global BPO corporation to gain a foothold in the U.S. ARM market.
  4. NCO Group announced a $325 million deal to acquire Outsourcing Solutions, Inc., combining two of the largest ARM firms in North America. This transaction is expected to close in the first quarter of ’08 and was not calculated in 2007 year-end results.

Looking to the year ahead, financial and strategic buyers are still looking for acquisition opportunities in the ARM industry, but some may be more conservative in evaluating acquisition targets, particularly if liquidation results in 2008 are below expectations. The fourth quarter of 2007 generated less than anticipated liquidation results by some collection agencies and debt purchasing companies, causing some acquirers to become uncertain as to where the market is headed. Deals will still get done in 2008, but some of them may involve a combination of cash and structure in order to bridge the gap between buyers’ and sellers’ value expectations.

The current credit crunch impacts ARM from both ends – it makes it more difficult for consumers to repay their overdue accounts, and it is forcing business changes among creditor industries that employ ARM firms. For example, fewer mortgage products mean consumers have less access to loans to consolidate debt, but it also means less business for small and mid-sized banks, which may merge in order to boost their branch networks and retain profitability. Mergers among this segment will trickle down to mean fewer clients for ARM firms.

I believe the lower liquidation levels experienced in Q4 of 2007 were primarily driven by consumers concerned about the economy and how it will impact their financial situation. We have been inundated over the past few months with news about the economy heading into a recession and increases in the unemployment rate; couple this with higher utility costs and mortgage payments, and it’s not surprising that consumers are behaving as if we are already in a recession.

During a recession, major credit issuers like credit card lenders typically increase the volume of placement outsourcing to collection agencies and debt buyers, but it becomes harder for the debt purchasing companies and collection agencies to liquidate the debts. This can potentially flatline or reduce the level of collections and profitability of ARM firms in the short term. Lower profits can cause buyers to change the way they structure deals, prompting business owners to either accept some deal structure in a transaction or defer selling.

However, companies and government entities are outsourcing increasing volumes of charged-off accounts, the declining pricing on portfolio sales will stimulate more debt purchasing activity, and the U.S. Department of Education student loan collection contract is renewing later in the year. With this in mind, 2008 has the makings of another decent year for M&A if the unemployment rate does not rise much above five percent and the economy doesn’t head into a deep recession. This would be especially true for “recession-resistant” firms – high-performing companies and niche players within growth markets in the ARM industry. The good news is that the debt collection industry tends to lag behind most major economic indicators, and comes out of a recession a lot quicker than other large markets.

*Major 2006 transactions were the management-led buyout of NCO Group,  and the recapitalizations of West Corporation and Cabot Financial Group.

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