Accounts Receivable Management Industry M&A Update

November 7th, 2013

This article appeared in Cornerstone Support, Inc’s Companion, Issue #10.16 

Debt collection agencies, debt buyers and other accounts receivable management firms have adjusted their business strategy over recent years to operate successfully in an industry fraught with intense regulatory scrutiny, dramatic client change and challenging economic conditions.  The “New Norm”, as this time period is often referred to,  has also had profound effect on mergers and acquisitions within the industry.

The number of transaction closings

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As this comparison illustrates, the number of ARM transactions closed is showing an uptick after a drop off from the middle of 2011 to the end of 2012. We expect a flurry of transactions to occur as owners of small and mid-size collection agencies and debt buying operations seek to sell out or combine forces with larger firms to combat increased operating costs running as stand-alone businesses.  We are also seeing significant and newfound interest in purchasing ARM companies in the healthcare, government and student loan sectors from non-industry (financial and strategic) and industry participants which will add to the overall number of transactions completed in the ARM sector.

 

The types of deals getting done

Deal Type Acq Purpose The most common type of deal getting done in today’s market involves industry buyer expansion (referred to as horizontal mergers), accounting for 38% of all transactions during the first half of 2013.  Vertical mergers, or transactions between 2 companies for client or services expansion purposes within a particular market sector, accounted for 15% of the total; however we anticipate this will spike up over the next 18-24 months due to increased operating costs associated with running ARM companies with emphasis on compliance amidst significantly increasing government regulation. Some owners will choose to make the necessary capital investments to position their business for growth while others will seek to exit from the industry.

Pricing in today’s market

We provide this current snapshot of valuation multiples for service providers in the ARM industry. As always, there were outliers, but these ranges should give you some guidance on current approaches to valuation based on designated size categories.

EBITDA matrix

Some points worth noting as you review this chart and determine how it might apply to your own business or acquisition you might be contemplating:

  1. Transactions that include little or no cash at closing are typically mergers among industry players and do not typically apply to outright sales or purchases.
  2. Higher amounts of cash tend to drive lower multiples for smaller size transactions or underperforming companies but not typically for the larger size transactions or performing companies.
  3. In those instances when severe client concentration exists, less cash is typically paid at time of closing and more is paid out over time based on retention of key client(s)
  4. Multiples have exceeded 8 times for platform companies with strong financial performance and desirable client base and/or service offerings.

Structuring today’s transactions

deal payment typeWe estimate that cash accounted for more than 70% of the ARM M&A transactions completed over the first 6 months of 2013. This percentage is relatively consistent with prior years; however it is worth noting that we experienced less use of earn-outs in the first half of 2013 compared to prior years.   Looking forward, we expect to see more risk sharing in the form of more deal structure, especially among debt buyers and those ARM companies focused on the financial services sector.

 

Where the deals are getting done

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We estimate that 54% of ARM M&A transactions in the first 6 months of 2013 involved selling companies based in the U.S. We did not find any M&A transactions in the ARM industry that involved a U.S seller and a non U.S. buyer. However, one large U.S. ARM company made a significant purchase of a European ARM company as we cited earlier and 2 large European ARM companies expanded through acquisition into other European countries. In the future, we feel it is likely that significant cross-border deals involving U.S. sellers will occur and we also expect to see an increase in the number of transactions involving U.S. buyers and non-U.S. sellers.

Important trends developing on the mergers and acquisitions front  

  • Large credit grantors may seek to consolidate their ARM vendor networks even further as they collapse various business lines that were previously managed separately into one focused center. As a result some specialty ARM companies will be forced to consider rapidly expanding or merging with other specialists to successfully maintain existing client engagements.
  • Because of the intense regulatory environment, and the increased demands placed on collection agencies by credit grantors across virtually all market segments, acquiring an ARM company will be more desirable than starting a new firm.
  • Some ARM companies focused on the financial services and telecom sectors will make acquisitions a part of their growth strategy to diversify their focus.
  • Healthcare receivables management, student loan service providers, and ARM companies focused on state and local government collections continue to be actively pursued by larger agencies and first time new market entrants.
  • We are starting to experience an uptick in cross-border M&A transactions involving ARM companies and we expect this trend will continue.
  • On the debt buying front, we expect more transactions involving small and mid-size debt buyers exiting by divesting their portfolios to larger debt buyers. However, sellers will have to produce nearly complete data in order for industry buyers to satisfy the needs of the CFPB when purchasing debt portfolios in the secondary market.
  • We are starting to see debt buyers who are not also servicers acquire stand-alone collection agencies to comply with anticipated regulatory and client changes.
  • Increased regulation will accelerate consolidation within ARM industry.  The intense regulatory environment is creating, for the very first time in the ARM industry, a true barrier-to-entry in the U.S. ARM industry.
  • Many corporate buyers are hoarding large amounts of cash and availability of debt financing has improved and, as a result, we anticipate an increase in M&A activity for the remainder of 2013 and into next year.
  • Some smaller companies, battling escalating operating costs and increased regulation, will find it more challenging to remain independent and may look more favorably toward a sale.
  • In the history of M&A in U.S., there has always been a big wave of M&A activity after an economic downturn. As the U.S. economy continues to improve and distance itself from the worst recession since the Great Depression, and companies strengthen their own financial performance, we expect to experience an uptick in M&A transactions.

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