As appeared in Vol. 27 No. 2 issue of the Southwest ACA of Texas Collector Connector Magazine
As we leave the first quarter of 2014, important trends and developments are setting the stage for the remainder of the year, and beyond, for accounts receivable management firms. Let’s take a look.
Client Changes Present New Opportunities and Challenges
U.S. student loan debt has reached $1 trillion with $100 billion in delinquencies in 2013. From 12Q1-13Q1, there was a drastic increase in student loans and the amount in +90 days delinquent increased at a much faster rate than the total amount issued. Private lenders have been leaving the student loan market since the Obama administration started originating loans in 2010. Currently, about 85% of loans come from the government, and we expect this will peak at 90%. Many lenders have been leaving this particular market segment, including JP Morgan Chase, as Wells Fargo expands its student loan concentration.
The healthcare market revenues have been on a steady increase from 2004-2012 for both non-profit and for profit hospitals. By 2016, the hospital market will generate $1 trillion in revenue. Historically, healthcare providers were reluctant to refer debt to collections in fear of scaring away the consumer, because half of the bad debt was paid off by charity institutions. However, the contribution from charity institutions is slowly decreasing. This will lead to a need for hospitals to outsource their collection efforts in order to recover delinquent receivables.
More and more states are turning to collection agencies: California leads the pack with non-tax bad debt of 24%, followed by Ohio at 16% and NJ at 14%. The delinquency rate mirrors the unemployment rate and the real estate market. During the 2007 mortgage crisis, delinquency rates were much higher than the years previous. We see this as a growth market because state governments are struggling to meet their budgets and they must either cut spending or increase taxes. Outsourcing collections is an enticing alternate solution for this budget crisis.
Telecom is a growth market for ARM companies. The overall market growth has increased from 5.9% in 2011 to 6.2% in 2012 and collections have increased 15% in that period. Consumers spent nearly $100 billion on data in 2012. The difference in telecom is that there is significant client concentration, which is only going to get worse as consolidation in the telecom industry continues.
The total financial services sector totals to $10.25 trillion, this is down 15% from the levels at 2008. There was a drop across all market segments, except the student loan market, as consumers started to deleverage. Major lenders are cutting their vendor networks when it comes to collections. This may even mean that they only keep 1 recovery manager to handle all their debts. The silver lining: regional banks are returning to the credit market which will create growth in this particular segment.
Macro-Economic Developments Will Impact Recoveries
The current round of consumers’ efforts to pay down debt is to be coming to an end. For the last 5 years, consumers have been paying off debt, which means that they are not incurring new debt. With economic recovery, consumer confidence is increasing. This means that personal savings rates are decreasing, people are spending more while tapping into their savings. Generally favorable trends in the housing market also allow consumers to borrow more. Consumer deleveraging will have a profound impact on collection liquidation results across all market segments over the next 18-24 months.
The decreasing unemployment rate continues to be the most important indicator of improved collection performance because as unemployment decreases, consumers will have a higher repayment capacity. Some economists argue recent drops to unemployment rate are directly attributed to the growing number of people who stopped looking for work or who have settled for subpar or part-time jobs and students who have decided to forego employment by furthering their education (a good thing for those ARM companies focused on the student loan market).
M&A Trends and Predictions
Buyers remain cautious as they pursue M&A transactions in the ARM industry. The volume of merger and acquisition activity in the ARM industry has shot up significantly in 2014 when compared to the activity of the past two years.
Due diligence is taking longer to complete compared to pre-recession times because buyers and their lenders tend to be more fixated on compliance issues and regulations that must be addressed today. Buyers don’t want to encounter any surprises once the deal is closed. Transactions involving underperforming companies are requiring more creative deal structure and risk sharing to ease the buyers’ concerns. Before 2008, financing was more readily available, multiples were higher and cash was more prevalent in a transaction.
On the debt buying front, Portfolio Recovery Associates announced in February that it would acquire Norway-based debt buyer Aktiv Kapital for $1.3 billion. This announcement came after Encore Capital Group’s announcement that it will acquire UK-based debt buyer Marlin Financial Services for £295 million (approximately $481 million) and finish buying the rest of Cabot it did not purchase previously. In the first 2 months of 2014 we already saw 6 ARM deals announced. These transactions are game changers and will have a profound effect on the industry for years to come as clients will be more at ease because of the size and transparency of larger debt buying organizations. In addition to the big deals announced, more transactions are involving small and mid-size debt buyers exiting by divesting their portfolios to larger debt buyers. Debt Buyers are requiring sellers to produce nearly complete data to satisfy the CFPB requirements. Some collection agencies are downsizing operations and using M&A to diversify away from collections. Smaller ARM companies battling escalating costs will find it more challenging to remain independent and may look more favorably toward a sale.
As Obamacare sets in, we expect to see more hospital mergers and more M&A transactions involving smaller and mid-size healthcare service providers. Healthcare providers have no choice but to consolidate as their costs spiral out of control. It is forecasted that as much as 20% of hospitals will seek mergers or go for sale over the next few years.
This is a current snapshot of valuation multiples for ARM companies.
There are always outliers, but these ranges should give you some guidance on current approaches to pricing and structure based on size. Most transactions include some cash at closing. Those deals that include little or no cash at closing are typically mergers among industry players and do not typically apply to outright sales or purchases. 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. 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). In any market condition, a rock-solid company will always sell for full market value.
Increased regulation will accelerate consolidation within ARM industry. Looking forward over the next 12-24 months, we expect a flurry of vertical transactions as owners of small and mid-size ARM companies seek to sell out or combine forces with larger firms to combat increased operating costs running as stand-alone businesses.
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. Fewer ARM companies will be equipped to service needs of the larger grantor due to increased data security and compliance costs.
Consolidators will become a part of industry history. The private equity backed roll-ups that took place from 1996 to 2002 were fixated on amassing market share as quickly as possible, regardless of the industry focus, even if the clients serviced by the selling company overlapped significantly. Today’s focus is toward acquisitions with a clear purpose that add select clients or services in a particular market segment.
Government will become the single largest source of new business for ARM service providers for the next decade. When you factor in the U.S. Department of Education, other segments of the Federal Government that I am confident will be outsourced to 3rd party professionals, and what has been developing at the state and city level, government will easily replace financial services which was king of the hill in placement volumes for 15 years leading up to the great recession.
Comments are closed.