The ARM Industry M&A Pulse – Recapping the Last 12 Months
The ARM industry faced numerous challenges in the past 12 months between fiscal regulation, macroeconomic variability, client behaviors and unconventional monetary policies. To meet these unprecedented challenges, ARM service providers, debt buyers and tech vendors alike embraced the time-held beliefs of diversifying risk and utilizing economies of scale through mergers and acquisitions to support long-term organic growth.
Geography of ARM M&A Activity
- Of the 19 M&A transactions announced in the last 12 months, 12 occurred within the U.S.
- Five of the M&A transactions were U.S.-based operations acquiring foreign operations.
- Only one announced transaction involved a foreign company as a buyer.
- Significantly above-average corporate tax rates and repatriation tax on foreign-generated profits have encouraged multinational companies to seek out M&A in other developed countries for numerous benefits.
- Lower levels of corporate tax: 40 percent U.S. vs. 21 percent UK
- No tax to repatriate foreign generate profits.
- Overall greater profits to expand business operations.
Diversification as a Primary Motif
- Eight transactions involved a diversification of service offerings
- Six transactions involved market expansion of current services.
- Three transactions occurred within a market to increase the scale of operations.
- Two transactions involved new private equity investments.
Deal volume has maintained its current level and we expect it will accelerate so long as regulatory conditions become stricter, resulting in increased operational costs and client demand, as strategic tax inversion becomes more a part of corporate development.
Current acquisition activity speaks volumes about the direction the ARM industry is headed. Diversification of services offered and/or the geography of client base help insulate companies against fluctuations within a given sector or region. Moreover, larger corporations are better positioned to absorb the increased costs associated with regulatory compliance in today’s modern world of collections.
Analyzing ARM Deals by Segment
Technology and Vendor Deals
Trends are starting to develop in the technology-vendor segment of the ARM industry, leading to an uptick in deal activity. Transactions highlight the value of compliance technology and data collection to the ARM industry as a whole. Ever-increasing importance on regulatory compliance since the launch of the CFPB and greater involvement by the FTC and FCC has been a boon to technology and vendor companies. Expect to see higher levels of investment in these industries that support the ongoing development of the ARM industry.
Private Equity Deals
There has been a great deal of M&A activity in the first half of 2014, but new private equity transactions have in large part been left out when compared to historical levels. In many cases, large corporations have been willing to spend a great deal more than private equity funds to acquire competitors or expand their services and market. Dry gun powder held by private equities has been sitting idle, just waiting to explode. Based on improved financial performance among many market-leading ARM companies and increased interest in specific market segments – including student loans, government and healthcare verticals – we expect to see an influx of private equity investment in coming quarters.
Breaking Down the Deals
The estimated value in the first six months of 2014 for ARM deals is between $1.97 billion and $2.1 billion. While this value is rather large, it is also deceiving. Encore Capital and Portfolio Recovery Associates accounted for nearly 94 percent of total deal value during this time through their international acquisitions in the UK and Norway. That being said, the nearly $130 million in M&A through the first six months by ARM companies is no small sum by industry proportions, and all indicators point to sustained levels of M&A activity. Massive investments in foreign acquisitions by debt buyers has started speculation that we could see a debt buyer in the near future move its operations to a developed foreign country to take advantage of lower taxes and regulation, just as other non-ARM U.S. multinational corporations have done.
A Look at Current Transaction Pricing and Deal Structure in the ARM Industry
Over the past 12 months, buyers and sellers demonstrated an eagerness to pursue M&A transactions in the ARM industry. This has not occurred since the start of the Great Recession nearly seven years ago. Current levels only tell part of this story: there is growing interest that has not yet resulted in completed transactions, and pricing levels are starting to reflect this increased level of interest.
We provide this current snapshot of valuation multiples for service providers in the ARM industry for buyers and sellers interested in mergers and acquisitions. Be advised that no “rules of thumb” exist when it comes to valuing an ARM company. Value is predicated on numerous converging topics, including seller performance, buyer needs, securing financing and overall market conditions. There are always outliers, but these ranges should give you some guidance on current approaches to valuation based on specific size categories.
It’s important to note as you review this chart and determine how pricing might apply to your own business or an acquisition you might be contemplating:
- Transactions that include little or no cast at closing are typically mergers among industry players and do not apply to outright sales or purchases unless the seller is not profitable or has severe performance issues.
- Most small ARM companies have owner(s) who have major client relationships and are involved in all facets of the business. Mid-size businesses start to develop a team concept, which adds significantly to the transferability of a service business
- Higher levels of cash tend to drive lower multiples for smaller-size transactions or under-performing 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 the time of closing, and more is paid out over time based on retention of key client(s). Exceptions take place when that client is difficult to penetrate and/or when that client is locked into a long-term contract.
- Multiples have exceeded 10 times for platform companies with sustainable financial performance, a desirable, diverse client base, and/or service offerings.
- In certain situations involving under-performing companies, creative deal structuring and risk sharing is required to satisfy both the buyer’s concerns and the seller’s needs to consummate a deal.
Predictions: What to Watch for in the ARM Industry
- On a microeconomic level, and as this graphic illustrates, we expect more consumers will wind up in collections, and the average account balance will increase overall. These trends bode well for ARM companies well-positioned to receive the windfall of new placements.
- We expect a strong wave of consolidation within the ARM industry over the next 24-36 months as the increasing cost of compliance sets in and smaller and midsize service providers find it more challenging to operate profitably as a stand-alone business.
- We anticipate mergers to occur among the trade associations that service U.S. collection agencies, debt buyers and/or collection law firms as membership totals drop amidst consolidation, start-up replacements become less frequent, and lobbyist costs escalate to confront escalating regulation.
- There will be even more moves among the largest ARM companies as companies seek to capitalize on growth or exit alternatives. With announcements to start the second half of 2014, including Teleperformance acquiring Aegis USA Inc. and NCO Group divesting all of its third-party collections to Platinum Equity, change is afoot at the top and these will not be the last big name players that participate.
- Because of the intense regulatory environment and the increased demands placed on collection agencies by credit grantors across virtually all market segments, fewer successful start-ups will emerge, and acquiring an established ARM company will be more desirable for new entrants than starting a new firm.
- Expect even more cross-border M&A transactions involving U.S. ARM companies seeking expansion by moving into developed and/or emerging credit economies.
- Because debt buyers require nearly complete data in order to satisfy regulators when purchasing debt portfolios in the secondary market, most transactions will occur at historically low prices or with the seller burdened with increased transaction risk.
- Expect to see some debt buyers who outsource their collections to acquire contingency collection agencies in order to comply with anticipated regulatory and client requirements.
The ARM industry will again attract attention from private equity firms and other financial-type buyers, fueled by several trends in particular:
- Aging populations require more specialized services that ARM companies provide.
- Companies and governments continuing to seek ways to better manage their costs by outsourcing non-core services to ARM specialists.
- Stricter regulation and client compliance requirements are creating consolidation opportunities within certain markets and scalable competitive advantages that insulate and enable well positioned companies to operate profitably in a less competitive environment.
- As the U.S. economy continues to improve, ARM companies will continue to strengthen their financial performance.
- As we proclaimed last year, the intense regulatory environment is creating a true barrier-to-entry in the U.S. ARM industry for the very first time. This is good news for operators and investors alike.
Keep a close eye on the following areas over the next 12-24 months:
- An increasing number of technology and compliance vendors seeking to capitalize on regulatory change by increasing service offerings and decreasing competition through mergers and acquisitions.
- Sizeable debt buyers looking to embrace the benefits of tax inversion, expansion and decreased regulation through additional foreign acquisitions and potentially relocating their headquarters overseas.
- Healthcare collection agencies expanding their service offerings into broader revenue cycle management, or selling to larger participants seeking specialty service offerings or geographic/client expansion.
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