M&A Trends in the U.S ARM Industry
By Kaulkin Ginsberg
Two strategies are taking center stage across numerous U.S. accounts receivable management (ARM) industry boardrooms in 2017: making an acquisition and selling out.
Leadership teams continue to face numerous challenges ranging from escalating operating and compliance costs and increasing client demands and audits, to decreasing commission rates and postponing contract awards. As a result, many are considering mergers and acquisitions.
On the buy side, there is a division between those companies actively and passively seeking M&A opportunities. Those actively seeking opportunities are accelerating their efforts to locate at least one company to acquire or merge with in the hopes of expanding faster than through organic efforts alone. They tend to view the first six months of the year as a critical step in this process. Conversely, those passively seeking opportunities are reacting to opportunities only as they are presented, and tend to be focused on organic growth opportunities.
On the sell side, a growing number of owners are positioning their companies for eventual sale. Some are performing very well within their respective markets, and have an attractive clientele. These owners realize they may be able to generate more generous deal terms as numerous strategic, industry, and financial buyers are seeking the right company to acquire. The rules of supply and demand tend to work to these sellers’ advantage. Other ARM companies are not faring so well. Some businesses suffer from the loss of a major client, while others have experienced a reduction in revenue due to a loss of market share from existing clients to lower-priced competitors. Potentially faced with upside-down balance sheets and dwindling cash resources, these owners are determining if they are prepared to operate their businesses under less than ideal conditions while satisfying their clients’ growing demands. As a result, some owners are warming up to the concept of selling or merging their operations with owners that are willing to make the capital investments required for long-term success.
Market Segment Trends
ARM companies focused on serving large financial institutions continued to experience client attrition in 2016. On the one hand, some companies in this market successfully diversified organically by onboarding mid-sized banks and credit unions, in addition to clients from other market segments (e.g. healthcare). Because they already incurred significant costs associated with compliance and data security, these ARM companies recognize they are well positioned to serve additional credit grantors that are experiencing growing regulatory and security requirements.
On the other hand, firms that are reliant on serving large banks are attempting to diversify either by acquiring other bank specialist ARM companies or by acquiring companies servicing other asset classes altogether. While they hope to realize cost savings by eliminating duplicative expenses, the primary goal is to expand their client base. In a recent example, Value Recovery Group (VRG), a diversified financial services firm, acquired Regional Adjustment Bureau (RAB), a multifaceted agency with education, retail, and banking clients. Management announced that RAB will be integrated into the larger VRG platform and clients will be provided with additional services.
Federal Government Contracts
Three federal government agencies – the Department of Education, Internal Revenue Service, and Department of Treasury – are at various stages of awarding lucrative contracts to private collection agencies (PCAs). In September 2016, the IRS contracted with four PCAs to collect certain overdue federal tax debts starting in the spring of 2017. The U.S. Department of Education finally awarded its coveted unrestricted student loan collection contracts to seven PCAs in December 2016. Currently, the Department of Treasury is in the process of reviewing PCAs’ proposals to collect non-tax debt, and is expected to announce this award early this year. Kaulkin Ginsberg believes these federal government contracts will impact M&A in the U.S. ARM industry in two very distinct ways:
- PCAs that are awarded any of the three very desirable and lucrative federal contracts will experience significant client concentration within their respective companies. On the surface, this might appear to be a concerning factor if any of the companies want to sell out; however, history demonstrated that federal contracts are highly sought after by financial and strategic buyers alike who recognize the contracts will exist for relatively long periods of time at defined terms and conditions.
- The majority of large ARM companies will not be awarded a contract. As in past years, this will lead to a group of buyers eagerly looking to fill the void created in their own organizations by potentially acquiring one of the companies awarded the contract.
The healthcare segment of the U.S. ARM industry continues to appeal to industry and non-industry buyers who want to capitalize on outsourcing trends among hospital systems and other healthcare providers. Some healthcare providers are also going through their own consolidations, resulting in fewer and larger hospital systems and physicians groups. As a result, larger ARM companies focused on healthcare are being aggressively pursued by financial buyers looking to find the right entry point to serve as a platform company. These buyers want companies with proven management teams that run profitable operations and are well-positioned for organic expansion and acquisitions growth. However, these buyers face a limited number of platform-size investments and substantial price expectations due to increased competition to own or invest in these companies. We expect a considerable amount of M&A activity within the healthcare segment of ARM over the next 24 months.
There is increased interest in M&A among tech vendors in the ARM industry. In recent examples, Billing Tree and RevSpring completed major recapitalizations with private equity firms Parthenon Capital Partners and GTCR Golder Thoma, respectively. We are forecasting an increase in transactions involving this segment, including platform investments as well as add-on acquisitions by those looking to expand their client base and service offerings.
What is driving value in today’s market?
Industry buyers and financial investors alike are aggressively trying to acquire ARM companies with desirable attributes they can leverage for growth. These are the top five value drivers in today’s market:
- Sustainable Performance – Buyers prefer to acquire firms that consistently demonstrate revenue growth and profitability. They realize that service companies experience fluctuations in business volumes from existing clients or outright client losses. They want losses to be offset by gains in market share and/or additions in new streams of business from new and existing clients.
- Proven Leadership with a Plan – Some industry buyers base deals predominately on whether they will gain new clients, and structure transactions around retention and expansion of existing client engagements. In those instances, buyers are less concerned about retaining a seller’s leadership team except when those individuals possess client relationships. Typically, buyers seek businesses with established leaders who are involved in all facets of their operations, possess longstanding client relationships, and have a strategic plan to address market dynamics.
- Financial Controls in Place – Experienced buyers realize there will be financial performance fluctuations on a quarterly or yearly basis. They prefer buying a company with executives who demonstrate a proven ability to operate within a budget and are able to define profitability down to the individual client level. Having insight into the future through an annual projection and a multi-year forecast is preferred; however, most ARM companies do not possess this level of detailed financial information.
- Low Levels of Client Concentration – Most buyers prefer acquiring companies with low levels of client concentration risk. Concern levels start escalating when one or more clients generate 20 percent or more of a company’s revenue. Some market segments like healthcare are experiencing a higher level of client consolidation compared to prior years, resulting in increased concentration among ARM service providers. In instances where clients represent more than 25 percent of revenue, sellers should expect some amount of deal structure around client retention.
- Strong, Competitive Position in a Growth Market – Buyers looking to enter a new market want to buy a company that maintains a longstanding, competitive position. A buyer will be more willing to pay a premium for companies that consistently demonstrate an ability to onboard new clients while increasing business from existing clients.
About Kaulkin Ginsberg
Since 1991, Kaulkin Ginsberg has provided value-added strategic advisory services tailored specifically to the accounts receivable management industry and other outsourced business services (OBS) companies. The firm’s client-centric approach covers almost every stage of a company’s lifecycle. For more about Kaulkin Ginsberg, please visit www.kaulkin.com.