By Scott Calliham and Janinne Dall'Orto
First Annapolis Consulting
The Europay, MasterCard and Visa (EMV) liability shift is a matter of months away, and the impact EMV has, and will have, on valuations of merchant-related assets is an increasingly topical issue in mergers and acquisitions. EMV has either a neutral or negative impact on valuations of portfolios of merchant agreements and other going concerns in the merchant acquiring industry.
Buyers, in essence, purchase the sellers' problems when it comes to EMV, whatever those problems may be. While the processors themselves are, for the most part, ready for EMV, the downstream value chain continues to have challenges. Though there will be opportunities in the market, EMV is largely a defensive issue for acquirers.
There are three primary categories of issues:
There are dozens of third-party gateways and thousands of terminal applications and integrated point-of-sale (IPOS) solutions in the market today. In order for an EMV transaction to occur, each of these parties and their related applications need to be EMV capable and certified. We expect the certifications, particularly in the IPOS space, to become a considerable bottleneck, given the number of independent software vendors (ISVs) and gateways serving the market.
Depending on the number of gateways and ISVs an acquirer/processor utilizes, the certification process could be long and costly and involve out-of-the-ordinary-course attrition risks during the transition. Without clarity into these issues, an acquirer's eventual costs to convert its merchant portfolio to be EMV-enabled are unknown, and could represent a hidden cost for a buyer.
Even if a target is well organized in terms of gateway and ISV certification status and its understanding of its IPOS base, for the next few years, almost all acquirers will be only part of the way through the migration to full EMV compliance. Understanding how far along an acquirer is with respect to the migration affects how much of this work the buyer will have to do on its own time and its own nickel.
This impact on value is a function of the situation. Does the buyer have a large number of obsolete terminals in the field that will require replacements (and related capital expenditure)? Does the acquirer own and control its encryption keys, or will the buyer have to swap out even EMV capable terminals in order to inject keys? In short, how big a special project does the remaining migration represent for the buyer?
Another hidden cost for acquirers is the liability shift itself. Estimates vary, but most observers predict that approximately 30 to 50 percent of the POS terminals will be EMV-enabled by the liability shift in October. Therefore, for a large segment of the merchant market, acquirers will be exposed to higher losses for some time until their merchants have fully implemented EMV solutions.
First Annapolis believes that as issuers accelerate their conversions to EMV, acquirers will be faced with consumer fraud levels that increase overall acquiring exposure by 5 to 10 percent. Depending upon the merchant composition of the acquirer's portfolio, this exposure may be materially higher or lower, as not all merchants pose equal risk related to the liability shift. The characteristics that make a merchant risky or not risky in this context are not the same factors that acquirers have historically evaluated in their risk management processes, because the EMV liability shift exposure arises from consumer counterfeit risk, which has previously been an issuer risk.
The EMV migration process is a major event for the payments industry, and we see it as one that could have an impact on the evaluation and valuation of acquiring industry assets. This issue will not only be applicable until the liability shift in October, but it will also continue for months and even years as the U.S. market completes its migration to EMV. The first and best defense for buyers is a prudent, due-diligence focus, the results of which will be factored into a valuation model realistically.
Scott Calliham is a Principal in First Annapolis Consulting's Acquiring Practice and Janinne Dall'Orto is a Senior Manager in the Acquiring Practice. 
Scott Calliham is a Principal in First Annapolis Consulting's Acquiring Practice and Janinne Dall'Orto is a Senior Manager in the Acquiring Practice.
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