By Patti Murphy
ProScribes Inc.
Investors flush with cash and buoyed by a low-interest rate environment are enamored of payments companies, especially companies in the transaction processing loop. And for good reason. Payments are crucial to commerce (regardless of whether the economy is booming or lackluster). Also, consumers and businesses are growing ever more comfortable with electronic payment networks, which as the financials of large payments companies indicate, can generate significant revenue for network operators and their partners.
"It's an easy money period, which makes it a pretty attractive environment," said Marc Abbey, Partner at First Annapolis Consulting, a Maryland company that advises parties to mergers and acquisitions involving payment firms. Abbey added that many new investors are being drawn on the market by the accomplishments of earlier investors. Adam Atlas, a Toronto-based attorney who often advises ISOs selling portfolios, agrees. "Outside investors have spotted our industry, and they've come to realize they can earn good money," he said. And that compares well to investments in newbie payment companies, like Square Inc. "that are fetching a lot of investor dollars without any promise of revenues," Atlas added.
Square, which has been challenging the traditional merchant acquiring model with a device that lets anyone with a smartphone accept credit and debit cards, reportedly has been hemorrhaging red ink, and has been forced to postpone a long rumored initial public offering. In an April 24, 2014, article citing anonymous sources the Wall Street Journal reported that Square posted a $100 million deficit for 2013, and that the company had blown through better than half of the $340 million in venture capital it has raised over the last five years. Analysts have said Square would be hard-pressed to secure anything approaching that amount of money in an IPO.
"I see this as a vindication for ISOs who have been scared about the potential of companies like these," Atlas said. He added that he's dealt with investors who were keen on alternative payment companies now looking to invest in more mainstream companies. "Traditional providers like ISOs have proven track records in terms of revenues and cogent business plans for growth," Atlas said. "That can't be said for these new models."
Harold Montgomery agrees. Montgomery is Chairman and Chief Executive Officer of Calpian Inc., a Dallas firm operating payment businesses in the United States and India. In the United States, Calpian has built a large merchant portfolio by acquiring small ISOs (under $10 million in revenues).
"Payments is a difficult business; it takes a lot to scale," Montgomery said. "The investors who went after Square are 'shoot for the stars' kind of guys." They are gamblers; the smart investors are looking for payment companies with strong cash flow and profits, a stable business and a strategy for growing the business, according to Montgomery. "Payments companies with these qualities can find investors," he said.
For better or for worse, a recent post, by Quentin Webb, a columnist who writes about mergers for Reuters, portrayed how the general investing public views electronic payment companies. "[H]andling bank-card payments is a vital, utility-like function," he wrote. "Cash flows are strong and predictable, and equity returns can be easily amplified by leverage."
Webb's comments were contained in a March 2014 post about the acquisition of a large Nordic merchant acquirer, Nets Holding A/S, by a Danish firm in partnership with Advent International Corp. and Bain Capital LLC. Advent and Bain already own WorldPay, which had been the merchant acquiring arm of the Royal Bank of Scotland until that bank was forced to sell in the aftermath of the economic turmoil of 2008.
Advent also holds an ownership interest in Vantiv LLC (formerly Fifth Third Merchant Services), which has grown significantly in the past few years through acquisitions. However, in March, Vantiv disclosed that Advent would be cashing out its five-year investment, making its holdings in Vantiv available through a secondary offering. Market observers said they expect some of that cash to finance additional acquisitions that will complement WorldPay, much like the Nets investment.
Closer to home, several recent transactions have caught the attention of acquirers and their partners. Among them: Mercury Payment Systems Inc., SecureNet Payment Systems and EVO Payments International.
EVO, formerly EVO Merchant Services, is a U.S. acquirer that has been expanding internationally through portfolio acquisitions, most notably those of Grupo Banco Popular in Spain and Germany's Deutche Bank. Last year the investment firm Madison Dearborn Partners LLC purchased a minority interest in EVO to help fund the acquirer's aggressive acquisition strategy. "Payment processing is a dynamic industry, with new growth opportunities emerging worldwide each and every day," said Jim Kelly, EVO's CEO, in announcing the deal.
Vahe Dombalagian, Managing Director at Madison Dearborn, said, "EVO has a scalable business model supported by industry leading end-to-end technology that we think positions the company for sustained growth moving forward." He said the investment would be earmarked for acquisitions, especially international purchases. EVO President Jeff Rosenblatt added, "There's a lot of momentum behind our business."
Abbey said deals like these are becoming more common: deals involving equity investors with deep pockets that help fund ISO and acquirer growth strategies. But not just any ISO or acquirer, and size can often take a back seat to underlying technologies.
"Investors are looking for companies with platforms that can do big things," Abbey said. He pointed to a recent investment in SecureNet by the equity investment firm Sterling Partners.
SecureNet has built a sophisticated software-as-a-service platform that it said can readily support the evolution of multichannel payment integration, but at the time of the deal it had only about 12,000 merchants. SecureNet is led by Brent Warrington, an industry veteran who, among other jobs, was Senior Vice President and General Manager at First Data Corp.
Also in March, Mercury, which is majority owned by the private equity firm Silver Lake Group LLC, filed documents with the U.S. Securities and Exchange Commission for an IPO that is expected to raise at least $100 million. Mercury, which plans to list on NASDAQ under the symbol MPS, has had a controversial tenure in its four-year climb into the ranks of leading ISOs and acquirers.
In early 2014, the company was taken to court by Heartland Payment Systems Inc., which alleged Mercury was engaging in deceptive pricing practices. Abbey doesn't see the legal entanglement hampering Mercury's planned IPO. He pointed out that both Visa and MasterCard Worldwide were embroiled in a legal entanglement with merchants at the time of their IPOs, with contingencies in place had the lawsuits not been settled. He said he expects similar contingencies are being made by Mercury.
Interest in ISOs and their portfolios is not necessarily limited to the biggest and brightest names in merchant acquiring. For example, Colorado-based Intrix Technology Inc. has been on a buying spree. In April 2014, it acquired Witt Merchant Services, a small ISO with a strong presence in New Mexico. That was the sixth ISO acquired by Intrix in a year. Intrix executives said they are building the company's ISO portfolio on a payment gateway that integrates with customer accounting applications and enterprise systems to better streamline payment processing.
Although some observers say money is not being invested in merchant acquiring this year at quite the pace witnessed in 2013, both Atlas and Abbey are optimistic about the market for well-run smaller ISOs. "We're seeing private equity at all levels of the industry," Abbey said, explaining that there are some "really positive case studies" in which private investors have fared well betting on acquirers, ISOs and other payments companies. "It's influencing the prices we're seeing in the market," he added.
Nonetheless, the experts caution sellers that their expectations may not always be met. "We see a lot of situations where the value expectations are quite different," between buyers and sellers Abbey said. The disconnect often occurs over technology. He said some buyers are "just not able to value the assets" in line with what sellers are looking for. "We're also seeing some sellers selling too soon," he added.
Atlas said he's seen some "broken hearts" over deals that didn't go the way sellers had expected. He said some of those ISOs have lost out on anticipated future payouts due to shady dealings on the part of buyers. He also said he's seen situations in which buyers have "purposely reneged on payouts" that were promised post sale. "It should be a warning to sellers that they need to ensure that buyers are ethical and financially solvent," he said.
Abbey offered another warning: the acquisition process can be long and involved, and unsuccessful negotiations can be devastating. It's a major effort to sell, and failing can have an impact on morale and a company's financial condition, he said.
Montgomery, who has built Calpian by acquiring small ISOs, said he hasn't seen much in the way of competitive activity this year "It's a lonely segment to be in," Montgomery said. But he is optimistic that investors will return. "This business has been a darling of the investment community for a long time," he said. He also believes that although more recently money has been flowing out to opportunities in other sectors promising higher growth, it's likely a short-term trend. "It would not surprise me to see equity players that have left come back to this business because this is a business that has been very good to them for the past 20 years," he added.
Nothing is a given, however. "In today's environment there are some big unknowns," Abbey said. Several of these could have implications for buyers and sellers of merchant portfolios.
Europay/MasterCard/Visa (EMV), the new card security standard being implemented now in the United States – following near worldwide adoption – is one variable. "We've seen in other markets where [portfolio] values have been affected by the status of EMV implementation," Abbey said. Acquirers and processors are now supposed to be able to support merchant acceptance of EMV cards, under a timetable set by the card brands. The only exception is card acceptance automated fuel dispensers, which must be EMV compliant by 2017. Issuers have been slow to make EMV cards broadly available.
But that should begin to change: under EMV rules beginning October 2015 the party responsible for lack of an EMV authorization when a card is subsequently compromised is financially liable for any resulting counterfeit fraud losses.
Advances in technologies represent another variable. There are plenty of expectations around technology changes that are occurring at the POS. Are tablets the future? What will become of traditional terminal devices? What role will "the cloud" play in merchant acquiring? What technologies will prevail in the mobile arena?
Indeed, Abbey emphasized that the sophistication of technology and ease of integration are things that can make or break any merger or acquisition. "The value of technology is a big variable; these investors are not just looking at cash flow," he said.
Perhaps the biggest unknown is what's coming next. "We're seeing big changes in distribution models, and we've seen them deliver strong growth," Abbey said. New players like Mercury, for example, have employed more aggressive strategies than some older players. However, no one can predict the future.
Patti Murphy is Senior Editor of The Green Sheet and President of ProScribes Inc. She is also the founder of InsideMicrofinance.com. Email her at patti@greensheet.com.
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