he merchant portfolio sale phenomenon began in the United States in the late 1980s and flourished throughout the 1990s. During this period, large acquirers buying scale and distribution channels from sellers, the so-called strategic buyers, drove liquidity and valuations of portfolios.

Recently, however, the percentage of deals completed by private, equity-backed acquirers, which essentially serve as investment vehicles pursuing an intermediate term liquidity-event (the so-called financial buyers), has increased dramatically.

First Annapolis Consulting Inc. believes this changing profile of buyers has significant implications for smaller acquirers (bank or non-bank) pursuing a potential divestiture in the coming years. The 1990s served as the decade of strategic buyers building out national businesses and developing economies of scale. Central aspects of portfolio sales in the 1990s included the acquisition of sales organizations and the formation of referral arrangements, especially with financial institution sellers.

Of course, pure market share was also a significant factor. Over the course of the decade, First Annapolis estimates that more than 25% of the top 10 acquirers' growth came from acquisitions.

Beginning in the middle of the decade, the publicly traded acquirers, including NOVA Information Systems, PMT Services Inc., Paymentech LP, National Data Corp. and First Data Merchant Services (FDMS), also enjoyed an arbitrage of sorts. The shares of many of these companies traded for at least six to seven times their net revenue in the stock market, while portfolios were being bought and sold for 2.5 to three times their net revenue in the private market.

Strategic buyers dominated mergers and acquisitions (M&As) in acquiring. Our database of acquiring M&As totals just below 160 separate transactions dating back to 1988. Prior to 2000, financial buyers completed only 5% of transactions.

Between 2000 and 2003, this proportion had increased by a factor of five to total 25% of the deals. For the period of 2004 - 2005 (May-YTD), the number increased to 32%.

We believe several factors are driving the increasing importance of financial buyers. First, although strategic buyers still close the majority of deals, they are less aggressive than before. Companies such as FDMS, NOVA and Bank of America Corp. have already built national sales channels and are less in need of building these channels and related assets through acquisition. Now they can be more selective.

Some strategic buyers focus on product strategies or geographic markets as a primary matter, which reduces their focus on acquisitions, per se. Valuations in the market have increased significantly since the mid 1990s, and organic sales strategies are now a more financially attractive means to building merchant relationships than in the past.

The nature of the strategic buyer has also changed in recent years, with buyers such as Intuit Inc., Hibernia Corp. and The Royal Bank of Scotland making acquisitions of "platform companies" to support entry into U.S. acquiring once again.

Second, financial buyers are attracted to the business in greater numbers. Early venture-backed players CES (Welch, Carson Anderson & Stowe) and NOVA (WarburgPincus) established early precedents of highly successful venture investments, inevitably getting the attention of the broader venture capital and private equity communities.

The economic fundamentals of the business have become more widely understood over the past six to eight years. Suffice it to say, the business has the fundamentals investors tend to like: recurring revenue, fragmentation, wide and expanding profit margins, good core growth and significant deal flow, which creates confidence in the viability of an ultimate exit.

Private, non-bank acquirers steadily have become savvier and willing, self-interested vehicles for financial investors. This has allowed financial buyers to secure platform companies with which to pursue additional acquisitions in the ever popular roll-up strategy.

These trends are creating nuanced changes in the M&A market. We think we can measure some softness in the market for non-bank portfolios, although the market for bank portfolios remains frothy. Further, the financial buyers are really driving valuations.

For certain types of buyers and sellers, this is important for two reasons. First, for sellers that will have long-term relationships with the buyers (which will include basically all bank sellers), a financial buyer likely to go through a change of control in the short to intermediate term is perhaps a less attractive partner than a strategic buyer committed for the long haul. If these types of buyers become less prominent, divesting banks will have fewer strategic options.

Second, the greater the proportion of the market represented by financial buyers, the harder it will be for them to exit. Two or three steps down the road, this could have a profound impact on valuations.

New strategic buyers might very well emerge. Certainly, merchant portfolios are increasingly a scarce commodity, and scarcity value will keep acquiring valuations at current levels in the short term, barring some unforeseen new factor. Nevertheless, for acquirers planning or even considering divestiture, these trends bear monitoring.

Charles Marc Abbey is a Partner at Baltimore-based consulting and M&A advisory firm, First Annapolis Consulting. Abbey is responsible for First Annapolis' Acquiring Practice. E-mail him at marc.abbey@firstannapolis.com .