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2005-09-15
Acquiring Minds - Collections and Credit Risk
The biggest news in M&A deals so far this year is the intended marriage of two of the country’s top five collections firms. Still, most deals today are a far cry from the flawed, quick-growth strategy of the 1990s.
By Darren Waggoner
Collections and credit companies chasing growth - through acquisitions, maybe a merger - must feel like date seekers on match.com: plenty of potential partners; few qualifying as marriage material. Yet suitors are queuing up to the $15 billion accounts receivable management industry, eager to pounce on low interest rates and buy a new company. Banks are flush with cash, too. Deals are getting done, thanks to a healthy economy and a wealth of financial backers. Buyers are showing patience, waiting to acquire firms that aren’t just attractive and interesting, but financially fit. In the world of mergers and acquisitions, with millions at risk, a good personality alone doesn’t go far. Still, M&A activity is brisk, says Michael Ginsberg, president and chief executive of Kaulkin Ginsberg, a Bethesda, Md.-based M&A advisory firm. In the first half of 2005, deal value in the accounts receivable management space - a broad field that ranges from traditional third-party collections to debt buying to business process outsourcing and beyond - totaled more than $350 million in 26 transactions, reports Kaulkin Ginsberg. Marion Financial Corp., a Houston-based M&A advisory firm, also reports great interest in growth-via acquisition strategies. (In mid-August, Marion wrapped a deal advising American Coradius Inc. in the company’s sale to a private equity group for undisclosed terms.) Still, the overall M&A pace for the first half of 2005 trails the record-setting first half of 2004 by nearly $400 million in deal value, although there were actually two fewer transactions a year ago. That’s a reflection of how strong M&A activity was in 2004, rather than pointing to any kinks now, Ginsberg says. ‘The market is healthy and it’s on course for a strong second half,” he says. “There’s a lot of activity and interest from both financial buyers and strategic buyers, and deals from both sides are taking place.” Last year, dealmakers pushed M&A growth to new marks. Kaulkin Ginsberg counted 55 industry deals with a total deal value of $1.5billion this year, the headline act so far is NCO Group. The Horsham, Pa. company, the biggest of the big money consolidators that controlled M&A activity through the 1990s, announced plans in July to buy Risk Management Alternatives in a $118.8 million wedding that will, if consummated, join the largest ARM company (NCO Group) with the fifth largest (RMA). The marriage of giants is a marriage of convenience. NCO - per usual- wants to grow. RMA needed to be bailed out, and had become a relatively easy target, filing bankruptcy to help spur the deal. ‘The real value is RMA’s portfolio. We were very interested in acquiring that, as well as their servicing platform,” says Paul E. Weitzel Jr., NCO’s executive vice president of corporate development and international operations. “But, really, we wouldn’t have touched the service platform, if not for the ability to buy it under bankruptcy. It was all about the portfolio.” Under bankruptcy, NCO can pick and choose which of RMA’s liabilities it . absorbs in the purchase, says David King, senior management director with Bear Stearns Merchant Banking. If they’re not interested in a certain operating center, for example, they can cut it from the shopping cart, he says. The RMA acquisition, not completed at press time, is a throwback to the big-ticket consolidation strategy practiced through the 1990s by leading ARM companies such as Outsourcing Solutions Inc., IntelliRisk Management Corp. and RMA, too. Companies in the consolidation era chased fast growth by acquiring several companies and rolling all of them into one mega-firm. In hindsight, large-scale consolidation looks flawed. IntelliRisk went through a recapitalization. RMA and OSI both filed for bankruptcy protection, from which OSI restructured and emerged in six months last year. One key mistake many top consolidators made, says Gregory Hagood, SunTrust Robinson Humphrey’s managing director of investment banking, was choosing not to keep key management from the acquired companies. “These companies were buying companies and taking on too much debt before learning how to manage it or run the new business,” he says. “They ran themselves up on the rocks.” NCO proved an exception to the consolidation backlash. While its stock has been flat for a few years, the company seems to have handled the many integration issues related to taking on new companies.
Buyer Strategies
Acquirers in the collections and credit space today are broken down by type, Ginsberg says. Generally speaking, “financial buyers” are private equity investors and former industry executives planning a comeback. “Strategic buyers” are companies looking at the ARM industry to build or complement their existing operations. Last year, for example, West Corp., a communication and conferencing business, acquired Worldwide Asset Management, a debt purchasing company, for $178 million.
And finally, there are “industry buyers” the “consolidators” - of which NCO Group is the poster child. Before the RMA deal, NCO snagged dozens of companies over the years. The RMA deal itself, meanwhile, is a no-brainer for NCO, adds King, the director with Bear Stearns Merchant Banking. “NCO had the chance to buy a big chunk of business without having to add many of the liabilities attached to it,” he says. “It was a smart play. It’s not a can’t-miss, but it’s somewhat close.” Since big consolidation ended, industry acquisition strategies changed. Acquirers today want to build by diversifying or they want to grow organically with targeted purchases. Credit card collectors might seek to tap into the booming, yet largely untapped, healthcare receivables business where the margin potential is higher. Debt buyers might look to jump into third-party collections, although overall interest in traditional third-party credit card collections firms has softened since the consolidation era, Hagood says. Specialty companies are popular acquisition targets, says Hagood, who advised Nationwide Credit on an earlier recapitalization and represented Equifax and Dun & Bradstreet on selling their collection operations. Those with strong commercial platforms, healthcare collection specialists and bad-debt buyers are particularly hot. “If you’re a company that focuses on any of those areas, a lot of potential buyers are interested, a lot of people want to talk to you,” Hagood says. Healthcare receivables are drawing attention because the area largely avoided the eye of consolidators- the NCO’s, the IntelliRisk’s, Hagood says. Some healthcare-driven deals in the past year include MedAssist Inc. acquiring Argent Healthcare Financial Services Inc. for undisclosed terms, and Revenue Cycle Solutions, an outsourced ARM services provider to hospitals, announcing an infusion of $12.4 million in private equity capital. On the debt-buying front, Joseph Chumbler, an analyst with Stephens Inc., says: “Bad-debt prices don’t seem to be abating and it makes some sense that companies will keep looking for M&A opportunities to spur growth.” Last year, Sallie Mae became one of the largest ARM players after buying a majority stake in Arrow Financial Services, a Chicago based privately held debt buyer and collections agency. For Sallie Mae, the top education-funding provider, the deal follows the purchase in 2002 of Pioneer Credit Recovery, a student loan collections firm, and General Revenue Corp., the largest university-focused collections agencies. This year the debt buyers themselves are jumping into the takeover activity. Witness several recent deals:
Asta Funding, an Englewood Cliffs, N.J. debt buyer, purchased Option Card for $13.5 million in March. Option Card is a Denver-based consumer debt buyer and debt management company. Encore Capital Group, a San Diego based debt buyer and ARM firm, bought assets from Jefferson Capital, an arm of CompuCredit Corp. in June for $142.8 million.
Portfolio Recovery Associates, a Norfolk, Va.-based bad-debt buyer, acquired Alatax Inc., a privately held company that specializes in government collections work, for $17.5 million in August. Kaulkin Ginsberg advised Alatax on the deal. Steven Fredrickson, PRA’s chairman, president and chief executive, wanted part of the growing market for government receivables management. ‘This transaction follows our strategy of selective acquisitions that bring us complementary skills ... Alatax is a perfect fit,” he says. The deal follows PM’s $14 million purchase in late 2004 of IGS Nevada Inc., an asset-location firm.
New Deals
The flurry of deals are good signs for M&A activity which stumbled in the first quarter of 2005, with just 12 deals combining for $100 million in value, well behind the 15 deals/$535 million pace set in the first quarter a year ago. Numbers jumped almost four-fold in the second quarter. Several deals occurred at the end of the second quarter and start of the third, a strong sign of what’s ahead, Ginsberg says. Early third quarter deals included: Creditors Interchange, a receivables management services firm, acquiring Abrams & Swartz, a commercial receivables company; D&B acquiring Live Capital, an online credit management software provider, for $16 million; and Gecis - formerly GE Capital International Services - purchasing Creditek Corp. for an undisclosed price. Creditek focuses on invoicing and collections for healthcare and commercial markets. Other talked-about deals: . Protiviti Inc., a risk consulting company, acquired Lender Advisory Services for undisclosed terms. Protiviti wants to push into lender due diligence services for banks and insurance companies. GTCR Golder Rauner, a private-equity firm, and one of RMA’s financial backers, announced that H-Cube, a company it helped form to buy other firms, purchased Zenta Technologies, a Wayne, Pa. business process outsourcing company that operates mostly in India. Zenta focuses on credit card and mortgage servicing. BPO occurs when a company hands management of a function, such as accounts payable or purchasing, to a third party that conducts the activity based on preset rules. Some BPOs began adding debt collection services to their repertoire; others are buying call centers and collections agencies in foreign markets where labor costs are cheap, say Kaulkin Ginsberg officials. The result of the new interest: Larger BPOs are housing accounts receivable and customer relationship management and BPO functions together, says Thomas Edens, president of Marion Financial. Edens says the BPO market is hot and notes strong interest from private equity-sponsored BPO companies looking to jump into ARM. Elsewhere, a ramp-up in offshoring capabilities can’t be ignored as the credit economy becomes more global. Kaulkin Ginsberg last year worked deals in China and Japan, and Ginsberg notes that the interest in offshoring and outsourcing is up. “This business today is more global and that’s due to trends to extend credit internationally,” he says. “Look at the sponsors for the Olympics set for Beijing in 2008. There’s Citibank. There’s Visa. China is a substantial market for them.” Yet another possible engine for future M&A activity is the estimated $250 billion in delinquent taxes that the Internal Revenue Service plans to farm out to private collections agencies. Several shops are gearing up to bid on the work (possibly including PRA with its recent purchase of government accounts receivable firm Alatax, although PRA officials won’t say). A lawsuit recently delayed the IRS’ plan, after the U.S. Court of Federal Claims ruled the agency must open bidding to all interested collections agencies, not just those currently collecting for the government. (See “Court Order Delays the IRS,” pg. 13.) The eventual winning bidders will become prime acquisition targets, insiders say.”The IRS issue gets a lot of buzz,” says Billy Levine, vice president with SunTrust Robinson Humphrey. “For a couple of companies winning that bid might end up being like winning the lottery.”
The Outlook
Kaulkin Ginsberg and Marion Financial both reported deals in the works at press time. Both expect activity to be strong for the near-future. “It’s competitive and there are a lot of folks talking to each other,” Ginsberg says. “Those companies that are looking to put some capital to work are finding lots of opportunities. That’s not always been the case.” Weitzel, with NCO Group, says interest in ARM companies is showing no signs of abating. “I think you’re going to see more activity. You’re going to see another round of consolidation in this industry over the next 18 to 24 months,” he says. “If you look at the top five today, I think 18 months from now that group will look remarkably different. I think companies will take advantage of the pent-up capital out there. And there’s plenty of that floating around.” It’s unclear if the industry will witness more weddings as lavish as the NCO/RMA affair, but doubtless more will marry. The question is whether once the wining-and-dining ends, companies are ready for a long-term commitment.
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