The need to diversify a merchant portfolio with small and midsize merchants that typically afford better profit margins than large merchants likely drove Fifth Third Processing Solutions LLC’s acquisition of National Processing Co., observers say.

Cincinnati-based Fifth Third announced the NPC acquisition on Sept. 15 (see story). Terms were not disclosed.

The companies expect to complete the deal later this year, at which time the new organization would process transactions for more than 420,000 merchant locations, Fifth Third Processing says.

“We can leverage our single platform on our back end and front end to bring more products to those clients,” Charles Drucker, Fifth Third Processing president and CEO, said in an interview after the deal was announced. “Their distribution channel was very complementary to us.”

For the first time, it gives Fifth Third Processing an independent sales organization channel through which to sell services, he says. Fifth Third Processing had sold its third-party and agent-bank merchants business in 2004 to TransFirst Holdings Inc., a Hauppauge, N.Y.-based acquirer.

Transactions made at small and midsize merchants often generate a larger profit margin, says Kurt Strawhecker, managing partner at The Strawhecker Group, an Omaha, Neb.-based payments consultancy.

Large merchants often can negotiate lower per-transaction costs more easily than smaller merchants because of the volume at their stores. That can be especially important as merchants await Federal Reserve Board regulations that could lower PIN-debit interchange rates, Strawhecker says.

“The theory is very large merchants will be very aware of the PIN-debit rates,” Strawhecker says. “If there is any price decrease, they will be on their processors immediately.”

The NPC acquisition also represents a shift for Fifth Third Processing, suggests Adil Moussa, an analyst at Boston-based Aite Group LLC.

“By acquiring NPC, Fifth Third (Processing) is changing direction from focusing on larger merchants to re-entering the small-merchant market with its heavy dependence on ISOs and agents,” he says. “This shows the continuation of two trends in the market. First, the continuing consolidation of the players and, second, the focus on smaller and medium size merchants in the portfolio as a way to leverage risk and increase margins.”

And a larger profit pool is available to merchant acquirers focused on the [small and midsize enterprise] space relative to the larger merchant space, says John Maldonado, a principal with Boston-based Advent International Corp., the private equity firm that bought a 51% stake in Fifth Third Processing from Fifth Third Bancorp in 2009 (see story). 

New acquisitions will remain a part of Fifth Third Processing’s strategy going forward, but the processor and its owners are not in a rush to do deals.

“There have been a number of businesses that have been in the market in the last year and are coming to market for a variety of reasons,” Maldonado says. “We have the luxury of being a selective buyer. We are typically looking to buy capabilities, products and distribution channels that bolster and supplement what Fifth Third already has today.”

Advent also recently partnered with Bain Capital to buy RBS WorldPay (see story).

That acquirers and processors make recurring revenue from transactions is not lost on the investment community.

 “There is a lot of interest in this space,” Collin E. Roche, a principal at Chicago-based GTCR Golder Rauner LLC, an investment firm that is selling its interest in NPC, tells PaymentsSource. “It gets into the recurring revenue. Across the economy, there aren’t many areas that have that.”

In 2004, GTCR bought Retriever Payment Systems. Two years later, it formed National Processing Co. when it combined Retriever with the BA Merchant Services ISO processing group and Best Payment Solutions Inc., both of which it had acquired from BA Merchant Services in 2006.

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