From the March 2010 issue of ISO&Agent.


Buyers and sellers of ISOs and merchant portfolios appear to have said good riddance to 2009 as merger-and-acquisition activity has picked up dramatically thus far this year.

Acquisitions are one way an organization can grow or, in some cases, create a merchant-services company. Before the recession began in 2008, mergers and acquisitions abounded, only to be derailed by the weakened economy.

With the economy seemingly regaining strength, the market for mergers and acquisitions similarly appears to be rebounding as sellers look for capital. But sellers' expectations for sale margins now are much lower, and buyers appear ready to take advantage.

The activity began to pick up in the fourth quarter, says Ray Sobczyk, a senior associate and strategic acquisitions expert at the Strawhecker Group consultancy who helps merchant-portfolio buyers and sellers make deals. Sobczyk bases his observation on the number of deals Omaha, Neb.-based Strawhecker is involved in and on other deals he is aware of in the industry.

But not all buyers saw an uptick as quickly as late last year. Velocity Funding LLC, for example, experienced a difficult 2009 overall, especially during the fourth quarter, says Dean C. Caso, president of the Norwood, Mass.-based merchant-portfolio buyer.

"That has changed dramatically since the beginning of February," Caso tells ISO&Agent. Since Feb. 1, Caso estimates his firm has spoken with about 15 sellers and issued eight offers. Of those, four sellers accepted the offers.

Caso speculates consolidation activity picked up this year, in part, because many potential sellers "have completed their business plans for 2010 and have decided they may need additional capital to achieve their goals."

Among the recent examples, Merchant Data Systems Inc. in January bought a 1,300-merchant portfolio. And payment processor and ISO North American Bancard in January hired Deutsche Bank Securities as a financial advisor to "explore the opportunity to strategically align ourselves with financial partners to pursue any opportunities," Marc Gardner, president of the Troy, Mich.-based ISO, tells ISO&Agent.

"We have new players in the market," Sobczyk says, noting venture capital firms in particular are eyeing the midsize to larger deals. "They find the business attractive for its predictable, recurring revenues."

Many sellers rely on building a merchant-sales business so it can be attractive to buyers. Likewise, buyers turn to merchant portfolios as a way to expand their revenues.

However, the sellers have not had much opportunity to sell their enterprises during the past 18 months, Sobczyk says. This was not because the sellers ran the businesses poorly. Instead, the revenue was not strong because consumer spending at many retail locations dropped off significantly, he says.

Sellers without debt may find more interested buyers because the economy is still in a lull, which lowers the value of a merchant portfolio, Sobczyk says. "If the retail sales come back strong, the value of those businesses would go up," he says. "They are in a tempered growth mode due to same-store sales being down."


Pricing Multiples

Merchant-portfolio sellers that harbored visions of selling their portfolios at 36 times their monthly residual revenue finally have acquiesced to buyers' demand to pay less, say observers of the acquiring market. Residual revenue is the recurring trans- action income acquirers collect from merchants, and often this price is called a "multiple."

"Now we're seeing sellers adjusting to the economic environment and market conditions," Adam T. Hark, managing partner of Boston-based, tells ISO&Agent. Hark's company is a broker for merchant-portfolio buyers and sellers.

As recently as 2007, sellers held out for high selling prices, but they now accept that those days will not return, he says, noting buyers today are paying between 22 and 24 times a portfolio's monthly residual revenue.

"The money was always there," Hark says. "But sellers had not adjusted to the marketplace." Last year was a very difficult year, "but things are boding well for us" in 2010, Hark says.

Buyers also must have the money to consummate a deal, and only a "select few organizations" have either strong financials or a capital partner to enable them to be acquisitive, says Mike Rovner, a partner at Austin Ventures, an Austin, Texas-based investment firm. "Most are not in that position," he says.

At International Payments Corp., a San Jose, Calif.-based merchant-services company formed last year, CEO David McMackin says sellers long have wanted to sell, but access to capital to make the sales was limited. As such, McMackin says many more sellers have approached his firm seeking capital.

"Many of them have already been a part of a proposed transaction in the recent past that has failed to fund," McMackin says.

As a potential ISO buyer, Rovner says it is a "ripe time to become part of a rollup" among multiple businesses. Century Payments Inc., with Austin Ventures' backing, bought four ISOs in 2009 to form a larger company.

Still, the impact of the economic downturn continues to cause some in the ISO industry to remain committed to selling their portfolios. "The declines in the numbers of small businesses and in consumer spending have had a widely felt impact on near-term revenue growth and portfolios," Rovner says. "There are folks whose asset bases have not met plan or are declining."

In other words, they are losing money.


Buying More Than A Portfolio

Many organizations rely on acquisitions to grow sales and to generate additional revenue. Sometimes it is easier than securing new merchants through traditional sales methods.

While many reasons exist for acquisitions, "the underlying reason is generally to further either a financial or strategic objective," Velocity's Caso says.

Strategic purchases can help expand an ISO's merchant base along with adding the sales organization that built the purchased portfolio, he says.

"By making the proper strategic portfolio purchase, a company can expand its geographical read by purchasing a portfolio that has sales agents in markets where the company is not currently operating," Caso says.

The purchaser also may benefit from buying a technology, such as an Internet payment gateway, that the acquired company developed successfully, he says.

Buyers exist in all sizes, Hark says. Some specialize in buying the residual revenue, such as Velocity Funding. Others want the merchant portfolio and sales staff, such as Merchant Data Systems.

Drew Freeman, Merchant Data Systems president, tells ISO&Agent the two co-founders of Delray Beach, Fla.-based ISO Merchant Services, who built the sales organization, are staying with the company, which ties into a buyer's strategic goals of obtaining sales expertise along with merchants and their processing volume.

"We bought the sales engine," Freeman says, referring to the sales force and its structure of agents. The two co-founders have "done a great job recruiting [sales] agents."

Merchant Data Systems' model provides owners of acquired companies the option to stay with the company, but it assumes at least a 51% ownership stake in the acquisition, Freeman says. "Primarily we like partners that have relationships with agents and still want to work at" merchant sales, Freeman says. "They don't want to get out."


Legal Concerns

Aside from the business considerations of acquisitions, buyers and sellers should address legal concerns, too.

"Anyone getting into this has to know that most deals negotiated are not closed," says Adam Atlas, a Montreal-based attorney with Adam Atlas Attorney at Law. "Every buyer and seller should have that healthy attitude in mind."

Deals often do not close for a couple of reasons, notes Atlas, who has counseled merchant acquiring and ISO buyers and sellers. One reason is the buyer ends up not having the money to close the sale. Another is the buyer or seller has an "unrealistic perception of the value of what is being sold." This outcome often happens when sellers set multiples they will not go below.

One method to reduce the possibility of a failed deal is to talk about price earlier in the conversation, Atlas says. Doing so early enough can eliminate incompatible partners, he says.

Both parties to a sale also should be cognizant of obligations to the portfolio's processor, Atlas says. ISO agreements with processors often include obligations not to reveal pricing and to give the processors the right of first refusal, Atlas says. That means sellers have to check with processors that it is OK to reveal the pricing structure for their merchant portfolio, he says.

Processors typically do not like to see portfolios move around because the sale could be disruptive and ignite merchant attrition, he says. And not every ISO contract has these clauses, so ISOs must "study their agreements to see what kicks in," Atlas says.


Quality Improvement

Attrition also can affect the quality of a merchant portfolio. "Generally speaking, attrition rates are definitely higher than they were 18 months ago," says Caso. Buyers typically value portfolios with higher attrition rates less than other portfolios available for sale, he says.

"Much depends on the merchant mix in the portfolio," Caso says. For example, Velocity's portfolios comprised primarily of medical-related merchant accounts have experienced a much lower attrition rate than have other portfolios, such as ones with a large restaurant concentration, which Caso says "have performed poorly."

Factor in uncertain economic conditions, and the role of attrition in determining a portfolio's value elevates.

In the past 18 months, attrition rates ran higher than historical rates, Caso says. "As a result, we have discounted the monthly residual by an additional 10% to 15% to account for the uncertainty of the economy," he says.

Caso expects attrition in many portfolios to be up at least an additional 10% from historical levels for the next 12 to 24 months.

Hark, too, has witnessed the impact of attrition rates in acquisition deals.

In 2007, a merchant portfolio might have a 15% attrition rate that buyers considered acceptable, he says. Today, buyers want something to counter higher attrition rates, sometimes requiring a certain percentage of growth in the portfolio before they fully compensate sellers.

"That's a result of the problem of high attrition rate in a lot of portfolios," Hark says.

As the ISO and acquiring industry adjusts to the economy, comfort levels appear to have increased, and buyers and sellers also are discussing deals. Merchant portfolios once again appear to have regained marketplace value, though not as high as before the economy sunk into recession two years ago.

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