Maximizing Portfolio Value in a Sale: Capitalizing on the Valuation Variance of Downline MLS PortfoliosSubmitted by Adam Hark on February 25th, 2018
M&A activity in payments is prodigious, and maximizing portfolio value in a sale has never been more important. Though the heavy level of deal activity in the marketplace is a fairly current phenomenon ( the past 18 months or so), there’s nothing particularly new about trying to maximize the value of the businesses and/or assets we own when we attempt to sell them. In the merchant acquiring space, saleable properties are unique, and their worth is ultimately valued on the basis of “primary attributes” tied directly to the performance of the underlying payments processing portfolio: attrition, revenue concentration, and SIC/MCC distribution for starters. However, in such an active market, where demand is so high, new buyers emerge, and by virtue of their expansion of the marketplace, these new buyers bring new deal structures and the concomitant broadening of those primary attributes which drive portfolio and ISO valuations.
The Usual Suspects
Year over year attrition, revenue concentration, and SIC/MCC distribution are widely recognized by the bankcard processing community (and the M&A specialists who serve as brokers to it) as primary drivers of merchant portfolio and ISO enterprise valuation. And they are. But to assume that these “usual suspects” account for 100% of a given property’s value is folly. There’s so much more that goes into maximizing portfolio value in a sale that owner/operators need to understand, not the least of which is the distribution of accounts, processing volume, and residual revenue attributable to each and every downline MLS writing new business for an ISO. And it’s with the downline agent portfolios where we see a changing trend in the industry: new entrants to the marketplace - buyers of payments portfolios and ISOs - are becoming less sensitive to the risk associated with the downline MLS/agent portion of an ISO’s merchant portfolio. As such, we (brokerage firms like mine) are seeing more deals where the acquiring party is making offers on the gross residual received by ISO from its portfolio, as opposed to traditional deal structures where buyers’ offers were based on the net residual received by ISO, after payouts to downline MLSs.
Understanding the New Way Deals are Being Put Together
To illustrate the aforementioned new deal structures and how the MLS/agent’s portion of an ISO’s portfolio is playing into valuation, let’s assume a seller has a portfolio throwing off $400k per month in processing residual, but after paying out downline agents, the seller’s net is only $200k. Traditional portfolio acquisition deal structures contemplate the acquisition of the seller’s portion only: meaning the portfolio valuation is based on a factor/multiplier of the $200k in residual that seller nets each month.
What we’re starting to see in the marketplace are buyers looking to acquire the entire processing revenue of the portfolio. Using this same portfolio as an example, that would mean buyer would be looking to acquire the entire $400k per month. Sellers would then work out the buyouts of the downline agents’ portions of the portfolio. As a direct consequence of this, the risk associated with the agents’ portions of the portfolio revenue requires much more scrutiny, particularly of an oft overlooked and ignore factor in traditional portfolio acquisitions: the contractual relationship between an ISO and its agents.
To Maximize Portfolio Value in a Sale, Owner/Operators Need to Re-think the Contracts with their Downline MLSs to Account for Valuation Variance
To understand this concept, we need to accept the following premise as true: all MLS / agent books are not worth the same. By way of example, let’s imagine taking the following two MLS/agent portfolios to market:
Portfolio #1: 200 active merchants and a monthly residual (after split with ISO) of $15,000.
Portfolio #2: 30 active merchants and a monthly residual (after split with ISO) of $1,500.
Assuming the primary attributes of both portfolios are the same, attrition, SIC/MCC distribution, and revenue concentration, the variance in valuation between Portfolio #1 and Portfolio #2 would be stark as a function of size (number of active merchants). The risk concentration of Portfolio #2 is much greater than Portfolio #1 as a function of its small size, resulting in Portfolio #2 necessarily trading in a lower valuation range. Thus, when contemplating a transaction where and ISO’s gross residual is being purchased, the valuations of the downline MLSs’ portions of the portfolio would not be equal. If the ISO’s owner assigned a standard, one-size-fits-all buyout formula to all of his or her downline agent portfolios, there’s the potential to lose out on a lot of money in the transaction. How? Remember this is a gross residual buy, so buyer would assign a multiplier to the gross residual amount before ISO pays out downline agents. For the sake of this example, let’s say the multiplier is 40X. So if the ISO owner has to buyout all of his or her downline MLS’ portions of the portfolio at 40X, the ISO owner is losing out on the valuation variance of the downline MLSs’ portions of the portfolio because many or most of those smaller, downline agent portfolios aren’t worth 40X!
What does this mean? ISO owners today need to anticipate the possibility of gross residual purchases and account for that potentiality in their agent and MLS agreements. In a portfolio deal where the gross residual is being purchased, ISO owners need to have already included buyout formulas in their MLS/agent agreements addressing the inherent valuation variance in the downline portfolios. This can be established by creating multi-tiered valuation ranges in the MLS/agent agreements based on the specific portfolio attributes of each downline’s book of business: number of accounts, total processing volume, etc. I would encourage all ISO owners to take a close look at their agent agreements and discuss with an industry specific attorney or consultant the insertion of a framework which addresses the same.
Article originally published in The Greensheet on February 12th, 2018
Adam T. Hark is Managing Director of Preston Todd Advisors. With over a decade of consulting in the payments and financial technology sectors, Adam advises clients on M&A, growth strategy, exits, and business and portfolio valuations. Adam T. Hark can be reached at email@example.com or 617-340-8779.