What’s It Worth
In the bankcard industry, there are two main methodologies used to estimate the values of portfolios of merchants which are usually sold in conjunction with the sale of an ISO or even a larger processor. Those two ways both use a multiple but they vary in that one method looks at EBITA and the other the net monthly residuals of the seller. Below I will discuss each way of determining value and how they can be applied.
EBITA Multiple:
The first step to understanding the EBITA multiple method is to define what EBITA means. EBITA is an acronym that refers to Earnings Before Interest, Tax and Amortization as measured over a calendar year. So for example the EBITA figure is the earnings (profits) of the seller before any deductions for interest expenses. If any interest expense is ignored, then a potential buyer can get a clearer picture of the actual cash flow from a company since any interest expense can vary widely based upon how much debt the seller has and hence can tend to distort the true cash flows from the company. So EBITA is used by buyers to better understand a company’s relative net cash flow and to be able to compare it on a more even playing field to other companies in the same industry.
Once the EBITA figure is determined, it becomes a measuring stick for the value of certain companies in our industry. For instance, Payments Source reported in August of 2010 that the sale by Royal Bank of Scotland of its WorldPay unit was for a value of approximately 10 to 11 times EBITA. Given the sale price of approximately $3 billion, if you use the 10 times figure, that implies that the EBITA for WorldPay was approximately $300 million.
The type of companies that are usually valued in such a manner tend to be the very large companies in the industry. For the most part, we are talking companies valued in the hundreds of millions of dollars. I believe that is the case because the EBITA figure gives the buyer a clearer picture of what the purchaser can expect it can get on an annual basis in increased cash flow as a result of the purchase.
These large sales include a tremendous amount of assets such as people, offices, processing platforms and other things that are needed to run the operations of the seller. A buyer in the same industry might be able to get some benefits from consolidating operations of the seller but likely will not be able to drastically reduce operating expenses attributable to the seller. So in most cases the EBITA of the seller will be added to the EBITA of the purchaser without the purchaser being able to just divest itself of the operations of the seller. Compare that to the smaller portfolios we will discuss next that are valued in a completely different manner.
Multiple of New Residuals:
The more common way to value companies at the lower range is by using a multiple of the net monthly residuals of the seller. By that I mean that all the relevant monthly revenue streams that are recurring in nature are tallied up. Then any payments made to sales agents, referral sources, employees and anyone else that shares in the revenue is deducted. The remaining net residuals are multiplied by a number, giving us the value of the seller.
By way of example, assume an ISO has some number of merchants in its portfolio generating $100,000 a month in gross residuals that is paid to the ISO by its processor. But, the ISO has a lot of sales agents that are paid a portion of those residuals along with some referral sources and employees amounting to $65,000.00. Those sharing in the income rarely are also bought out when the ISO sells. So since those residuals paid to the others are not going to be sold, the ISO really only owns $35,000.00 in monthly residuals.
Once the net residual figure is determined, then the multiple is applied to determine the value of the seller. The multiple can vary based upon a number of different factors. First, a small agent portfolio that is essentially just the right to get paid some residuals is usually at the bottom of the value range. If the portfolio is with one of the larger processors and the ISO has some control over merchant customer service, then the multiple increases. For larger ISOs with some measure of portability for their merchants who control risk and underwriting the multiple can go even higher.
So for instance if for our imaginary ISO with $35,000 of net residuals per month, a buyer offered a multiple of 15 times the monthly net residuals, the purchase price would be $525,000 and at a multiple of 30 the purchase price would double to $1,100,000. As you can see, the purchase price can vary greatly based on the multiple which is driven for the most part by the factors previously mentioned and the quality of the merchants.
But why is the multiple of net profit used for the smaller portfolios sales instead of a multiple of EBITA? Likely because it is a better reflection of the value of the portfolio to the buyer than an EBITA figure. Sure the seller has expenses associated with operating the portfolio it wants to sell. But likely the buyer, if it is in the industry already, will not have much in the way of operational expenses it has to take over from the seller or any substantive increase in the costs for to the buyer for operating the portfolio in the future.
If the buyer is already in the business, it has in place the customer service, risk monitoring, equipment deployment and other operations pieces it needs to run the portfolio it is buying. So a smart buyer can go out, find a new portfolio on a comparable platform that is say 10% of the size of the buyer, and add those merchants to its existing portfolio. The buyer does not have to take over any of the employees of the seller, the office space of the seller of anything else for that matter since the buyer already has all it needs to take over the portfolio in place. Generally an increase of that amount will have little impact on the purchaser’s operations. The purchaser already has a risk team in place and does not have to do much more to monitor that increased number of merchants.
In my experience, in the bankcard industry in once you get your company set up with all the various departments like risk, customer service and underwriting, the company is very scalable. By that I mean if you double in size, you do not need to double the number of employees, you just need to make incremental increases that are much smaller than the size of the increase to your portfolio. So that favors the larger players in that their cost per merchant for servicing, risk and the like is much lower than for the smaller players which is generally know as “economies of scale.” This applies to ISOs on the smaller end of the spectrum but does not necessarily apply to the much larger organizations like our WorldPay example.
The way your portfolio is valued is important to you if you are looking to sell. Making sure you get the highest value demands that you pay attention and try to get the highest multiple be it of net residuals or EBITA.
The information contained herein is for informational purposes only and should not be relied upon in reaching a conclusion in a particular area. The legal principles discussed herein were accurate at the time this article was authored but are subject to change. Please consult an attorney before making a decision using only the information provided in this article.
