The Most Valuable Merchant Portfolio
What a useful academic exercise it would be to cobble together the perfect portfolio: the one to which all other merchant portfolios aspire. A variation of this exercise is commonly performed through “benchmarking,” an analysis of a subject merchant portfolio as compared with a premium book which is known to have carried a top valuation in the marketplace. Benchmarking is a highly effective tool for owners interested in maximizing the value of their merchant portfolios. It can show them where their portfolios are strongest and where they need improvement, as related to valuation.
But what if we were to indulge in this academic endeavor and build the perfect, most valuable portfolio? Where would we start? First, we would need to identify the top drivers of value in merchant portfolio sales. Second, we would need to know that for each of these drivers, there exists what the marketplace perceives to be the optimal range, value, type or level.
Here are the six top drivers of merchant portfolio value in today’s marketplace:
- Number of accounts: In case you haven’t noticed, as a general rule, smaller portfolios trade in a lower multiple range than larger portfolios. The operating principle here is risk concentration; simply put, as the number of merchants in a portfolio approaches zero, the inherent risk associated with the acquisition increases because the percentage of the total residual tied to each merchant becomes disproportionately larger. Therefore, if a merchant is lost for any reason, there is a high probability a large portion of the revenue may be lost as well. In larger portfolios, the percentage of the total revenue attributable to a single merchant account is usually much smaller, and therefore less risky to buyers.
- Revenue concentration: Has anyone ever told you your portfolio is top heavy? If so, the person was alluding to a revenue concentration issue. When a single merchant, or group of merchants, represents an extraordinarily large percentage of the overall revenue of a book, the revenue concentrated therein must be addressed. Think of it like this: you’re looking at two portfolios for acquisition, and each portfolio has 10 merchant accounts and throws off $1,000 per month in residuals. In the first portfolio, each of the 10 accounts throws off $100. In the second portfolio, nine merchants throw off a total of $100, and one merchant throws off $900. The portfolio with the major revenue concentration issue is, of course, a more risky acquisition. This example is extreme, but you can see why revenue concentration is weighted so heavily when it comes to portfolio valuation.
- Processing platform: The idea that one processing platform is technologically or functionally better than another is legitimately debatable, but that merchant portfolios processing on certain platforms will fetch higher valuations than portfolios processing on other platforms is not. It’s just the way it is.
- Account composition: Account composition can speak to two attributes of a merchant portfolio: the ratio of card-not-present (CNP) merchants to brick-and-mortar merchants and/or the percentage of merchants within a certain industry type within a given portfolio. These days, there are plenty of buyers for portfolios with both CNP and traditional brick-and-mortar merchants, so this aspect of portfolio composition isn’t a top driver of valuation.
However, in a portfolio where a certain industry vertical has been penetrated, and consequently, a material concentration of that business type exists in the portfolio, that book will be perceived as being more valuable than a portfolio with an across-the-board admixture. Niche vertical penetration suggests there’s something there beyond the payment processing, often some form of business management solution or POS technology, or specialized knowledge about a certain type of merchant. In both instances, this usually translates into “stickier” merchants, and this has a lot of value to would-be buyers.
- Portfolio seller’s plans: This driver is particularly interesting because it doesn’t directly relate to the merchant portfolio itself. But if a seller of a merchant portfolio is willing to commit to manage the merchant accounts being sold, offset future losses with new accounts or write new business with the acquiring party, this plays a huge part in the ultimate valuation.
- Attrition: The big one. The value driver of all value drivers in merchant portfolio sales. Think about it: if you’re trying to determine the value of a portfolio by projecting its future cash flows, doesn’t it make sense that you would need to know at what rate those cash flows will attrit (lessen) over time? It’s really that simple. What’s not so simple is understanding which aspects of a portfolio’s attrition buyers pay the most attention to. Six or seven years ago, it was the year-over-year revenue/residual attrition. Today, you’ll find a lot more buyers modeling in the credit and debit card charge volume attrition as opposed to revenue attrition because of all the new fee-based revenue mixed into the total revenue number. ISOs are constantly adding and taking away fees, which can make it difficult to extract a meaningful year-over-year revenue attrition number. However, card volume is a much cleaner number, and thus can give a buyer a much more accurate read of the true performance of the portfolio over time.