Throughout the years, an interesting phenomenon related to payments processing portfolio valuations has arisen: the fair market value of a merchant acquiring portfolio has, more often than not, been equal to or greater than the fair market value of the payments processing company, or enterprise itself. A review of Preston Todd Advisors’ proprietary database reveals that across the spectrum of ISOs with roughly 2,500 to 15,000 MIDs, approximately eight out of ten portfolios displayed this characteristic from 2008 through 2015.
The notion that a merchant portfolio asset can be worth more than the entirety of the company that built it is arguably counterintuitive – it doesn’t seem like that should be the case. After all, it’s human nature to intuit things this way: that a part of something cannot have a greater value than the whole. But when you take a closer look at the cost structure of a traditional ISO, the explanation as to why this phenomenon has historically proven true comes to light.
The old ISO model…
ISOs of the traditional mold were designed to sell payments processing. The ability to process the transaction itself was the value proposition ISOs provided to merchants. Transaction processing was sold to merchants via sales channels comprised of 1099 agents, W-2 sales people, or a combination of both. From a market valuation perspective, the costs associated with the revenue derived from an ISO’s merchant processing portfolio would be tied, in many instances, directly to the costs of the sales channel. This is because a portfolio acquisition typically contemplated carving out the processing portfolio and the sales channel assets only: the deal structure and valuation was based on a buyer being able to “pull” the portfolio and sales channel and “plug them” into their own ISO platform, leaving the selling ISO’s remaining operational costs behind.
Thus, the valuation of the merchant portfolio asset often exceeded that of the entire ISO because ISO valuations, for their part, were based on a more traditional valuation methodology, whereby a company’s valuation, or enterprise valuation, was based on a multiple of their earnings, before interest, taxes, depreciation, and amortization were calculated out. Because enterprise valuations were based on a company’s entire cost structure, which included all the general and administrative costs in addition to the sales channel expenses – the valuations often came in lower than the merchant portfolio itself. (The principle in play being that netting down a business’ cash flows by all of its operational expenses further reduces its future cash flows, and pushes the valuation downwards)
The new ISO model…
The basic ISO business model has changed. ISOs are no longer just in the payments processing business – they’re in the technology business. ISOs provide value added products and services that go well beyond payments processing. Integrated POS, end-to-end business management solutions, and new infrastructure schemes like omni-channel are part and parcel of today’s ISO business model and the merchant portfolios included therein.
This is significant because…
The sale, implementation, and servicing of these new technologies that ISOs are employing doesn’t come without a price. Whether an ISO elects to build, develop, or acquire these new technologies, or leverage someone else’s technology in some form of a joint venture or strategic relationship, the ISO is necessarily accruing new costs, and these new costs have a direct impact on the ISO’s portfolio valuation.
And the historical gap between portfolio and ISO valuations is narrowing because…
The merchant portfolios being built today are no longer products of the sale of payments processing, they’re the products of the sale, installation, and support of customizable, sophisticated technology platforms that provide operational efficiencies, robust reporting, and frictionless, multi-channel consumer shopping experiences to businesses. And because of this, there are additional expenses that are directly tied to the portfolio assets that did not exist before.
A merchant portfolio and attendant sales channel can no longer be pulled as a stand-alone asset. Payments processing is only part of the value that ISOs are selling to businesses. As such, all the costs associated with the technologies and transaction processing that ISOs are selling need to be factored into the projected future cash flows of the portfolio, in addition to the costs of the sales channel, which ties directly to valuation.
As a result, it is imperative that buyers now model portfolio acquisitions as they would enterprise acquisitions, and as the methodologies for portfolio and enterprise valuations become comparable, so do the valuations themselves.
Article originally published in The Green Sheet on October 10th, 2016