LBO Firms Take Note: Acquiring Is Now a ‘Quite Cyclical’ Business

The fortunes of individual merchant acquirers not withstanding, the acquiring industry as a whole for decades has proffered an unofficial guarantee of recession-proof growth. But a new study by First Annapolis Consulting Inc. shows that changes in the acquiring industry's growth rates are increasingly correlated to retail sales growth. And that means certain assumptions about the industry that make it attractive to private-equity firms looking to do leveraged buy-outs?such as highly predictable and steadily increasing cash flow?may need to be revisited. First Annapolis's findings come in the wake of recent deals that will take such prominent, publicly traded payment processors as First Data Corp. and Alliance Data Systems Corp. private (Digital Transactions News, May 17). “This industry is an LBO target because the revenue streams are so stable,” says C. Marc Abbey, a partner at Linthicum, Md.-based First Annapolis. “But if those assumptions are changing, then it could get interesting.” The firm's recent study compared changes in Visa/MasterCard volume?a proxy for the acquiring industry?and retail sales. The spread between Visa/MasterCard credit and signature-based debit card volume growth and retail sales growth is still healthy, but narrowing. In the mid-1990s, it was 12 to 14 percentage points, but it has narrowed considerably in recent years to 4 to 5 percentage points. In 2006, retail sales grew 7.0% while Visa/MasterCard volume rose 11.9%, according to First Annapolis research. At the same time, correlation between changes in card sales and retail sales has increased. In 1997, the correlation coefficient calculated by First Annapolis for retail sales growth and Visa/MasterCard volume growth for the preceding five years was 0.65 (1.0 indicates a perfect correlation). In 2001, the corresponding coefficient was 0.83 and by 2006, it hit 0.94. Taken together, the narrowing spread but increasing correlation of Visa/MasterCard charge volume and retail sales shows that the acquiring industry is falling more into lockstep with the economy in general as its days of easy growth fade into history. “Our thesis is the acquiring business for the first time in its history has become quite cyclical,” says Abbey. Merchant acquirers still have plenty of opportunity to convert cash and check sales into card sales, which accounts for the persistence of the spread, according to Abbey. But, on the card-issuing side, the days of big growth fostered by mass-appeal cobranding programs and the penetration of cards into new customer markets such as subprime are largely tapped out. “We're just facing a more mature industry,” he says. What the findings mean for acquirers is that the industry is more vulnerable than ever to a general economic downturn, though a recession would have to be particularly severe to negate the spread between retail sales and Visa/MasterCard volume and actually cause card sales to fall. But individual acquirers will be more likely to post volume declines?and negative earnings?if problems particular to their own companies coincide with weak retail sales. Ultimately, the findings show that a better term to describe the acquiring industry is no longer “recession-proof,” says Abbey, but “recession-resistant.”