Should They Stay Or Should They Go?

Non-bank acquirers are increasingly looking to foreign markets for growth and profits. Some are thriving, but others would be better advised to stay home.

The North American acquiring market may have been more challenging at one time or another than it is these days, but if so few independent sales organizations and other non-bank acquirers can recall when. Merchant attrition is up, margins are down, and transaction pricing seems to be all merchants want to talk about.

ISOs can, and do, respond in a number of ways. One way is to look for new, presumably less competitive, markets overseas. And, increasingly, that’s what they’re doing.

“The idea is that the market here is very competitive and very saturated,” says Jason Oxman, chief executive of the Washington, D.C.-based Electronic Transactions Association, a trade group for ISOs and other payments companies. “Merchants are lucky the market is so competitive. There are hundreds of ISOs.”

Many national markets in Europe, Asia, and Latin America, by contrast, are, or are perceived to be, either virgin territory for acquiring or dominated by single acquirers and hence ripe for competitive challenge. “Europe is the second-largest market compared to the [United States], and it’s far from saturated,” says former Visa Inc. executive Linda Perry, executive consultant with San Mateo, Calif.-based Global Vision Group, a consultancy that organizes a London conference on overseas acquiring opportunities. “That’s why people are going there.”

Figuring out whether making the move abroad is the right strategy, though, is a challenging affair, bound up in complications like foreign operating costs and practices and the question of whether domestic profits have been mined as efficiently as they could be.

‘Crushed And Crowded’

To be sure, factors pushing acquirers abroad are powerful. One is the rapid growth in e-commerce. Online merchants in the U.S. increasingly are selling to customers in foreign markets, and are frustrated by cross-border interchange costs. Their foreign customers also want to buy with their local currency and avoid foreign-exchange fees, a hurdle that can hike abandonment rates.

“In the early days of e-commerce, the majority of e-commerce companies were U.S.-based. Then companies like Amazon went everywhere,” says Perry.

Setting up shop in major foreign markets can erase those problems. It’s an expensive move, but “if we don’t service those merchants, they’ll seek out those that will,” says Doug Lewin, executive vice president at Optimal Payments PLC, which operates in Europe, Canada, and the U.S.

Numbers on how many U.S. non-bank acquirers have already established operations overseas are hard to come by. Even estimates are rudimentary, and are complicated by the fact that not all those that venture abroad succeed.

But those who watch this trend say it’s heating up. “It’s expanding far faster than ever in the past,” says Caroline Hometh, managing director at RocketPay Group, a Newburyport, Mass.-based firm that counsels acquirers on foreign ventures. “There is no conversation left where someone says, ‘Tell me why this is important.’ Now it’s, ‘I’m in Canada, how do I get into Asia and how do I add alternative payments?’”

The London conference Perry helps organize drew 135 attendees from 22 countries last year, when it was held for the first time. “We had to add tables at the last minute. It was crushed and crowded,” she says. The next one, set for May, may attract 150, and that’s only because Perry wants to cap attendance to allow delegates to mingle more effectively. “Networking is a critical factor,” she says. “It’s very senior people. We don’t want to do a 300- or 400-person conference.”

No More ‘Middleman’

A number of factors are turning up the flow of acquiring migration. For one thing, as Hometh notes, more venture-capital money has been pouring into the ISO business, and as it does executives want to expand abroad. “Every single week, I get a call from a VC firm thinking of buying a company that is interested in pursuing these strategies,” she notes. “Just follow the money.”

Legal changes have also played a part. Much of the industry’s attention has turned to Europe since the European Union’s Payment Services Directive in 2009 made it possible for non-bank acquirers to perform acquiring services without a bank sponsorship.

If companies qualify, they can obtain an acquiring license from a national financial-services authority (FSA), which under certain circumstances may then be used in one or more of the other 27 EU countries. These companies are also eligible for principal membership in the Visa and MasterCard networks.

This development has grown more appealing to U.S. ISOs as they have become more aware of it. Not only does the new license confer independence from acquiring banks, it also cuts out the fees ISOs must pay to these institutions. “Having a license eliminates the middleman, so the cost to us is lower,” says Lewin of Optimal, which has the EU license and recently obtained principal network membership.

Optimal this summer bought Meritus Payment Solutions, an Irvine, Calif.-based ISO with 8,000 U.S. merchants, in part with the intention of expanding the ISO’s reach into Europe, a prospect Allen Kleinman, principal at Meritus and a former venture capitalist, looks forward to. “Having Optimal’s European acquiring license is a tremendous advantage,” he says.

What makes this step especially appealing is that the cost, at least for reasonably capitalized non-banks, isn’t out of this world. The cost of obtaining both the EU license and the network membership ranges from $500,000 to $750,000, estimates Thomas A. Layman, founder and chief executive of Global Vision Group.

The U.K. and Malta regulatory authorities are popular FSAs, experts say, because of language and because they impose fewer restrictions and rules. The investment of time can vary widely, but Layman estimates six months.

Adding in consulting fees and operational set-up costs brings the total to between $1 million and $2 million, Layman figures, a hefty number to be sure but one Layman labels “not insurmountable.”

To be sure, at least some established U.S. ISOs are laying plans for international expansion. Atlanta-based Priority Payment Systems LLC expects to move into Canada and the U.K. within 12 months, says president and chief executive John Priore. “It’s exploratory right now,” he says. “Our partners have clients over there they think we can be helpful to.” Priority’s partners include American Express Co., Citigroup Inc., and MasterCard Inc., he says, adding, “We’re not going there because it’s greener pastures, we’re going there because it’s part of the value proposition of partnership.”

Strategic decisions by major U.S. processors to set up operations overseas have also emboldened ISOs to follow. Global Payments Inc. and US Bancorp’s Elavon, both based in Atlanta, have established businesses abroad, and First Data Corp., also headquartered in Atlanta, has been overseas for years, for example.

Elavon clients “are following their existing merchant base,” says David McAlhaney, a senior vice president at Elavon, which processes in Europe for an undisclosed number of acquirers. “They need to create a footprint in the EU.”

In other cases, larger, well-funded U.S. ISOs are entering markets via acquisition as price trends present an opportunity. Melville, N,Y.-based EVO Payments International, for example, bought Germany’s Deutsche Card Services acquiring business in the summer of 2013 and since then has bought a portfolio in Spain and signed an agreement with the Bank of Ireland to process for merchants in the Republic of Ireland and in Northern Ireland.

“Where EVO has been successful, it has done it organically through the acquisition of key bank portfolios,” says Darren Wilson, who is based in the U.K. and is president of EVO International. “Few have that capital.”

Barriers to Entry

And that’s the rub—one of several hurdles, in fact, for U.S. non-bank acquirers looking wistfully at seemingly greener fields overseas. Many European markets remain heavily dominated by local or national banks, making it hard for interlopers to find business. “Merchants will go to their banks first,” says Wilson, who estimates ISOs still command a sub-5% market share in Europe. Even in friendlier markets like the U.K., that share is probably no more than 7%, he says.

That may seem enticing at first blush, but the cost entailed in acquiring key portfolios—assuming they can continue to be found for sale at the right price—and then lining up a “passportable” EU acquiring license (one that works in multiple EU countries in addition to the one whose FSA granted the license) as well as principal network membership is daunting.

That’s just the start. Outside the U.K., barriers like language can’t be underestimated, experts warn. Even seemingly mundane factors like the condition of local roads can be a costly hindrance. “Here in the U.S., it’s easy to get around,” says Elavon’s McAlhaney. “In Europe, it could take you half a day” to get to some merchant locations to install a terminal.

Indeed, the costs and barriers are such that an acquirer realistically assessing a business, at least in Europe, should not plan for green-field returns in the early years. “You’ve got to understand the economies of what you’re getting into,” cautions McAlhaney. “Whatever you’re used to seeing as a net spread on your portfolio, you need to reduce it by at least one-third.”

Eyeing the ambitions of other U.S. ISOs to follow EVO’s example, Wilson puts it another way: “Many looked, few have succeeded.”

Clearly, the economics of foreign operations haven’t scared off all U.S. ISOs. Determined acquirers could do better. But it requires scale to begin with. Or the willingness to branch into related businesses beyond transaction processing, McAlhaney says. “You’re not going to make all your revenue off of processing,” he notes. “It could be the top-up of prepaid cards, it could be bill pay, but you have to add services to cover your operating expenses in the EU.”

‘A Golden Goose’

For a good many ISOs looking overseas, staying home might just be the best option. Experts point out that domestic conditions that might be pushing some ISOs to look abroad may not be quite as bad as they think, particularly if they can escape the downward pricing spiral.

“There is so much they can do in the U.S. still,” says Adil Moussa, principal at AdilConsulting, an Omaha-based firm focused on merchant acquiring. “They need to compete a little differently.”

McAlhaney agrees, pointing out that most ISOs continue to sell on price rather than value. “Too often, I hear, ‘It’s tough, margins are compressed,’” he says. “It’s because ISOs aren’t following the right business model.”

That model, in most cases, need not include exporting the firm to Europe. Instead of price, ISOs could sell value in the form of transaction security or help with the deadline on accepting Europay-MasterCard-Visa (EMV) chip cards, McAlhaney says. The card networks have set an Oct. 1, 2015 deadline for when the party not capable of handling EMV transactions will have to assume the liability for counterfeit fraud. Petroleum dealers have an extra two years.

Advising and equipping U.S. merchants for this big transition presents acquirers with a valuable domestic opportunity, one many aren’t exploiting. “What I’ve found with 99% of the [ISO] population is, we’ll worry about that later,” says McAlhaney. “Guys, you’ve got a golden goose.”

For Moussa, U.S. ISOs can escape the pricing trap by specializing in a vertical market and becoming a go-to advisor for merchants in that vertical. That opens the way for added margins, he says. But many acquirers shy away from this strategy because they think it forces them to decline business. “It doesn’t mean that, if a merchant outside the vertical comes to you, you can’t accept them as a client,” counters Moussa.

Even merchant attrition in the U.S., while running high, may not be as bad as many portray it. While losing better than 20% of their portfolios quarterly, ISOs are replacing that business at the same time, ending up with a small net gain.

Still, the siren song of overseas business will likely grow stronger as the months and years pass. U.S. e-commerce merchants in particular, as they grow, will demand local acquiring services for their expanding roster of foreign customers. And large ISOs able to make the investment will see opportunity in markets where few if any competitors have staked a claim.

How many will succeed in the long term remains the open question.