Mike?s Take: Good News on M&A in the ARM Industry

It is no secret that the US economy is having a significant impact on mergers and acquisitions overall. But the ARM industry is showing remarkable signs of resilience. Let’s take a look:

Worldwide, M&A was beaten down considerably in the 1st quarter of 2008. In fact, it suffered the biggest quarterly decline in 6 years, falling nearly 25% compared to the 1st quarter of 2007. Much of this decline was due to particularly low M&A activity in the U.S., which was down more than 50% from Q1 2007. By comparison, Europe’s M&A activity was virtually the same as last year.

Private equity-sponsored M&A deals were off some 70% from Q1 2007 overall and over 85% in the U.S., its lowest mark since Q4 2003. Down stock prices are negatively impacting some corporate buyers’ ability to pay market prices for acquisitions. The Dow Jones is down 7.6% from where it started ’08, its worst quarter since the dot com bust. If stock prices continue to drop, more publicly-traded corporate buyers will be forced to lower valuations or risk transactions that are dilutive.

However, I am happy to report that M&A is alive and well in ARM. In fact, the first quarter produced the same number of M&A transactions that occurred in Q1 of 2007. Nine transactions were completed in Q1 2008, totaling $461M in deal value (of which $325M was generated by the NCO-OSI deal). The important note is that deals are still getting done despite the current economic conditions.

Several key points came out of this recent quarter’s M&A activity:

1.     Buyers are continuing to secure debt financing for their transactions. Lenders are financing up to 4.5X the adjusted EBITDA value for top performing ARM servicers.

2.     Buyers are successfully structuring deals with sellers to take into account any perceived risk in the transaction.

3.     Sellers sustained their financial performance despite the economic conditions. While liquidation rates for some ARM servicers are still being impacted by the reduction in PIFs and SIFs, the successful ARM servicers quickly converted their collection strategies from large payments to recurring payment plans that debtors can afford. The low unemployment rate supports the notion that debtors can still make monthly payments; they just can’t tap their home equity lines to make larger payments.

4.     Starting at the end of January, the positive effects of tax season kicked into gear and resolved some concerns that the ARM industry was being severely impacted by the economic conditions.

5.     Credit issuers and debt buyers increased their outsourcing and debt sales volumes, and in some cases increased commission rates and incentive fees to motivate their top servicers.

6.     And finally, while the public markets have been extremely volatile throughout the quarter, stocks have started to rebound recently enabling some strategic buyers to begin looking at deals again.

The ARM industry tends to be more recession proof than most industries, and while recoveries in some market segments may be off, placements mount during down times. Buyers continue to be attracted to the ARM industry because it still possesses the characteristics of an attractive investment. It is a sizeable and growing industry, still highly fragmented, naturally competitive and profitable. The bottom line is that we are not seeing any noticeable changes in the number of deals completed or in purchase price levels.