The Next Golden Egg? Investors Are Interested In Debt Buyers . . . Again

Parthenon Capital?s significant $45 million investment last August in debt purchasing company Arrow Financial was just one transaction in a flurry of recent financial activity involving debt buyers.

In August of this year, Cavalry Partners acquired debt purchaser First Credit Solutions and NCO Group and NCO Portfolio Management purchased GE Capital?s Great Lakes Collection Bureau subsidiary and its purchased accounts receivables portfolio for $33.5 million.

Quad-C Management, Inc.?s November investment in Asset Acceptance Corporation won it fifty percent of the charged-off consumer debt purchasing firm and recent months also saw the well-received initial public offering (IPO) of Portfolio Recovery Associates, in which the company raised $51 million. Opening at $13 a share on November 11, the company?s stock is now up more than 30 percent.

With the substantial transactions that companies like Parthenon, Calvary Partners, NCO and Quad-C are completing in today?s market, along with the success of Portfolio Recovery Associates? IPO, it?s no wonder financial buyers are seeking additional opportunities in the debt buyers? space.

This heightened interest may be attributed to the developing nature of the space; less than ten years old, debt buying is maturing and beginning to stabilize as an industry through the development of more sizeable players and the inception of two industry associations. Perhaps equally important is the continued receptivity of creditor grantors to sell their receivables.

In many ways, the current state of debt buying is very similar to the debt collection industry in the mid 1990s. At that time, most agencies were still independent companies owned by sole practitioners. But an aggressive merger environment quickly changed the space as companies like OSI began their acquisitive ways. Seven acquisitions later, OSI became one of the largest players in the industry, and from 1997 to 1998, private equity firms had acquired or invested in 21 different agencies.

Now that several sizeable transactions have occurred in the debt buying industry, investors may be preparing for an aggressive round of consolidation here too.

Tye Hanna of Worldwide Asset Management recognizes the initial signs of a trend. ?You have a downturn in the market and companies like Parthenon are looking for places to invest,? he says. ?These are strategic investors and they see an opportunity.?

Hanna believes we will see continued activity and diversification, noting that Portfolio Recovery Associates? registration documents indicate the company intends to expand into third party collections.

And why not? Promising financial returns in a depressed economy are bound to attract attention.

?Investors are interested in debt buying organizations because they can make money more quickly than in the stock market,? says Dennis Hammond, president of The Debt Marketplace, a firm that specializes in educating buyers and sellers on all aspects of marketing delinquent receivable portfolios. Hammond notes that he has even seen a few firms with brokers, testing the investor waters.

The space is made even more attractive by anticipated growth in certain segments. While most portfolio sales are still post charge-off and originate with bankcards or within financial institutions, this market is rapidly becoming saturated. Predicted growth in healthcare and telecom is certainly helping to drive this renewed interest and the belief that the government may start selling receivables presents a huge growth market for would-be investors.

The effect this potential influx of capital will have on the industry itself is unclear. What effect, if any, these larger, stronger buyers would have on creditors and their willingness to sell portfolios at certain prices remains to be seen.

Jack Lavin, CEO of Arrow Financial says ?Generally speaking, increased investment activity is good for the industry because it helps create more discipline and stronger infrastructure for debt buying companies.?

Hammond agrees, stating ?There may be a slow-down in sales from long standing sellers, but there are a lot of new sellers out there. It could impact prices, but we haven?t seen much change in six months.?

A warning to owners and investors alike: in the past organizations flush with capital have been tempted to overpay and have ultimately spent themselves out of business. The survivors have learned the lesson.

?In the end, it all goes back to knowledge and the capability in analytics of those buying the accounts,? says Hammond.

Hanna agrees. ?These are not investments in mom and pop start-ups. This activity involves well established debt buyers who know what they are doing. Even with lots of capital, these guys aren?t going to overpay for paper. They are going to buy wisely.?

Hanna advises buyers to ?stay the course? by continuing to make smart investments and not succumbing to the temptation to overpay.

One thing is clear – early consolidation and cash-heavy debt buyers mean that the owners with less financial strength need to prepare themselves for the future, as they will continue to encounter larger and financially stronger competitors in the marketplace.

Owners should also be aware that the debt buying industry has attracted sophisticated investors. Whether owners intend to raise investment capital or sell their company to someone who does, understanding their businesses? competitive position today can greatly enhance the owner?s position down the road, as interest in the debt buying industry continues to grow.

Mike Ginsberg is President and CEO of Kaulkin Ginsberg. Since 1989, the Kaulkin Ginsberg team has provided industry-leading information, expertise, and advice to the Accounts Receivables Management/Customer Relationship Management and other business service industries. Kaulkin Ginsberg has advised on more than 100 deals valued at more than $2 billion for a variety of family, private equity and public owners. Ginsberg is a member of the board of the Institute of Merger and Acquisition Professionals (IMAP), a member of the Association for Corporate Growth (ACG), and a member of the American Collectors Association (ACA). He also serves as an expert witness, and sits on the advisory boards of several industry associations and publications.