OSI's Valuation a Surprise for Some in the ARM Industry

The high-profile acquisition last week of Outsourcing Solutions, Inc. by rival collection giant NCO Group has generated widespread industry buzz, including a basic question about the price of the deal.

NCO is paying a $325 million for St. Louis-based OSI, a major ARM agency that reported on its Web site revenues of $440 million last year.

How can you buy a firm for less than its annual revenue? 

There are several answers, one related to mergers and acquisitions basics, while another relates to OSI and its business model of recent years.

Company valuations, especially for the purpose of acquisitions, are rarely pegged to revenue figures, said ARM industry business valuation expert David Lavine.

“Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) is typically the measure that is used in determining the value of a company,” said Lavine. “The total acquisition price will undoubtedly be a multiple of EBITDA.”

Lavine, a director with debt industry consultant Kaulkin Ginsberg, said that the multiple is determined using a wide range of criteria, such as expected profitability after integration or future growth prospects.

EBITDA is a non-GAAP (generally accepted accounting principles) measure of potential profitability, a metric that is proprietary and closely-held. EBITDA is also used by stock analysts and private equity players to assess publicly-held companies.

Privately-held companies rarely divulge numbers such as EBITDA, and Kevin Keleghan, president and CEO of OSI, declined to disclose the figures or the multiple used to value the company in the deal with NCO, during an interview with insideARM.com last Thursday. Keleghan did say that the price OSI will receive for the company was “a very strong multiple.”

OSI’s EBITDA may have been impacted by recent events in the firm’s history. The company racked up $600 million in long term debt from 1996 to 2002 as it grew through acquisition, borrowing the funds to purchase of several smaller agencies. Notable acquisitions over that time included Payco American Corp. — an agency with $180 million in revenue — in 1996; collection letter specialist North Shore Agency in 1997; and the super-deal to buy Union Corporation in 1998 which saw OSI gain control of Transworld Systems.

But many of those add-ons didn’t generate the revenue expected, and OSI declared bankruptcy in 2003. During the bankruptcy reorganization period OSI shed some $425 million in long-term debt. It emerged from Chapter 11 bankruptcy protection four years ago (“OSI Emerges from Chapter 11 with Credit Facility from Merrill Lynch to Support Portfolio Purchasing,” Dec. 10, 2003), but still carried around $175 million in debt.

The deal has attracted some negative attention. Forbes.com reported last week that ratings agency Moody’s has placed NCO’s bonds and other debt securities under review for a possible downgrade in the wake of the acquisition announcement. Moody’s said its review “will focus on the degree of leverage used to finance the acquisition, the terms of the financing package, (and) the profitability of OSI and NCO’s integration strategy.”

Moody’s typically reviews its rating on debt securities for a company after a major material change is announced, such as an acquisition.