40 Years of M&A…

by Bruce Kropschot Sept/Oct 2013

The Alta Group’s Bruce Kropschot notes that throughout the past four decades, mergers and acquisitions have played a key role in the development of equipment leasing and finance. Here he shares with the Monitor his reflections and outlook regarding the influence of M&A activity on the industry.

Bruce Kropschot,
Senior Managing Director,
The Alta Group

The Early Years

My involvement in the equipment leasing industry started in 1972. As the CFO of the largest designer and builder of hospitals, I was given the task of getting this company into the equipment leasing business in order to provide equipment leasing services to the parent company’s customers and prospective customers. Insurance reimbursement of lease payments had spurred rapid growth in the use of leasing by hospitals, and in 1972 two relatively new leasing companies (Telco Marketing Services and Hospital Financial Corporation) had successful initial public offerings.

To jump-start our company’s entrance into the hospital equipment leasing market, we acquired a small diversified leasing company, based in Philadelphia in late 1972, and we shifted its emphasis to the healthcare equipment market. That was the first of more than 160 equipment leasing company acquisitions that I have been involved in during my career. Beginning my leasing career with this Philadelphia-based company also provided me the opportunity to get to know Mike Molloy shortly after he founded the Monitor and Jerry Parrotto, the current executive editor and owner of the Monitor, who was then our lending officer at one of our leasing company’s principal banks in Philadelphia.

When the Monitor was founded 40 years ago, the equipment leasing industry included the following participants:

• A few major captive finance companies such as IBM, Xerox and John Deere;
• A few large transportation equipment leasing companies such as GATX and Union Tank Car;
• One dominant national vendor leasing company — U.S. Leasing;
• A number of specialized computer lessors such as Leasco, MAI and Comdisco;
• Leasing subsidiaries of several major corporations such as GE; and
• Many independent leasing companies, most of which operated in a limited geographic area with their largest business segment being copiers and other office equipment.

Growth of Banks in the Equipment Leasing Market

Forty years ago there were very few banks in the equipment leasing market. Banks were not even permitted to be a lessor of personal property until a 1963 ruling gave national banks that authority. In 1970, banks for the first time were allowed to form holding companies, under which they could engage in a number of nontraditional financing activities such as equipment leasing. Probably no single factor changed the leasing industry in the U.S. as much as the entrance of commercial banks into leasing. Most banks were slow to enter equipment leasing, but the fact that some major banks entered the equipment leasing business “legitimatized” leasing and helped spur the industry’s rapid growth beginning in the 1970s, which led to the consolidation movement in the 1980s and 1990s.
Equipment leasing was one of the few financial services that banks in the U.S. could pursue aggressively beyond their home state until the late 1980s. This opportunity led many banks to obtain leasing expertise and expand their leasing activities geographically through acquisition beginning in the late 1970s and accelerating in the 1980s, thereby getting a jump on interstate banking before they could offer traditional banking services in other states. As leasing became an important profit contributor to banks, some of the more aggressive banks encouraged their leasing companies to enter new niche markets through acquisitions. Also, many smaller banks acquired local leasing companies in order to compete with the larger bank and nonbank leasing companies that solicit bank customers for leasing business.

Although deregulation in the American banking industry resulted in many banks acquiring leasing companies, the number of such acquisitions has declined in the past 15 years as almost all of the large banks in the U.S. now have leasing businesses. However, banks still represent the largest category of leasing company acquirers. Of the 49 leasing companies in the latest Monitor 100 annual survey having over $1 billion of assets, 24 of them are bank affiliates. This compares with only seven bank affiliates among the 28 leasing companies having over $1 billion of assets in the initial Monitor 100 survey 22 years ago. Of course the banking industry itself entered a period of rapid consolidation, and there has been a significant reduction in the number of banking organizations in the U.S. in the past 15 years. Many bank leasing companies grew as a result of this bank consolidation; for example, Bank of America’s equipment leasing business is the survivor of more than 10 separate bank leasing companies whose parent banks have become part of Bank of America through one or more mergers.
The growing importance of banks in the equipment leasing and finance industry in recent years can also be demonstrated by their share of the new lease and loan originations, as shown in the following summary of new business volume for the years 1999 and 2012 by the companies included in the Monitor 100:

 Monitor 100 Segment Mix
 Based on New Business Volume

CategoryNumberof CompaniesPercentof New Business
Year1999201219992012
U.S. Bank Affiliates354918%32%
Capitves171528%41%
Independents232724%4%
Foreign Affiliates1456%5%
U.S. Industrial Affiliates7121%16%
Not elsewhere classified433%2%

 

The strong increases in leasing market share obtained by both bank leasing companies and captives since 1999 has come at the expense of independent leasing companies. Independent leasing companies accounted for only 4% of total Monitor 100 originations in 2012, as compared with 24% of total Monitor 100 originations in 1999, even though there were 27 independents in the 2012 survey as compared with 23 in 1999. The decline in independent leasing company market share is primarily due to the fact that many of the large independent leasing companies have been attractive acquisition targets, with banks accounting for a large portion of those acquisitions. Also, with banks becoming more aggressive in the equipment leasing and finance markets, independent leasing companies are at a competitive disadvantage with regard to funding cost and capital availability, inhibiting their opportunities for growth.

Other Types of Acquirers Through the Years

Although banks have accounted for the largest share of leasing company acquisitions during the past 40 years, a number of other types of acquirers have played major roles during different time periods.

Non-Financial Corporations

In the 1980s, some of the largest equipment leasing company acquisitions in the U.S. were made by corporations whose principal activities were outside the financial services field. These acquisitions were made for a number of reasons, including the parent company’s access to low-cost capital and the high growth and profitability rates experienced by equipment leasing companies in the U.S. in the 1980s.

Many non-financial corporations entered the leasing market for the tax benefits of leasing. The liberalization of the investment tax credit and depreciation deductions in the U.S. in 1981 greatly increased the tax benefits of leasing. Many independent lessors were unable to use all of these tax benefits and became attractive acquisition candidates for companies with a large amount of taxable income. The era of tax benefit transfers in the early 1980s also spawned a host of corporate investors. The tax benefits of leasing in the U.S. were significantly reduced in 1986 with the elimination of the investment tax credit and the reduction in the corporate federal income tax rate from 46% to 34%. Thus, there have been fewer leasing company acquisitions in the U.S. for tax reasons since 1986.
Ford and Chrysler were among the industrial corporations that made sizable leasing company acquisitions in the 1980s. The breakup of AT&T produced seven large regional telephone companies, and several of them acquired leasing companies in the 1980s. AT&T itself formed AT&T Capital, which acquired a number of leasing companies in the U.S. and internationally. Several electric and gas utility companies also entered the equipment leasing business through acquisitions in the 1980s. Most of these major new entrants into equipment leasing in the 1980s disposed of their leasing operations in the 1990s to focus on their core industries, and there have been very few acquisitions of leasing companies by non-financial companies in this century. The one exception has been GE Capital, the only U.S. industrial affiliate included in the latest Monitor 100, although their interest in growth through acquisitions has declined in recent years.

Foreign Banks

From the mid-1980s to the early 1990s, a number of European and Japanese banks and leasing companies expanded into the U.S. leasing market through substantial acquisitions. Others opted for smaller acquisitions to obtain a U.S. market presence. Such foreign acquisitions of equipment leasing companies in the U.S. have declined significantly in recent years as most of the major foreign leasing companies and banks that want to be in the U.S. already have a presence in the market. Several Japanese companies exited the U.S. leasing market when they faced serious economic problems in Asia in the late 1990s. Also, many of the acquisitive European leasing companies and banks have seen more fertile growth opportunities in both Western and Eastern Europe in recent years. Thus, the market share of foreign affiliates in the Monitor 100 has declined from 14% of total Monitor 100 new business volume in 1999 to 5% in 2012.

Savings and Loan Associations

For a brief time in the 1980s, a number of savings and loan associations were attracted to the equipment leasing market. Not having commercial loan expertise internally, most of these S&Ls entered the market through the acquisition of independent equipment leasing companies. When the real estate bust of the late 1980s took place and many S&Ls experienced financial difficulties, almost all of the S&Ls got out of the leasing business by selling their leasing affiliates or liquidating their portfolios.

Other Equipment Leasing Companies

Unlike some other categories of active acquirers in the 1980s and 1990s, many equipment leasing companies have continued to pursue growth by acquisition in this century. Often they are looking to enter new market niches or to obtain specific expertise. It can be less costly and much quicker to acquire an established company in a particular niche than to try to develop the niche from a start-up operation. The niche may consist of expertise in a particular type of lessee, vendor or equipment category or a strong market presence in a particular geographic area. The segmentation of large leasing companies into a variety of leasing products and markets has helped create an interest in strategic acquisitions of small leasing companies that are successfully servicing attractive niche markets. A variety of leasing companies have made acquisitions of companies in niche markets through the years, but GE Capital has been a noteworthy active acquirer of other leasing companies for more than 30 years.

Roll-Ups

A phenomenon of the late 1990s in the U.S. was the consolidation or roll-up concept in which several independent companies in a particular industry consolidate to achieve economies of scale. In the leasing industry, there were four roll-ups that accounted for about 50 leasing company acquisitions from late 1996 through 1998, most of which were relatively small independent lessors. These consolidators enabled equipment leasing entrepreneurs to convert their ownership in a private company to cash and/or ownership in a public company while obtaining the funding cost benefits a larger company can provide.

This roll-up acquisition boom came to a screeching halt when gain on sale accounting for securitized leases lost favor among investment analysts. The four newly public leasing companies were forced to discontinue the use of gain on sale accounting, resulting in greatly reduced earnings and substantially lower stock prices. This made it more difficult for these companies to access the capital markets, and their problems were exacerbated by the difficulties these companies encountered in managing their rapid growth and integrating the acquired companies. Three of the four consolidators filed for bankruptcy and have been liquidated, and the fourth was acquired for less than 20% of its peak stock market price. This poor experience in the public markets in the late 1990s is likely a factor in there having been very few equipment leasing companies enter the public equity market since then.

Private Equity Firms

Private equity firms have greatly increased their investments in financial service companies in recent years. Several private equity firms have made investments in equipment leasing and finance companies, and an increasing number of firms are now looking at opportunities in this sector. One recent successful private equity investment was Flexpoint Ford’s acquisition of Financial Pacific Leasing, and the subsequent sale of this business to Umpqua Bank less than three years later. With the public equity markets often not a viable alternative, a sale to a private equity firm may be a good alternative for independent leasing companies that do not yet have the track record or the size to be attractive acquisition targets for banks. Some private equity firms are looking for privately-owned companies whose management wants to retain an equity interest; such firms could be good partners for equipment leasing companies that are looking for an equity investor to provide growth capital.

What Will the Future Hold?

The leasing industry has always been very entrepreneurial. Even though the industry is increasingly being dominated by banks and large leasing companies with greater access to low-cost capital, there is still room for smaller companies to develop market strategies that can be successful. As long as there are thriving independent leasing companies, there will be an active M&A market because these companies’ founders and investors will eventually need an exit strategy.
The active U.S. acquisition market in the 1980s and 1990s enabled many of the early leasing entrepreneurs of the 1960s and 1970s to convert their investments to cash and enjoy the fruits of their labor. The owners of some of the current leading independent leasing companies are reaching an age where they need to consider the sale of their business in order to provide liquidity for their estate. Other independent leasing companies are reaching a point where they need more equity to continue their growth, and their typical alternatives are to sell the company, bring in a private equity investor or have a public stock offering. The supply side of future M&A activity will also undoubtedly include equipment leasing businesses that no longer fit the plans of their bank or corporate owners.

On the demand side, banks will likely continue to represent the largest share of leasing company acquirers. Some larger banks will want to acquire companies to expand into new leasing markets, and some smaller banks will want to enter the leasing business through acquisitions. As we have seen numerous times over the past 40 years, we can expect that there will be aggressive public leasing companies eager to make numerous acquisitions. The future of private equity investment in leasing companies and the receptivity of the public markets to leasing company IPOs will largely hinge on the future successes or failures of companies accessing those markets.

The past four decades have been very interesting for those of us who have been continuously active in the equipment leasing industry. Mergers and acquisitions have played a major role in getting the industry to where it is today, and I expect that strategic acquisitions will continue to have a major impact on the growth of many of the leading equipment leasing and finance companies.

Bruce Kropschot is senior managing director of The Alta Group and heads the global consultancy’s merger and acquisition advisory practice. Kropschot has been active in the equipment leasing industry since 1972, serving as a senior executive with three large leasing companies and providing M&A advisory services for 27 years.

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