by Bruce Kropschot, Senior Managing Director, Head, M&A Advisory Practice, The Alta Group Mar/Apr 2012
In his latest take on the acquisition outlook for 2012, Bruce Kropschot notes that with the economy showing signs of improvement, new origination volume increasing, credit losses declining and financing becoming more readily available and more reasonably priced, some independent leasing companies that decided not to sell until their results improved will be in a better position to consider a sale in 2012.
My last update on the merger and acquisition (M&A) market for equipment leasing companies, published in the Monitor a year ago, noted that conditions appeared favorable for a rebound in 2011 from the depressed levels of the three prior years. However, despite the increased strength of the capital markets, rising valuations of public companies and the continuing improvement in the economy, the M&A market remained relatively quiet for the equipment leasing sector with the exception of several large aircraft leasing company sales. In fact, the modest growth in overall U.S. M&A activity in 2011 failed to come close to the robust increase that had been forecasted by many experts.
Most forecasts for 2012 predict solid growth in the U.S. M&A market this year, despite continuing problems in the U.S. economy, the potential impact of the European debt crisis on the capital markets and the possibility of legislative gridlock due to election year politics. Among the factors that could bode well for 2012 M&A activity are the high cash levels held by U.S. corporations, the substantial capital that private equity firms are seeking to invest and the availability of acquisition financing at relatively attractive rates.
Among the factors that could bode well for 2012 M&A activity are the high cash levels held by U.S. corporations, the substantial capital that private equity firms are seeking to invest and the availability of acquisition financing at relatively attractive rates.
The big question for the equipment leasing sector is whether leasing companies will participate in the expected increase in overall acquisition activity in 2012. The answer appears to be “yes,” with more leasing businesses indicating they are receptive to a sale, and an upswing in potential buyers.
Reasons for Reduced Acquisition Activity From 2008-2011
The main reason for the low level of leasing company M&A activity for the last four years has been the scarcity of attractive independent leasing companies available for sale. In the very active acquisition years of the 1990s, independent companies represented the vast majority of the equipment leasing companies acquired. Since then, the number of larger, more desirable independent equipment leasing company acquisition candidates has declined due to the tremendous amount of industry consolidation that has already taken place.
The reduction in relative size of the independent leasing company segment can be demonstrated by the Monitor’s annual ranking of the 100 largest equipment leasing and finance companies in the U.S. In 1991, there were 25 independent companies in the Monitor 100, accounting for 11% of the net assets of the 100 companies. In the Monitor rankings for 2010, the number of independent companies in the top 100 declined slightly to 23, but the independent companies accounted for only 3.6% of the net assets of the 100 companies and only 3.7% of new business volume.
This is further illustrated in The Place of the Independent Equipment Leasing and Finance Company, an Equipment Leasing and Finance Foundation research study prepared by The Alta Group in 2011. This study pointed out that from 1992 through 2009, the independent companies that entered the Monitor 100 accounted for $24.10 billion of new origination volume in their first year on the list, whereas the independent companies that exited the Monitor 100 during that period had $57.55 billion of new origination volume in their last year as an independent company in the rankings. Clearly independent leasing companies have lost market share, and the most significant reason has been the acquisition of many of the larger independent companies by other leasing companies and banks.
Past industry consolidation is not the only reason for the scarcity of attractive independent leasing companies for sale during the past four years. The disruption in the capital markets that began with the Lehman Brothers bankruptcy filing in September 2008 has hurt the independent leasing companies the most, making their debt financing more difficult to obtain and relatively more expensive than debt financing for their non-independent competitors. Also, the long recession hit the equipment leasing and finance industry hard by reducing demand for equipment, thereby adversely impacting new lease origination volume, and by increasing delinquency and credit loss levels for equipment leasing and finance companies. We know of a number of independent companies that would like to be acquired. However, they realize that many buyers rely heavily on a price/earnings multiple in their valuations, so these independent companies are waiting until their financial results will justify a higher price.
Acquisition Outlook for 2012 — Increased Supply and Demand
With the economy showing signs of improvement, new origination volume increasing, credit losses declining and financing becoming more readily available and more reasonably priced, some independent leasing companies that decided not to sell until their results improved will be in a better position to consider a sale in 2012. Several of the more attractive independent leasing companies are currently preparing for the sale process, and we expect that some of them will be acquired in 2012.
The largest category of equipment leasing and finance company owners are banks, which rarely sell their leasing businesses. Manufacturers also rarely sell their captive leasing businesses. Private equity firms usually plan to sell within five to seven years after investing. There have not been many private equity investments in leasing companies, but, as leasing company valuations improve, we expect some private equity investors in leasing companies will seek to liquidate their investments. The few publicly owned equipment leasing companies will not have a significant impact on leasing industry M&A activity. Thus, if there is an increase in the sale of leasing companies in 2012, it will need to come from the independent company sector.
The Alta Group knows that there is an increased interest in acquisitions because of the volume of requests we are receiving from potential acquirers. These inquiries are coming from banks, private equity firms and other leasing companies.
Because of their reduced lending levels in recent years, many banks are very liquid. Furthermore, their cost of funds is extremely low, and the incremental profits they could achieve by investing in leases instead of governmental securities may make the acquisition of equipment leasing and finance businesses very attractive. We expect that several banks will acquire equipment leasing and finance businesses in 2012.
Many private equity firms are flush with cash and need to put it to productive use. Although private equity firms have not been major investors in financial service businesses, an increasing number of them are now looking at opportunities in the equipment leasing and finance market. This can be demonstrated by the number of private equity firms that attended the March 2012 IMN/ELFA Investors’ Conference on Equipment Finance.
Several equipment leasing and finance companies are currently pursuing acquisition strategies. They are looking principally to enter new markets that will be complementary to their present business.
In summary, there should be a higher level of M&A activity in the equipment leasing and finance sector in 2012 than in 2011 because 1.) the supply of attractive independent companies receptive to a sale is increasing as their profits improve and 2.) a variety of buyers currently are actively looking to acquire equipment leasing and finance businesses. With demand potentially exceeding supply, some acquirers may decide to seek smaller leasing businesses because of the limited number of large independent leasing companies.
Keys to Obtaining Maximum Value in a Sale
Independent equipment leasing and finance company executives frequently ask Alta executives to suggest ways they can increase the value of their companies in order to maximize proceeds from an eventual sale. In response, The Alta Group recently developed the “Eight Levers of Equity Value” shown below:
The Alta Group’s Eight Levers of Equity Value
Management quality and depth
Growth in profits and originations
Financial statement ratios and interest rate spreads
Value proposition/competitive differentiation
Collection and residual realization performance
Growth potential and scalability
Operational excellence and efficiencies
The main reason for the low level of leasing company M&A activity for the last four years has been the scarcity of attractive independent leasing companies available for sale.
These levers are based on the experience of The Alta Group and its M&A advisory team in representing more than 200 sellers and buyers of equipment leasing and finance companies. In preparing an analysis of how attractive a company would likely be as an acquisition candidate, we have developed more than 60 operating metrics as a guide in quantifying a company’s ratings for each of the levers of equity value. Our experience tells us that these are likely the most important metrics that will be considered by potential buyers as they evaluate the attractiveness of an acquisition candidate. Senior executives of leasing companies may find the Eight Levers of Equity Value to be an important benchmarking, valuation and strategic planning tool that will help them achieve growth in profitability and equity value, whether or not the eventual sale of their business is a goal.
Bruce Kropschot is senior managing director of The Alta Group and heads the firm’s merger and acquisition advisory practice. Alta executives have arranged the sale of more than 200 equipment leasing and finance companies in the United States and several other countries. The firm’s M&A practice also arranges the sale of lease portfolios, assists leasing companies in obtaining debt and equity capital, performs business valuations and provides acquisition due diligence support. 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 25 years.
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