After a fallow period for acquiring alliances across
Europe, things are starting to pick up. Joel Van Arsdale looks at
this trend, and considers the reasons for the rapidly-changing
attitude among banks.
In recent years Europe has yielded fewer bank
alliances than the fundamentals suggested – fragmentation, legacy
platforms, lack of scale, and need for product improvements are all
characteristics endemic to European acquiring, and these same
characteristics tend to motivate bank-processor alliance
formations.
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So why were there so few alliances in recent
years? European banks often consider card acquiring to be a core
business, even a lead product, important for driving deposits, and
thus they place a high degree of value on full-control of the
business. Banks that think this way are not unreasonable; First
Annapolis research suggests that acquiring does drive synergistic
value within a banking franchise (such as higher retention, lower
price sensitivity, and higher product uptake).
The counter-argument, however, is that these
same benefits could still likely come through an alliance operating
model. Regardless of the merits, the outcome between 2007 and 2011
was relatively few new alliance formations.
Times are changing, however, and the next wave
of European alliance formations is officially upon us. This wave
started with the Global Payment – La Caixa transaction last year
and is now picking up pace. We expect that as many as a half-dozen
additional alliances to close in the next year. The macro-economy
and a need for capital have changed the bank mindset (at least
some). Additionally, legacy operating models are more exposed than
ever in a marketplace which is increasingly technology driven
(e-commerce, mobile payments, gateways, portals, analytics,
etc.).
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By GlobalDataBanks’ motivation
There are three primary reasons why a bank
should consider an alliance operating model:
- To improve the product and
lessen the operating burden of the business - To raise capital (even if the
capital raising is about strategic re-deployment and not a general
capital increase requirement) - To optimise shareholder
returns
Banks have more reasons than ever to favor
operating partnerships over go-it-alone strategies. Banks, acting
alone, are struggling to keep up with the increasingly technical
requirements of the acquiring business and as a result, steadily
losing market share to monoline specialists, PSPs, and ISOs.
Non-bank providers are out-competing banks with better,
increasingly software-driven, products that are. The days of simple
boxes dialing into mainframes are numbered.
The consensus is, of course, that e-commerce
and mobile are the future. As such the integrated POS, and cloud
technology come to the fore. In this future, software development
is the key driver for product differentiation. Tomorrow’s market
leaders will be those employing teams of developers to sit in a
room writing code. They will have the vision and capability to open
their processing platforms upon which external parties build
applications.
Banks generally are not brilliant when it
comes to building platforms and developing software. Certainly
there are exceptions, but by and large, banks struggle to recruit
the best and brightest technology visionaries and developers, and
to maintain continuous investment. Far too often banks either
over-estimate their own development capabilities or under-estimate
the burden of in-house platforms. As a result, banks tend to be
slower to market with product improvements and value-added services
than non-bank providers.
E-commerce is the perfect example. The
European e-commerce gateway and value-added services market is a
EUR700 million annual revenue business, but banks earn a remarkably
small portion of this revenue as a function of being late to the
market. Similarly, when you look at the businesses that have the
best sign-up and-boarding processes, the most innovative risk
management, or the best merchant MIS systems, they are not banks,
but the likes of Payment Sense, PayPal, Square and First Data.
So while control over the business has value,
this value is substantially diminished if the result is inferior
product. Banks that want to keep up with the market leading product
should therefore consider an alliance partner. Additionally, a
number of the structural advantages and barriers-to-entry that
traditionally supported banks in the acquiring business (card
scheme access, regulatory requirements, and access to settlement
networks) are fading away, opening the door to more intensified
competition from non-banks.
Practical approach
Acquiring businesses are highly salable and
alliance formations are easy ways for banks to raise or to
re-deploy valuable capital. Bank of America raised $3.8 billion in
capital as a result of its alliance formation, while RBS’s sale of
Worldpay raised £1.35 billion.
A bank does not even need to sell all of its
interests in the business in order to recognise the capital
benefits of a sale. Typically, a bank can realise the full capital
value of the enterprise by selling only 51% of the equity. There
are many banks across Europe that have achieved this, and many more
that should carefully consider it.
The shareholder value case for pursuing an
alliance is also well established. Bank acquirers tend to sell at
multiples around 8-10x EBITDA (based on total consideration) which
fall squarely between the share valuation levels for banks (which
tend to trade at 7-10x earnings) and publicly traded monoline
acquirers (typically trading at 15-20x earnings). In other words,
these deals are financially accretive to both parties.
Additionally, alliance formations tend to give rise to strong
revenue and expense synergies, which boost shareholder returns,
such as:
- Revenue growth via investment in
dedicated sales and new sales channels. - Profit margin expansion via
improved portfolio management and pricing strategies. - Expanded cross-selling and
up-selling of advanced product and value-added services. - Expense reduction via migration
to larger scale, centralized platforms, and applications.
Banks also have the flexibility to engineer an
alliance to satisfy their own financial objectives. If a bank
prefers cash, then it can structure the deal to focus on up-front
cash consideration. If however, the bank wants to maintain the
benefits of ongoing cash flows, then it can structure the alliance
as a dividend yielding joint-venture or as a contractual alliance
that includes robust ongoing revenue share and commission terms.
Banks also benefit from alliances by eliminating the need for
CAPEX, OPEX, and headcount. Ongoing earnings from an alliance come
with little to no expenses therefore, which is attractive for
shareholders sensitive to efficiency ratios.
But what about the loss of control, does this
not destroy shareholder value for a bank? The answer is largely no.
An acquiring alliance does not remove an acquiring product from a
bank nor does it necessarily hinder a bank’s ability to drive
deposits via this product relationship. The downside of lost
control can be well mitigated with the right alliance terms.
Alliance contracts virtually always provide the bank with
exclusivity over the deposit account and sale of other “banking
services” into the alliance’s customer base. Banks also often
retain a right to buy-back the acquiring customers or to prevent
the sale of these customers to competitors.
Banks across Europe are increasingly reaching
the conclusion that the alliance operating model and financial
benefits are attractive. The alliance model combines the relative
strengths of the bank (brand, distribution) and the
monoline/processor (technology, operations, focus) to create a more
powerful business. And of course, raising capital is not a bad side
benefit.
Joel Van Arsdale is a Partner at First
Annapolis Consulting
