The acquiring business has been such a good business for so long that it's easy to understand how leading companies in our industry became over-levered. For most of its life the industry has grown by every measure imaginable — number of customers, market share of payment types, same store sales volume, to name a few.
   In addition, the industry received significant help from the issuing side of the business in the form of increased numbers of cards issued to consumers, increased credit limits and new transaction types such as signature debit. All these factors contributed to steady double-digit growth in the acquiring business. Life was good.
    Companies capitalized on these positive trends, creating immense value over time. Banks also saw the endless growth as a lending opportunity and lined up to provide leverage for acquisitions, growth financings and partner buyouts. With such a strong growth and profitability history, lending was no problem and acquiring even achieved preferred industry status among lenders. Indeed, for a while, lenders couldn't find enough deals to make in the business and were left with more money than they could put to work in the industry. It was a borrower's market. And the industry borrowed and borrowed and borrowed, justifying loan requests with optimistic growth plans.
   That was a great era in the acquiring business, but unfortunately, it's over. Most of the growth drivers in the acquiring business have been neutralized recently. Growth drivers from the issuing side are gone — there are fewer cards being issued and credit limits are coming down. The new legislative restraints on the issuing business donÕt help because they reduce revenues to issuers and create uncertainty. More than likely, issuers will withdraw cards from those with less-than-perfect credit histories, creating an opportunity for pre-paid cards. Issuing will become more competitive and may shrink as a result.
   Just as troubling is the apparently enduring nature of the decline in same store credit card volumes.
    Since October, 2008, card volumes have been down vs. a year ago volumes. That's a first for this industry and will force a series of painful changes.
    Less volume per merchant means less revenue per merchant. Less revenue per merchant means that it will take more merchants to cover fixed overhead and interest charges on debt accumulated during the good times. Less revenue per merchant also means the present value of each merchant (and therefore the asset base underlying a loan) is worth less.
    As a result, the industry has a number of key players with staggering debt loads taken on in good times when rosy assumptions about growth made sense because they were in line with history. Unfortunately, using history as a guide to the future, couldn't possibly foresee the current financial crisis and its consequences, legislative changes and other negative factors. Companies with debt loads that made sense when they were profitable and growing rapidly now find themselves struggling with stagnant or declining revenues and debt loads that make no sense in the current or forecasted environment. Most likely, a number of them have debt that won't be repaid in full or on time.
    Right now, the bankers holding the senior debts in the acquiring business control the leading companies in the industry and have the fate of the industry in their hands. The sales guys and company builders have had their run, it's up to the financial guys now.
    Take the poster child for over-levered companies as an example — First Data. The 2007 $29 billion leveraged buyout left the company with over $22 billion in debt. Measured against First Data's earnings before interest, taxes, depreciation and amortization, (EBITDA, a common measure of the cash produced by the company each year), the debt level represents 7.5x EBITDA as of year end 2008.
    Likewise, iPayment, subject of a recent management-lead buyout financed with debt has a debt to EBITDA ratio of 5.8x as of year end 2008.
   There are only two ways to pay off debt, earn your way out over time, or sell the company to someone else who will pay off the debt. It seems unlikely that these two companies will wait around as many years as it will take to pay off the debt through operations. The bigger problem is that in today's market, they're probably not worth anything close to the value of the debt. If someone wrote a check to pay off FDR's debt today, they would have to wait 7.5 years just to get their money back and only then start to see a return on the investment.
    In an environment where margins are falling and companies can't grow earnings to reduce the debt, they're stuck. A persistently weak economy combined with a few adverse trends in volume, and you could see some financially driven bankruptcies in this industry for the first time.
    If companies aren't worth their debt amount, then there's no value left for the equity holders. Throughout the industry, it's clear that company and portfolio valuations are coming down based on a variety of factors including lack of capital, but more importantly, investor pessimism about the basic trends in the business. There's simply too much uncertainty out there to make people feel really good about the acquiring side of the business.
    All that taken together means that there's no equity in the major players in the acquiring business right now. Management teams that have bet years of their careers and their reputations on producing a positive return for shareholders have not been able to do it. Management equity holdings are underwater by significant measures. Investors and creditors alike are asking what happened to growth plans that would justify all the debt. Right now, there are no good answers.
   In my last article for Transaction World, I wrote about Heartland's data breach and its effect on the business from a financial point of view. I theorized that the drastic and surprising decline in Heartland's market value resulting from the damage the data breach caused made a public offering of another industry player like Heartland impossible for the near future. It's hard to imagine the public market warming up to any company with mass data breach liability.
   The problem is that almost all the leading companies in the business today have mass data breach liability in their business models. If they have significant leverage as well, then there's a double whammy effect since banks must take into account the impairment to the value of the merchant base in their collateral calculations and at the same time,  the classic exit strategy to realize value when a company is over-levered is off the table.
    When management teams and bank analysts make decisions based on past performance, they risk running into trouble when circumstances change. We're in a period of wrenching change now, and banks and management teams will have to scramble to preserve value and move forward in this new environment. This period is made more difficult by all the changes going on in the environment at large, including government regulation of banks and other financial industries that are very close to ours. The next big issue out there: What's the future of interchange and the consequences of a reduction to this key element of issuing side revenues. Debt and stagnant growth—the ultimate movers and shakers.