The merger and acquisition market for equipment leasing companies is showing renewed strength, although the market is much different than it was in the last boom period of 1996 through 1998. M&A activity is certainly most active when business prospects for the equipment leasing industry as well as for the overall economy are generally viewed to be favorable. With U.S. business equipment investment and leasing volume both declining by over 15% from 2000 to 2002 and recovering only slightly in 2003, it is easy to see why the leasing industry M&A activity was at a relatively low level in recent years. Now with economic prospects improving for 2004 and beyond and with business investment and leasing volume forecast to grow by about 5% in 2004, the outlook for the equipment leasing industry is getting more upbeat. The economic upswing that is expected to produce more leasing volume and greater profitability for equipment leasing companies is an important factor in the greater interest in acquisitions of leasing companies that we have seen in recent months.

During the downturn in M&A activity that accompanied the declining equipment leasing volume in the early part of this decade, a number of the acquisitions were opportunistic ones made by major lessors such as GE Capital and CIT. These large companies are able to move quickly when a motivated corporate seller is seeking to divest a substantial leasing company or a segment thereof. Such sellers often are not willing to wait until acquisition prices improve. Thus in some cases the sellers were content to exit a business by selling a lease portfolio and closing down the business instead of waiting for better market conditions when a going-concern premium might be obtained.

Kropschot Financial Services has been in the business of arranging acquisitions of equipment leasing companies since 1986 so we have been through many cycles in the M&A market. We have seen acquisition demand being fueled by industrial corporations, thrift institutions, Japanese banks, the Bell telephone operating companies and the roll-up companies. Most of the acquisitive companies in those categories have long since exited the equipment leasing business. Just as demand has subsided from many of the formerly aggressive acquirers of leasing companies, the supply side of the equation has also diminished because most of the sizable independent leasing companies have already been acquired. One of the reasons acquisition premiums are improving as demand picks up is the limited supply of quality companies available for sale.

Acquirers and Investors

What are the sources of this increased demand for equipment leasing company acquisitions? Each year banks are accounting for a greater share of total leasing volume, and banks represent the largest single category of acquirer. Many banks are quite liquid and are looking for opportunities to boost their lagging commercial loan production. Major national banks are interested in obtaining expertise in new niche markets. Also, a number of community and smaller regional banks are interested in entering the equipment leasing business and have been exploring acquisition opportunities in their bank’s footprint.

Of course, major diversified financial services companies such as GE Capital and CIT continue to be active acquirers of equipment leasing and other asset-based financing businesses. Such acquirers are in so many markets, however, that they are more likely to be competitive in portfolio acquisitions than in going-concern acquisitions where the seller expects to achieve a substantial premium from an acquirer entering a new market. Some small and mid-sized leasing companies have recently stepped up their acquisition efforts. Leasing companies that have excess funding capacity at reasonable rates may be able to greatly improve the profitability of acquired companies that do not have funding availability at competitive rates.

An increasingly important source of demand for equipment leasing company acquisitions and investment capital is private equity groups. With the demise of investment opportunities in the high technology sector, there are substantial amounts of private equity available to be deployed. Although private equity groups in the past have shunned leasing companies as not having high enough growth potential, there have been several recent investments by such groups who are now looking at leasing as a relatively stable industry with acceptable returns on equity. These private equity groups usually prefer to invest in privately owned companies whose management is willing to commit their own capital. We have introduced private equity groups to several independent equipment leasing companies that see the benefits of having a substantial partner join with them to help grow the business to the next level.

Private equity groups are very selective and invest only in those companies that have exceptional management and a history of strong growth and high profitability. They look for companies with a strong competitive position and a proven business model that is leverageable. Their investment is typically made with a 3 to 7 year time horizon for a liquidity event, and they prefer investments that have several exit strategy options. An active M&A market is important to private equity groups because the initial public offering market is not always available.

Since a flurry of IPO activity between May 1997 and May 1998 when six equipment leasing companies went public, there have been very few leasing company initial public offerings. CIT was spun off by Tyco in an IPO in 2002, and small ticket lessor Marlin Business Services went public in November 2003. Both CIT and Marlin have performed well in the public market; the performance of public leasing companies has an important impact on the valuations placed on non-public companies. Another small ticket lessor, Financial Pacific, filed a registration statement to go public this year, but it instead chose to be acquired by a publicly owned investment company. Marlin and Financial Pacific have demonstrated that the IPO market is now a viable option for independent leasing companies. Also of importance, both Marlin and Financial Pacific had significant investments by private equity groups, and these two companies have demonstrated that private equity groups can realize substantial profits on their investments in leasing companies through an IPO or a sale of the business.

Another positive indicator for equipment leasing as an investment opportunity has been the interest of private equity groups, venture capital firms and financial service companies in backing management teams in the formation of new leasing companies. There have been at least four leasing management teams that have secured substantial equity investment to start leasing companies this year. In one of these start-up companies that Kropschot Financial Services helped arrange, the key ingredients to attracting equity investors were an exceptional management team with a strong track record in a similar business and the willingness of all members of the management team to make an investment commitment that is significant to their personal net worths.

Perhaps the availability of equity investment for new leasing companies is an indicator that the rapid consolidation of the leasing industry has left some attractive niche markets underserved. With so many of the leading entrepreneurial independent leasing companies now owned by major financial service organizations, there appear to be market opportunities for small, nimble leasing companies that have a strong customer service focus, good systems capabilities and access to reasonably priced funding.

Sellers

As previously mentioned, the limited supply of quality companies available for sale has led to higher acquisition premiums now that there are more acquirers and investors looking for leasing companies. There are still a large number of independent leasing companies, and the owners of most of them expect to sell their companies eventually in order to create more personal liquidity. However, some of these independent leasing companies are too small and/or not successful enough for many acquirers and investors. In the 1990s many lease brokerage firms were acquired, but in the current market most acquirers want to buy companies that have portfolios. The independent leasing companies that are most attractive to acquirers are those that specialize in, and have strong market positions in, niche markets.

The consolidation in the banking industry has left many of the large banking organizations with a variety of leasing entities. Banks that acquire other banks often want to centralize these leasing businesses at the acquiring bank’s headquarters. However, it is often not possible to relocate the acquired leasing business’s management team. One solution for some banks has been to sell leasing businesses that do not fit into their market strategy and/or that cannot easily be assimilated into their leasing company.

The private equity groups that have invested in equipment leasing companies will one day be a source of acquisition candidates if the M&A market provides a more viable option than the IPO market. Corporations that have reassessed their business strategies represent another source of leasing companies for sale. Every year we see several non-financial corporations that decide they have no need to be in the equipment leasing business. In most cases, the reason they entered the equipment business is no longer applicable to their current situation.

Outlook for the Future

The leasing industry has been very good at adapting to change. We can anticipate that accounting rules and tax laws will continue to have major impacts on the business of leasing and may affect who the acquirers and sellers of leasing companies are. However, equipment leasing and financing should continue to represent about 30% of business equipment investment, and, as economic conditions improve and business investment grows, the equipment leasing industry will hopefully return to annual increases in volume. Most leasing companies became leaner by cutting employment levels and developing more efficient operations during the industry downturn. Thus the leasing industry appears to be poised to return to healthier profitability levels. Higher leasing activity and better profitability will create more interest in leasing company acquisitions and will attract more attention to the industry from private equity groups and for potential initial public offerings. This increased interest should be beneficial to equipment leasing company valuations, which will encourage more leasing company owners to consider the sale of their businesses. Although the M&A market is not back to the boom years of the late 1990s (and probably never will be), we are pleased to report that the merger and acquisition outlook for the equipment leasing industry is currently the brightest it has been this decade.

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Bruce Kropschot is President of Kropschot Financial Services in Vero Beach, Florida, a firm he founded in 1986. Kropschot Financial Services is the leading provider of merger and acquisition advisory services for equipment leasing and specialty finance companies, having arranged over 140 acquisitions. In addition to representing buyers and sellers of leasing companies, Kropschot Financial Services arranges lease portfolio sales, assists leasing companies in locating equity investment and lease funding and performs business valuations of leasing companies. Mr. Kropschot has been active in the equipment leasing industry since 1972 and has been a senior executive of three leasing companies. He is a CPA and holds BBA and MBA degrees in accounting and finance from the University of Michigan.