Appeared in the 2006 Asian Leasing Yearbook

Introduction

Mergers and acquisitions play a major role in shaping the global equipment leasing market. Many large leasing companies rely upon acquisitions for a substantial portion of their growth, both domestically and internationally. Sellers of leasing companies benefit from an active merger and acquisition market. This article will examine leasing company merger and acquisition trends, review the motivations of sellers and acquirers, discuss methods for acquisition pricing and examine what a potential seller can do in preparation for a sale in order to maximize the value of the business.

Merger and Acquisition Trends

Equipment leasing around the world is influenced by the local business environment, including tax regulations, accounting rules, alternative financing sources, the leasing penetration rate and the competitive environment. However, even though there are differences in leasing from country to country, there are many similarities. Although some of the details may be different, leasing companies in most countries face similar challenges and enjoy similar opportunities. Leasing has developed on different timetables in different countries, and thus the timing of various issues impacting leasing companies may occur at different times in different countries.

Leasing penetration as a percentage of business investment in equipment has been greatest in the United States, averaging about 30%, and thus it is not surprising that the U.S. has been a leader in the wave of leasing company consolidation. Each year a greater share of the total leasing business in the U.S. is done by a small number of large companies, most of which have grown by acquisition. By examining the factors impacting the growing consolidation of leasing companies in the U.S., one can get a better idea of the impact that consolidation can have in countries where the equipment leasing market has more recently become well-established.

Merger and acquisition activity in the U.S. equipment leasing industry has been booming for over 20 years. The leasing industry has experienced an unprecedented consolidation, which accelerated in the early 1980s in the U.S. and has spread to other countries with a well-developed leasing market. Leasing volume in the U.S. has become increasingly concentrated, with the 10 largest leasing companies accounting for $128 billion of leasing originations in 2003. The largest leasing company in the most recent Monitor Equipment Leasing and Finance annual survey is GE Commercial Finance with new lease origination volume of $47 billion in 2003. The next 3 companies, all with $14 to $16 billion of lease originations, are CitiCapital, IBM Global Financing, and CIT Group. GE, CitiCapital and CIT have all experienced significant growth in the U.S. through acquisitions, and acquisitions have played a major role in their global expansion. In addition to acquiring a number of high profile companies, some with billions of dollars of assets, GE Capital has acquired dozens of small companies.

The increasing consolidation in the leasing industry in the U.S. has led some industry observers to advance the whale-minnow theory. According to this theory, successful leasing companies will be either whales like GE Capital, CitiCapital and CIT, which remain competitive by obtaining increased market share and having a very low cost of funds, or minnows, which are able to effectively service the needs of a specialty niche market. According to this theory, medium-sized leasing companies could become an endangered species unless they become a whale or a minnow. Such an analogy is very simplistic, but it does in some respects reflect the changes that have been taking place in the equipment leasing environment in the U.S.

Certainly the increased competition in the marketplace has forced leasing companies of all sizes to look for ways to be more efficient in their marketing efforts, funding and operations. Because of the economies of scale and lower borrowing costs possessed by the whales, the small and medium-sized leasing companies are having to swim faster in order to compete successfully. The difficulty that privately owned independent leasing companies have in competing in the same markets with the whales is one of the main reasons that many of the most desirable privately owned leasing companies in the U.S. were acquired in the 1980s and the 1990s. In the June 2004 Monitor survey of the 100 largest equipment leasing companies in the U.S., there are only 7 privately-owned independent leasing companies, and the largest is ranked #48 in terms of origination volume.

Seller Motivations

Increased competitive pressure is only one of many reasons leasing companies are sold. Many independent leasing companies are owned by the entrepreneurs who founded them. These owners usually have the majority of their net worth tied up in this illiquid investment, and eventually thoughts of retirement, estate planning, diversification of investments, health considerations or a change in lifestyle lead them to consider a sale of the business. The active U.S. acquisition market in the 1980s and 1990s enabled many of these entrepreneurs to convert their investment to cash and enjoy the fruits of their labor.

Many successful, independent leasing companies reach a point where they need more equity to expand. With the public equity market often not a viable alternative for a small leasing company, the sale of the business to a larger entity is often the only way to obtain the needed capital.

Leasing companies with corporate owners are being sold for a variety of business reasons. Frequently, parent companies with financial problems have sold their leasing companies because they were easier to convert to cash at a fair price than other subsidiaries. Other leasing companies have been sold because of income tax considerations; if a company has little or no taxable income, it cannot compete in leasing markets that are tax-oriented. Other corporate owners have changed their corporate priorities, usually to shift their focus back to their core business, or they have decided to get out of leasing because the return on investment has not been adequate.

Acquirers and Their Motivations

There are a wide variety of acquirers of leasing companies, and these acquirers also have a variety of factors motivating their acquisitions. Probably no single factor changed the leasing industry in the U.S. as much as the entrance of commercial banks into leasing. 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. Most banks were slow to enter equipment leasing, but the fact that some major banks had entered the equipment leasing business “legitimatized” leasing and helped spur the industry’s rapid growth.

Until the late 1980s, equipment leasing was one of the few financial services that banks in the U.S. could pursue aggressively beyond their home state. This opportunity led many banks to obtain leasing expertise and expand their leasing activities geographically through acquisition, 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 banking industry in the U.S. resulted in many banks acquiring leasing companies, this trend subsided as almost all of the large banks in the U.S. now have leasing businesses. Of the 53 leasing companies in the latest Monitor survey having over $1 billion of assets, 26 of them are U.S. bank affiliates. Recently the banking industry itself entered a period of consolidation, and there has been a significant reduction in the number of banking organizations in the U.S. in the past 10 years. Consequently the number of bank-affiliated leasing companies has been declining. 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.

A substantial amount of equipment leasing business in the U.S. and in many other countries is tax oriented. Tax legislation has certainly been an important contributor to leasing company acquisition activity. 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 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 much fewer leasing company acquisitions in the U.S. for tax reasons since 1986.

Changes in the tax laws have impacted the leasing markets and influenced acquisition activity in other countries also. Canada and the United Kingdom are examples of countries that have had significant changes in depreciation allowances for tax purposes.

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 tax benefits, 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.

The breakup of AT&T produced seven large regional telephone companies, and several of them made sizable leasing company acquisitions. AT&T itself formed AT&T Capital, which acquired a number of leasing companies in the U.S. and internationally. Chrysler, Ford and 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.

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.

Unlike some other categories of active acquirers in the 1980s and 1990s, many equipment leasing companies have continued to pursue growth by acquisition. 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. Diversified financial service companies such as GE Capital have been particularly active in pursuing niche market acquisitions.

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 4 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 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.

Acquisitions Around the World

The consolidation of the leasing industry in the U.S. has been repeated in varying degrees in other countries. Those countries that have a regulatory and business climate receptive to the establishment of entrepreneurial independent leasing companies have experienced the greatest acquisition activity as successful small companies are acquired by larger financial service companies. Also, the growth of international business activity has led to many cross-border leasing company acquisitions. Leasing companies that support equipment vendors may find it necessary to offer leases in other countries where the vendor sells equipment.

It is advantageous for a leasing company entering a foreign market to have a local affiliate that is knowledgeable about local customs, regulatory requirements, and business conditions. Thus, the acquisition of leasing companies in foreign markets has been a strategy of several large leasing companies that support multinational equipment vendors. In some countries, government regulations limit the ability of foreign companies to acquire a controlling interest in a leasing company. Thus joint ventures, minority equity positions, or other types of strategic alliances may be more appropriate than outright acquisitions for companies seeking to enter certain leasing markets.

Neighboring countries are usually the easiest countries for leasing companies to expand into through acquisitions, especially when the countries share common cultures, business practices or language. Thus U.S. leasing companies have often made Canada their first choice for international expansion. Similarly, regionalization by leasing companies in Latin America and Europe has been aided by acquisitions in neighboring countries.

The globalization of leasing is best demonstrated by GE Capital, which has acquired a wide variety of equipment leasing and commercial finance companies in dozens of countries. Major international banks have also expanded their leasing businesses globally, although not always through acquisition. Some other premier global leasing companies are captives of international equipment manufacturers that have typically entered new leasing markets by adding leasing personnel to their foreign sales organizations.

Acquisition Pricing

Valuation of equipment leasing companies for the purpose of determining an acquisition price is not an exact science. In fact, valuation is better characterized as an imprecise art. It is said that beauty is in the eye of the beholder; thus, it is not surprising that different prospective buyers will develop widely divergent prices for an acquisition candidate.

One can never be certain of the acquisition value of an equipment leasing company until the seller enters into negotiations with one or more interested acquirers. Of course, the acquisition price is subject to the law of demand and supply. The more unique and attractive an acquisition candidate is, the greater the number of interested acquirers there will be and the higher the selling price will likely be.

The price a buyer will be willing to pay for a leasing company will be influenced by many factors, including the following:

• Tangible, realizable net asset value
• Recent profitable results
• Record of growth in profits and lease volume
• The absence of unfavorable financial events
• Business niche served by the company
• Cost of funds
• Organization and personnel capabilities
• Operating performance and productivity
• Realistic projections
• Expected return on assets and equity
• Compatibility of management and business philosophies
• Opportunities for scalability and synergism
  

Buyers use a variety of methods in valuing an equipment leasing company. The discounted net realizable asset value, utilizing the acquirer’s cost of capital and estimated collection costs, is appropriate for a portfolio purchase and for the acquisition of a company with the intent to liquidate. Also, determining the net realizable asset value may be useful as a minimum valuation for a going-concern acquisition. Some buyers determine an acquisition price based upon a specific premium, or goodwill factor, over the net realizable asset value of all assets, taking into account projected bad debts and reduced by the present value of liabilities assumed.

The price/earnings multiple is a common valuation guideline for public companies. Privately-owned equipment leasing companies typically are acquired at a price/earnings multiple that is less than the multiple for most publicly-owned leasing companies. However, comparisons with public companies are not always appropriate because there are so few public leasing companies.

Certain adjustments to reported earnings might be necessary when valuing a company on a price/earnings multiple basis. Of course, extraordinary items are usually eliminated. Also, owners’ compensation could be adjusted upward or downward, depending upon the owners’ compensation expectations after the acquisition. A prospective acquirer may want to recompute a selling company’s earnings to conform to the acquirer’s accounting practices for such items as reserve for bad debts, initial direct costs, residual values and operating lease depreciation.

A leasing company’s present trend, future prospects, market position and management capabilities are much more important to the valuation process for most buyers than are past results. For some leasing companies, applying a price/earnings multiple to recent results will not produce a selling price that is adequate in relation to the company’s potential, particularly if its growth has been constrained due to lack of capital. Such sellers should develop five-year projections that show what future results could be if the acquirer provides adequate capital. Although most acquirers will not value a company at a multiple of projected future earnings, future prospects certainly do influence the buyer’s valuation, and buyers will often agree to “earn out” provisions where the purchase price is adjusted upward if certain projected results are achieved.

Selling prices are often referred to as a multiple of book value. However, buyers of leasing companies rarely select a multiple of book value as a starting point in the pricing process. Furthermore, book value often varies considerably from the fair market value of the net assets, particularly in times of volatile interest rates. Thus, contrary to popular opinion, leasing company acquisition prices are rarely determined by a multiple of book value.

The discounted cash flow method is a popular valuation method and one that is theoretically sound. Under this method, the projected net cash flows from a business for a period of time (typically the next five to seven years) are present valued at a discount rate equal to the desired rate of return on equity. Also, the terminal value of the business at the end of the period (typically based on a multiple of annual earnings at the end of the period) is present valued at the same rate. The total of these two present value computations is the theoretical acquisition value to a buyer. The discounted cash flow method is difficult to apply because of the critical importance of assumptions regarding projected future business results, the terminal value and the discount rate. Many buyers are more comfortable determining acquisition prices from past results than from future projections, but the discounted cash flow method is helpful in providing a check on the reasonableness of acquisition prices determined by other methods.

The previously-described methods for valuing a leasing business have been from a buyer’s perspective, because buyers typically determine the acquisition value of a company, and the seller can either accept the highest offer or reject it. Nevertheless, it is important for a seller to understand the considerations of a buyer in valuing the seller’s business. Negotiations normally play an important part in determining the final purchase price. Thus, no matter how sophisticated the buyer’s valuation methods are, the success or failure of the acquisition efforts will be largely dependent upon valuations by other interested buyers and by the buyer’s skill in negotiating a transaction that satisfies the objectives of both the buyer and the seller.

What a Seller Should Do to Prepare for the Sale

Since the business owner often does not know in advance when a sale of the company may become desirable or necessary, the owner should constantly be prepared for that eventuality. Furthermore, by planning for the eventuality of a sale as part of the company’s strategic planning process, the owner will be better able to optimize the timing of the sale. The owner who retains timing flexibility is better able to maximize the value of the business than the owner who is forced to make a quick sale for personal or business reasons.

Following are some suggestions on how to make an equipment leasing company more of interest to potential acquirers, whether a sale is contemplated in one year or ten years:

• If necessary, strengthen the management team. Much of the premium the buyer pays is for management expertise. Make sure there is both quality and depth of management, including one or more individuals with the potential to succeed the chief executive officer.

• Try to sustain a stable growth pattern. Buyers are much more likely to pay a premium based on projected future results if the historical trend is one of steady growth instead of many ups and downs.

• Become an expert in one or more segments of the market. Equipment leasing companies that specialize in one or a few market niches and service those niches well attract a wider range of prospective acquirers and sell for a higher premium than companies that are generalists. Also, companies that provide value-added services are more attractive than those that are in a commodity-type business.

• Build a strong lease servicing capability. The more capabilities a leasing company has in-house, the more valuable the company will likely be to an acquirer.

• Develop good systems for financial statement preparation and management reporting, consistent with the size and needs of the company. Prospective acquirers expect to receive timely interim financial statements and management reports. Since much of the buyer’s due diligence efforts will be directed to financial analysis, the seller’s credibility can be heavily influenced by the quality of the accounting personnel and financial reporting systems.

• Use the preferred accounting methods, and err on the side of conservatism. Most prospective buyers will do enough due diligence work to uncover aggressive accounting practices for such items as bad debt reserves and residual valuations, so do not be embarrassed by using accounting assumptions that are difficult to justify.

• Prepare detailed annual budgets and long-range projections. It is difficult to get where one is going without a road map.

• Last but not least, retain legal and accounting advisors who have expertise in equipment leasing. Also, as the time to sell the business approaches, it is important to retain a professional merger and acquisition advisor who has sold other equipment leasing companies. The experienced advisor can provide an indication of the company’s probable market value, recommend a deal structure that will best fit the owner’s needs, introduce prospective acquirers who are interested in acquiring equipment leasing companies, market the company’s strengths and growth potential and guide the owner through the selling and negotiation process.

Getting an equipment leasing business in the best position for a possible sale is not an easy task. However, some advance preparation will not only make the business more valuable to a buyer but it should also improve the business’s long-term prospects. Equipment leasing can be an intensely competitive business; however, the highly focused leasing company that is always striving for improvement can continue to be successful. So, regardless of the timing of the exit strategy, owners who plan to eventually sell a leasing company should always be looking for ways to make their leasing company more valuable.

The Current M&A Market and a Forecast for the Future

Merger and acquisition activity is most active when business prospects for the equipment leasing industry are generally viewed to be favorable. Thus the leasing industry M&A activity was at a relatively low level in the U.S. in the early part of this decade as both business equipment investment and leasing volume declined over 5% from 2000 to 2002. More recently, the U.S. economy has been on an upswing, bringing with it growth in leasing volume, greater profitability for leasing companies and greater interest in acquisitions of leasing companies.

At the present time, the most aggressive acquirers of equipment leasing companies in the U.S. and elsewhere are major lessors such as GE Capital and banks, including smaller banks that have not previously had a leasing capability. An increasingly important source of demand for equipment leasing company acquisitions is private investment groups. These private investment firms usually prefer privately owned companies whose management wants to retain an equity interest, although they have also backed spin-offs of leasing businesses from major corporations. Such investment groups can be excellent partners for leasing companies that are looking for an equity investor to provide growth capital. Another source of capital for leasing companies is venture capital firms, which have recently been active in providing financial backing to a number of entrepreneurial management teams who have formed new leasing companies. Having an initial public offering is an alternative some leasing companies have used to raise capital or to provide an exit opportunity for shareholders; however leasing companies have not generally been well received by the public equity markets.

The next few years will likely show a modest increase in the number of equipment leasing company acquisitions in the U.S. but potentially a more active M&A market in some developing countries where the equipment leasing business is growing more rapidly. Of course, the equipment leasing merger and acquisition market will still be very dependent upon the health of the equipment leasing industry in a particular country. Successful companies with solid sales and back-office capabilities usually attract a number of interested acquirers. Companies that specialize in niche markets, those that provide value-added services and companies with strong equipment remarketing capabilities will be able to command the highest premiums.


* * * * * *

Bruce Kropschot is President of Kropschot Financial Services of Vero Beach, Florida, a firm he founded in 1986. The firm has been for many years the leading provider of merger and acquisition advisory services for equipment leasing companies in the United States, having initiated the sale of more than 140 businesses. The firm has also represented leasing companies in a number of other countries and is a founding member of the International Network of M&A Partners, an organization comprised of 60 leading merger and acquisition advisory firms from around the globe.

Mr. Kropschot has been active in the equipment leasing industry since 1972 and has been a senior executive of three large leasing companies. He has served on the Board of Directors of the Equipment Leasing Association of America and currently serves on the Association’s Capital Markets Committee. Mr. Kropschot is a Certified Public Accountant and graduated with BBA and MBA degrees (with honors) in accounting and finance from the University of Michigan. He can be reached at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it