Appeared in the July 2002 Monitor – Leasing and Financial ServicesThe 1980s and the 1990s were decades of tremendous consolidation in the equipment leasing industry. The proverbial whales seemingly had an insatiable appetite for eating the minnows. This is illustrated in this year’s Monitor 100 survey. The three largest equipment finance and leasing companies in the U.S., GE Capital, CitiCapital and CIT, are the surviving entities of what once were dozens of independent equipment leasing companies. Numbers 6, 8 and 9 in the survey, Fleet Capital, Banc of America Leasing & Capital Group and Wachovia Leasing, also encompass a number of leasing companies, including acquired independent companies and various bank leasing subsidiaries brought together by bank consolidations. However, M & A activity in the leasing industry has been greatly reduced in the current decade, even though two of the largest transactions ever (GE Capital/Heller Financial and Tyco/The CIT Group) occurred in 2001. What happened to the vibrant leasing company M & A market?

Where Have All the Buyers Gone?

To paraphrase the famous song written by Pete Seeger, we might ask, “Where have all the buyers gone?” Many of the buyers that were responsible for the go-go M & A years either are no longer in the equipment leasing industry or no longer have an appetite for acquisitions. Such former buyers include the non-financial corporations that got into leasing in the early 1980s in order to obtain tax advantages, including tax benefit transfer leases. Also in the 1980s, a number of new players entered the leasing industry by acquisition, including thrift institutions, telephone companies formed from the AT&T break-up and Japanese and European banks. None of these players have been active in the M & A market in recent years.

Large U.S. banks were major acquirers of equipment leasing businesses in the 1980s and 1990s. However, in recent years much of the bank M & A activity has involved one bank acquiring another. Since almost all of the large banks have leasing businesses, much of the recent growth in bank leasing companies has resulted from bank acquisitions and not from leasing company acquisitions.

Publicly owned leasing companies have often been aggressive acquirers of other leasing companies in order to move into new market niches. Large public leasing companies that made many acquisitions include U.S. Leasing, Associates, AT&T Capital and Newcourt Credit Group. All of these companies have been acquired and are thus no longer acquirers.

 With Wall Street experiencing euphoria and a receptivity to initial public offerings, six leasing companies went public from May 1997 to May 1998. Two of these companies, CIT and Heller, were formerly controlled by Japanese banks. Both made sizable acquisitions after going public, and both were acquired themselves in 2001. Two of this group of newly public companies, SierraCities.com (formerly First Sierra Financial) and UniCapital, had a major impact on the acquisition market for independent leasing companies in the late 1990s. Together with LINC Capital and T&W Financial, these four IPO companies accounted for about 50 acquisitions in less than 3 years. This rapid growth and problems related to the management of the growth led UniCapital, LINC and T&W into bankruptcy; SierraCities survived by being acquired by American Express for less than its IPO price.

There are now very few public leasing companies, and most of the remaining ones have not been very acquisitive. Many of the public leasing companies have been acquired, and Comdisco and Finova have joined the list of bankrupt public leasing companies. If Tyco is successful in selling CIT in an IPO, there will again be a major public leasing company. However, current stock market conditions do not bode well for other leasing company IPOs anytime soon.

The dearth of public leasing companies has reduced the demand for leasing company acquisitions, thus dampening prices in the M & A market. Four years ago, when the newly public companies were competing against each other for acquisitions, prices for independent leasing companies were bid up to exceptionally high levels. Today, with much less competition for leasing company acquisitions, sellers are more realistic in their pricing expectations, and they are willing to consider more creative deal structures. Thus today is an excellent time to buy a leasing company, but few of the potential leasing company buyers are taking advantage of this buying opportunity. To quote Pete Seeger again, “When will they ever learn?”

 Where Have All the Sellers Gone?

The hundreds of acquisitions of leasing companies in the 1980s and the 1990s have depleted the ranks of the most desirable acquisition targets. The majority of the sizable privately-owned independent leasing companies have already been acquired. In this year’s Monitor 100 survey, there are only 10 privately-owned independents, and the largest is ranked #59 in terms of assets. Of course, there are hundreds of privately owned leasing companies that are smaller than those in the Monitor 100, but many of them are too small or too limited in their capabilities to be of interest to many acquirers.

Funding constraints and the lack of access to the equity markets make it difficult for privately owned leasing companies to expand their lease portfolios. Thus, many privately owned companies sell off most or all of the leases they originate. However, acquirers generally prefer to buy leasing companies that retain their own portfolio.

Despite reduced acquisition prices and a limited number of buyers, many privately owned leasing companies likely will choose to be acquired in the next few years. Their pressing needs for equity capital and lower-cost debt sources do not allow them to wait until the IPO market is again receptive to leasing company stocks. Also, many individual leasing company owners are reaching an age where they must formulate an exit strategy.

 Where Do We Go From Here?

The leasing industry is not alone in experiencing greatly reduced M & A activity. In the first half of 2002, total M & A activity in the U.S. was about 25% of the level in the late 1990s, and the lowest since 1994. This reduced volume is partly due to the stagnant economy and the weak stock market. The terrorist acts of September 11, 2001 led some companies to reconsider their acquisition strategies. Also, the major problems of very acquisitive companies such as Tyco, AT&T and WorldCom have led some companies to question whether they want to grow by acquisition. Similarly, the failures and difficulties experienced by some of the more acquisitive equipment leasing companies have undoubtedly been a factor in leasing company acquirers becoming more cautious.

Despite the negative sentiment pervading the U.S. business environment, our economy is still very strong and showing signs of improvement. Business capital expenditures will eventually turn upward, and equipment lease originations will grow accordingly. Potential acquirers of leasing companies will begin to realize that it is a buyer’s market, with prices at their most attractive levels in recent history. Perceptive buyers will want to take advantage of this opportunity before competition for acquisitions heats up.

Who are these potential acquirers of equipment leasing companies? The large leasing companies are already in most of the markets they desire to be in, and many of the major bank leasing companies are busy integrating the parts that came together in the wave of bank consolidations. However, some of these large lessors are still receptive to considering acquisitions in specialized niche leasing markets, and they have also been diversifying into other asset-based lending markets. A number of community and regional banks are exploring opportunities in the leasing industry for the first time, and they could be good matches for smaller privately owned leasing companies. Many such banks are very liquid, and the yields available in equipment leases are very attractive to them. Private equity groups and venture capital firms have substantial funds to invest, and they are seeing far fewer investment opportunities in the typical high growth sectors they normally pursue. A few of these groups have recently considered investments in well-run equipment leasing businesses, and they could be good partners for companies that are looking for an equity investor to provide growth capital.

Equipment leasing is a mature industry with substantial concentration – 56 firms reported over $1 billion of assets in the recent Monitor 100 survey. Nevertheless, there are still opportunities for entrepreneurial leasing companies to succeed in niche markets through innovation, customer focus, value-added services and equipment expertise. Successful privately owned leasing companies will be able to attract buyers when they are ready to sell. Although selling prices overall may never be as high as they once were, the decline is more pronounced for larger companies. Good small companies are always salable; furthermore, their selling prices are not going to be appreciably less than historical norms, and sellers now do not have to accept inflated stock for part or all of the purchase price. The M & A market is alive, and motivated sellers and motivated buyers are still able to consummate transactions that meet their respective needs.

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Bruce Kropschot is President of Kropschot Financial Services of Vero Beach, Florida, a merger and acquisition advisory firm for the equipment leasing and financing industry, which he founded in 1986. Mr. Kropschot has been active in the equipment leasing industry for 30 years and has served as a senior executive of 3 large leasing companies. Kropschot Financial Services has arranged the sale of over 130 equipment leasing and specialty finance businesses and numerous portfolios. The firm also arranges lease funding, subordinated debt and equity for leasing companies and performs business valuations. Mr. Kropschot is a CPA and holds BBA and MBA degrees in accounting and finance from the University of Michigan. He has served on the Board of Directors of ELA, EAEL and UAEL.