Tuesday , November 24, 2020

COMMENTARY: Why Attrition Is No Longer a Core Metric for Valuing Merchant Portfolios

Strange times. Seemingly overnight, one of the most durable and heavily weighted key performance indicators (KPIs) for the quality and valuation of traditional, brick-and-mortar merchant-acquiring portfolios has lost its salience. Its meaningfulness has gone from a primary driver of value to a mere footnote. 

Not everyone will agree. But when thoughtfully contrasting the significance of the metric in the past with its utility today, we can’t rationally assign the weighting that it used to carry, nor tie a merchant-acquiring asset’s valuation directly to it.

Historically, attrition KPIs have provided quantifiable data directly tied to the performance of merchant-processing portfolios, and, by extension, to the quality of the acquiring organizations that owned and operated them. 

Regardless of which attrition metric was being evaluated—active accounts, credit/debit volume, transaction count, or residual revenue—the attrition rate (the rate of loss over time) provided a verifiable performance indicator to project the future performance of the asset. This includes the future cash flows for the portfolio asset itself or for the operating entity that held it.   

Hark: “Pre-Covid, attrition KPIs allowed analysts to make reasonable inferences about the performance of the merchants in a given acquirer portfolio, as well as of the acquirer itself.”

A deeper dive into the attrition data told us even more. When accounts, sales volume, transaction count, and revenue attrition rates moved asymmetrically, as they almost always do, we gained additional insights into the performance of the asset. By way of example, when revenue attrition was low but account attrition was high, we knew the asset was losing small, low-revenue producing accounts. 

This rate-asymmetry between the different metrics acted as an indicator for a host of other attributes of the portfolio and operating entity. They typically provided color as to the types of merchants targeted for services, the quality of customer service, the proficiency of the sales channels in targeting financially healthy merchants, and even whether the merchant accounts were integrated with technology—all of these (rightfully) factoring into valuation.

Having been in a position to database hundreds of acquirers’ portfolio data over the years has provided my firm with a large enough data set for the application of meaningful statistical analyses. It has allowed us to determine industry averages for all attrition categories, by which we could compare any two assets’ performance on a relative basis, and by extension, arrive at a relative valuation.

Historically, the performance metrics provided by attrition analytics were relevant, meaningful, and provided a sound way to understand merchant-portfolio performance and the quality of the operating entity. But not anymore.

Today’s economy is the product of what were previously thought to be unfathomable constraints to small and mid-size businesses (SMB’s), and consumers. The unprecedented, government induced proscriptions on business openings and operations, combined with historic levels of unemployment, have dramatically reduced economic output (GDP). The Covid-19-induced government-policy changes have produced an artificial, exogenous economic dislocation that has stripped attrition KPIs of their significance and meaning in the context of evaluating a merchant-acquiring asset. 

Pre-Covid, attrition KPIs allowed analysts to make reasonable inferences about the performance of the merchants in a given acquirer portfolio, as well as of the acquirer itself. Today, analysts can no longer make such inferences because it’s not reasonably clear which external, and often artificial, factors are contributing to the rate of loss. 

There is a host of reasons for this that did not exist before: the geographical area where a business is located is in lockdown; the business has been artificially propped up with Paycheck Protection Program monies that sunsetted; certain types of merchant category codes have been completely shut down due to regulatory proscription. 

Layer onto the equation the Covid-induced changes in consumer behavior, and the picture becomes more opaque. Lack of consumer demand as a product of increased savings, high unemployment, and government obstruction of effective economic stimulus, factor into the merchant’s viability, as well. Taken together, we’re living in a time where it’s almost impossible, on attrition rates alone, to make any reasonable inference about the performance of either the merchant or merchant acquirer. 

For all merchant acquirers and all those investing in merchant-acquiring assets, here’s the takeaway: Attrition analyses no longer carry the weighting they once did. As such, attrition KPIs cannot be used as a primary driver of valuation. 

Merchant acquirers would be remiss to let investors knock down asset or enterprise value using attrition KPIs as the primary reason. And for investors, a different set of sophisticated and nuanced analyses must be employed to properly value merchant-acquiring assets.

—Adam T. Hark is principal and managing director at Wellesley Hills Financial.

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