In this installment of our series of executive interviews, Charlie Perer sits with Tim Stute to understand his views on the ABL industry, consolidation, new trends including specialization and state of the M&A market, among other things.
Charlie Perer: Thank you for your time Tim. To begin, can you please briefly talk about your background?
Tim Stute: Thanks for having me, Charlie. I manage the specialty finance-focused investment banking team at Hovde Group, where my team and I have been for four years now. I previously spent five years at Houlihan Lokey, which had acquired my old firm, Milestone Advisors, where I was one of the four shareholders and had worked for 11 years. All told, I’ve been advising commercial finance companies on M&A transactions and raising capital for about 20 years. Since the beginning of 2019, my team and I have advised on more M&A transactions involving commercial finance companies than any other firm.
Perer: The M&A market for ABL companies seemed to be re-set a few years ago when BDCs aggressively entered the space. Where are we right now in terms of a consolidation cycle?
Stute: COVID naturally created a big pause last year that lasted through the early part of 2021. But in recent months, we’ve seen an increase in M&A activity, both with closed deals and a more robust pipeline. Today, there is a wider variety of buyers interested in specialty finance M&A than before the pandemic. You mentioned the BDCs, which have continued to build market share both via organic growth and acquisitions. They have so much dry powder right now and the market for their primary core leveraged lending product overheated, so looking for other ways to find yield is top of mind. That was one of the driving factors behind recent deals like Barings BDC acquiring Encina Business Credit and SLR Business Credit adding FastPay on to their platform. But it’s not just the BDCs looking for a return – banks are back to battling all-time low net interest margins. Larger independent finance companies may have access to capital but still aren’t able to grow as quickly as they’d like. You even have insurance companies looking to deploy capital in the space.
Perer: Should there be more consolidation given a lot of ABLs are stagnating right now due to COVID stimulus and intense competition?
Stute: I think there will be more consolidation, not just because of the stagnation and competition you mention, but also because of the demand for yield from the buyer universe. An independent ABL that has had a hard time growing in today’s competitive market can make a case to a buyer that with access to cheaper capital, they’d be able to grow. That’s enough for a lot of buyers right now, who can’t find a reasonable place to put their capital and earn a return.
Perer: Can you speak to potential M&A activity in different parts of the market, i.e. small and medium ticket? Will some of the smaller M&A deals be defensive in nature?
Stute: We are seeing activity involving ABL companies of all sizes right now. I think an interesting path for smaller ABL companies and even some factors, is a potential “merger of equals,” so to speak, whereby two like-minded owner-operators look to combine operations, eliminate redundant positions, and thus grow earnings. The result is each owner now has a smaller piece of a larger pie. And that incremental critical mass could lead to both more interest from buyers down the line and better pricing if the bottom-line returns improve. It’s not necessarily defensive in nature, but the alternative for most owner-operators is to run in place on the treadmill of booking a client, then losing a client, and on and on. This concept could be a good intermediate step before a full exit.
Perer: How important is scale as it seems to be driving a lot of the market changes?
Stute: Scale is certainly helpful because more of it can lead to greater buyer interest. But to me, the inherent scalability of a platform is most important. On one hand, a large ABL company with a few hundred million in outstanding loans, a great track record of credit quality and consistent earnings is going to generate a lot of interest from buyers. But so too will the ABL business with less than $100 million in loans that has proven it can grow prudently over a relatively short period of time, maintaining low to no charge-offs. Frankly, even ABL companies with no growth, but consistent earnings and low losses, will sell at a premium, but just not quite as high as those that have consistently scaled.
Perer: Do you think the trend of non-banks using one team selling multiple products (i.e. ABL & factoring) is here to stay?
Stute: I do. Finance companies, in general, will position themselves best in the market if they have multiple products to offer, as long as the products are similar in nature. ABL and factoring are about as natural of a pair of complementary products as you can find given the largely similar collateral (i.e., accounts receivable). Plus I think companies that offer both ABL and factoring have a better chance of retaining borrowers by graduating them from factoring to ABL as their performance improves and vice versa when performance deteriorates. Also, look at some of the BDCs that have gotten into ABL in recent years. The idea for the buyers, in addition to seeking yield, was to add another product to their platforms that largely make their money off of leveraged lending to small sponsors, and additionally, to diversify revenue sources. So the one-stop-shop mentality is already there and it will continue. I also think you’re going to continue to see diversification into other complementary products like equipment finance.
Perer: Can you speak to platform innovation or changes you have seen or anticipate seeing in the operations of ABL companies?
Stute: When I think of innovation in ABL, I think a lot about “fintech” versus “tech enabled.” I’m more of a traditional specialty finance guy, so I get wary when I see a company bill themselves as “fintech,” but then you peel back the financial statements and see loans on the balance sheet. To me that’s a finance company, not a tech company. But in recent years, after some highly publicized flame outs of self-described fintech lenders, we’ve seen more lenders who I would term “tech-enabled” who have developed really compelling, proprietary systems that help to automate part of the lending process – but only part of it. The automation with these businesses we see does not come into play with credit decisions. That’s the key. ABL still requires roll-up-your-sleeves underwriting in my opinion. But technology is the key to greater scalability and thus a huge value driver in the sector.
Perer: There is a lot of talk about industry specialization whether it be consumer products or healthcare. How will this trend play out?
Stute: Specialization is another value driver, no question about it. There has been significant M&A activity in the transportation factoring sector, for example, given how well that sector bounced back after the early days of the pandemic. The transportation industry is the largest user of factoring services so there is a lot of market share to chase in that world. But there is obviously some cyclicality in that market that can be severe from time to time. Over the long haul staffing is a really attractive sector for buyers. It’s a natural fit for ABL given the billing cycle, and even better, there’s no inventory and minimal equipment to finance. Healthcare is also really attractive given the scarcity value of ABL companies that understand the uniqueness of the reimbursement model. You have to really know what you’re doing and, truthfully, some buyers just don’t want to even try to understand it. But there is interest in that sector from investors and buyers, no question about it.
Perer: Do consolidation trends in the regional commercial banking market play any role in shaping the non-bank market?
Stute: I think so. The non-bank market prides itself on taking advantage of inefficiencies and slowness from the banks in competing for business. Bank M&A has picked up considerably in recent months with banks both big and small participating. As those merging banks are working through consolidation and integration, will they really be able to stay as active as they want in the ABL market and beat the non-banks to the closing table? I would be skeptical. The increased bank M&A activity should help the non-banks find new business opportunities.
Perer: What are some of the lessons you have learned advising clients through different
cycles?
Stute: Every cycle is a little different than the last, but what we’ve learned is that regardless of the cycle, credit quality is always the number one driver of value in an ABL company M&A deal. My job is to help position a business for sale and put it in the best light, but the first thing I’m always going to look at is historical credit quality through good cycles and bad. If our client has a clean track record of modest losses, it makes my job easier and most importantly, leads to better value than average. And that’s the case whether you sell in a down cycle or the best seller’s market ever.
Perer: Lastly, tell us something you are worried about that the rest of the market has yet to figure out.
Stute: Charlie, I’m not smart enough to come up with some fancy new negative trend to worry everyone in the ABL sector. But what I will say is that I think the ABL industry has to be really careful to retain its young talent. The churn in the broader finance workforce and availability of jobs coming out of the pandemic worries me when I think about succession planning in the ABL sector. I do think this topic is front and center for most in the industry, so I’m optimistic that companies will be able to do what it takes to retain their up-and-coming stars.
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