Comment: Ask the Right Questions Before You Join ATM Boom

Among the many revolutions in the financial services industry over the past five years, few have affected the average consumer as broadly as the explosion in off-site automated teller machine deployment.

Five years ago the ATM industry was the domain of financial institutions. Today, banks and nonbank deployers (often referred to as independent sales organizations, or ISOs) coexist in the marketplace and place ATMs everywhere from cruise ships to ski lodges.

The reasons behind the rise of the off-site ATM business-surcharging, inexpensive terminals, low-cost telecommunications-have been well documented. However, a number of questions about the future of the market have surfaced. Is the market saturated? Will surcharging be banned? How are deployers making money at many sites? (Hint: They're not.) What is the right business model, given changes in industry dynamics?

Though the market has been blessed with explosive growth over the last several years, the key trends for the next 12 to 18 months will be consolidation and retrenchment. Banks and nonbanks alike will reevaluate their businesses, with many deciding to pursue exit or partnership strategies. This wave of divestitures is just around the corner, and is likely to include terminal portfolios, undeployed placement contracts, and ISOs looking to quit the business entirely.

Despite questions over long-term prospects for the business, the market is still full of companies looking to make acquisitions. These include ISOs and financial services providers seeking to expand delivery channels.

As with many consolidating markets, there are more buyers than sellers. This has led to irrational acquisition prices: Rational buyers are finding it hard to justify price levels and compete for deals.

What's the difference between a rational buyer and an irrational one? A rational acquirer asks the right questions and uses a disciplined approach to financial valuation. In this context, disciplined doesn't necessarily mean conservative; it simply means realistic. Irrational buyers are just the opposite-they usually fail to recognize warning signs, and adopt the often overly aggressive viewpoint of the seller.

As with any due diligence effort, the key to making a rational acquisition is asking the right questions. There are three critical issues in making a rational off-site ATM acquisition: historical terminal performance, site location, and merchant contract terms.

Asking the right questions in these areas and incorporating the answers into a disciplined financial valuation approach can help minimize the chances of buying someone else's headache.

Though mutual fund companies are fond of saying that past performance does not guarantee future results, this doesn't really hold true in the ATM business. One of the simplest yet most effective ways to evaluate the prospects of an off-premises terminal portfolio is to review historical transaction data and determine if there are any factors that hint at the chance for significant future growth.

Key questions to ask include:

Is the terminal portfolio mature? We have found that the average terminal matures six to nine months after installation. Subsequent fluctuations in volume are caused primarily by such major events as a change in the surcharge price or the remodeling of the store.

To what extent is seasonality a factor? Terminal portfolios with a large number of placements in retail locations (such as malls) can experience transaction volume increases of 50% to 75% during peak months.

What are the prospects for adding new product functionality to the existing terminals? Setting aside the issue of whether or not money can really be made from selling stamps, phone cards, and other items, terminal models and configurations should be reviewed to ensure that new functionality can be added.

Terminal location is clearly the primary driver of profitability, but there are a number of specific location issues that a potential acquirer should consider.

Has the merchant category, as a group, performed well? ATMs in convenience store chains have performed relatively well, with monthly averages of more than 1,500 transactions not uncommon. However, ATMs in many grocery stores have shown disappointing results, with typical monthly averages of 500 to 750 transactions. Early returns from placements in drug stores, movie theaters, hotels, and other locations are mixed.

What type of foot traffic does the location get? Analyzing monthly foot traffic is one of the best ways to assess the ability of a location to support a profitable ATM. As a rule of thumb, between 3% and 5% of all passers-by will conduct an ATM transaction.

Where in the store would the machine be placed? Does the merchant cooperate-or, better yet, actively participate-in the placement of signage? Are there local zoning ordinances restricting the type and placement of exterior signage? No matter how many people enter and exit a store, the placement will fail unless the terminal is easy to find.

The point of sale policy is also a concern. Specifically, deployers want to know if a large number of merchants offer cash back at the point of sale, or whether they are likely to in the future. Our research, based on performance of terminals in two major grocery store chains, indicates some correlation between POS cash back and lower terminal performance. Average monthly transactions at the locations studied were less than 400, well below volumes at certain non-cash-back locations.

Regardless of the performance and location of a terminal, a poorly structured merchant contract can doom any terminal to a life of subpar profitability.

Unfortunately, many deployers find themselves in the same position as cobranded credit card issuers-locked into a one-sided contract. As in cobranding, contracts must meet the needs of both parties. If they don't, even the merchant ends up paying a price in the long run, if the deployer is forced to cancel the program.

Key quesitons to ask about merchant contracts include:

How much of the surcharge and interchange is shared with the merchant? First Annapolis has reviewed contracts in which more than 75% of surcharge revenue is paid to the merchant. At those levels, even an ATM that does 1,500 transactions per month can lose money for the deployer.

At what transaction level does the deployer have to start paying rent to the merchant? From the first transaction? From a pre-defined break-even point? As a deployer, you should know your break-even levels and resist making any payments to the merchant until a terminal starts to turn a profit.

Does the deployer have the right to remove poorly performing terminals reasonably quickly?

Is the deployment relationship exclusive? Does it include future locations and provisions for acquisitions of the merchant or its parent company?

At the right price, any potential acquisition can make sense for your organization. The first step is to understand what information is necessary for making rational financial valuation and strategic decisions.

Be cautious about planning. For example, don't include a large premium in your acquisition price based on incremental revenues you are projecting from cross-selling mortgages through ATMs.

Lastly, stick to your guns. If you're involved in a competitive bidding process and you overpay to win the deal, have you really won?

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