U.S. Acquirers Eye Europe

  Europe is drawing investors as the European Union expands east and changing market conditions force banks to consider outsourcing their transaction-processing operations.
  Some salesmen live by the phrase that timing is everything. Others will tell you location, location, location. This year, Europe fits both those adages.
  Whenever the subject of hot economies comes up, most of the attention goes to Asia, especially China. But for American merchant processors, particularly U.S. Bancorp's Nova Information Systems unit, Global Payments Inc. and First Data Corp., some very attractive growth markets are located in Europe.
  While Europe is huge-there are nearly half a billion people in the 25 countries of the newly expanded European Union-it may be likened to a group of small or mid-size markets with differing rules and procedures. Experts compare Europe's card market to that of the United States about 15 years ago with its regional issuers.
  Similarly, Europe today appears to offer some of the same opportunities for merchant processors that card visionaries saw in the States at the start of the 1990s. In Western Europe, payment cards are well-entrenched but many banks don't want to invest in the computing and telecommunications technology needed to keep their merchant-acquiring divisions competitive.
  Eastern European banks, many of which trace their origins to the Communist era that ended in 1989, face the same issues. But in those cash-based societies, cards are just starting to make headway and present ground-floor opportunities for foreign processors willing to make the investment.
  "It's a very good time to be in Eastern Europe," says Jaymin B. Patel, chairman of the supervisor board of PolCard S.A., a Warsaw-based processor now majority-owned by GTech Holding Corp. of West Greenwich, R.I. "It's exciting to be at the beginning of the cultural change in the use of cards."
  Patel adds that card transactions in Eastern Europe are growing at a compound annual rate of 18% to 25%, depending on the country.
  Change is coming to European acquiring for several reasons. Besides the general need to keep up technologically, European banks have an onerous task at hand: meeting the requirements of the so-called EMV (for Europay/MasterCard/Visa) standards that will put into place a smart card-based payment system across the continent. Acquirers, merchants and issuers have a January 2005 deadline to comply with EMV card-acceptance and processing rules, which are designed to reduce fraud. Firms that aren't EMV compliant could be held accountable if fraud occurs in a transaction in which they are a party.
  (Observers say there is a push to extend the EMV deadline, but the bank card associations, or schemes as they are known in Europe, are holding firm to January.)
  Many banks are debating whether to invest in the systems necessary to become EMV compliant. Some are opting to outsource their merchant-acquiring units to outside experts, a role that U.S. processors are eager to fill.
  Meanwhile, Europe's longstanding merchant-acquiring model in which most banks are both issuers and acquirers in relatively sheltered national markets is coming under pressure as old trade barriers fall. In this environment, banks are starting to conclude that they would rather put their money into issuing than into the poor cousin, acquiring.
  "The issuing side is where the money is made, but most banks jumble up the acquiring side in (their) corporate banking relationship with clients," says Gerald Hawkins, president for Europe, Middle East and Africa at processor First Data.
  Necessities
  Billy Saunderson, chief executive of euroConex Technologies Ltd., a merchant processor based near Dublin, Ireland, estimates that bank card divisions earn over 90% of their revenue from their issuing side but devote 55% of their spending to acquiring-side necessities like systems.
  "We hammer that home" when meeting with potential clients, says Saunderson. "We encourage them to look at cards as a product in their portfolio."
  It won't be long before processing in Europe will resemble the high-volume, low-margin U.S. model, according to Saunderson. Many banks will see how much it will cost them in technology investments to compete in that market and choose to go with an outsourcer, he predicts.
  Complicating the situation is a long-standing European policy that an acquirer must also be a card issuer. U.S. processors grate at the Issuing-Before-Acquiring rule, which was set by Visa International and MasterCard International. Visa contends the rule ensures that banks and processors are committed to its systems. In practice, though, some European banks are moving toward a model in which they are merchant processors in the traditional sense in name only, keeping their brands on the sales and marketing aspects while allying with an outsourcer to run the operations.
  And that's where the Americans come in.
  EuroConex, a division of Atlanta-based Nova, is a full-service third-party processor that is now focused on the United Kingdom market and Eastern Europe. Nova and partner Bank of Ireland created EuroConex as a joint venture in September 2001. Under the alliance, Nova provided its processing technology and experience in serving card-accepting merchants while the Bank of Ireland tossed its existing merchant contracts and contacts in the U.K. into the mix.
  This year, Nova bought out Bank of Ireland's 50% share of euroConex. Still, Nova plans to use that deal's template as the model for future deals with European banks, says Edward Grzedzinski, Nova's president and chief executive.
  EuroConex will buy and service a bank's merchant contracts, accept the account risk, and offer the merchant customer a range of products. The bank keeps its name on its merchant relationships, cuts its risk, and receives residuals valued at about five basis points of the per-transaction charge that euroConex collects from merchants, according to Grzedzinski.
  "We offer our services without paying for (the bank's) brick and mortar," he says. "(Banks) make no capital investment and eliminate back-office expenses."
  Grzedzinski estimates that euroConex has grown about 35% annually since its beginnings. "We will process about eight billion euros (approximately $9.7 billion) this year and will become a top-10 processor in Europe in four years," says Grzedzinski.
  This April, Nova and euroConex ratcheted up the competition with other major deals. EuroConex bought the acquiring business of Alliance & Leicester Commercial Bank, a portfolio of about 27,000 merchants in the U.K. EuroConex also bought CardPoint, a unit of Warsaw-based Bank Zachodni WBK. In addition to becoming the card processor for CardPoint's merchants, euroConex began a marketing alliance with Bank Zachodni. Nova hasn't disclosed terms of those deals or the cost to buy out the Bank of Ireland.
  EuroConex's affiliation with Minneapolis-based U.S. Bancorp, with $192 billion in assets, helps with acquisitions and in opening some Old World doors. "Banks in Europe appreciate the stability, longevity and security of a top-10 U.S. bank," says Grzedzinski.
  First Data, the largest U.S. transaction processor, has been in Europe for about 30 years, processes for 194,000 merchants and handles about 25 million card accounts, according to Hawkins. One processing client is Amsterdam-based ING Group, the financial giant that reported assets of 830 billion euros, or $1.01 trillion, at the end of the first quarter.
  Think of Europe as a series of markets in various stages of development, says Hawkins. That means a two-prong sales approach with First Data making sales calls on the largest domestic banks in each market. Greenwood Village, Colo.-based First Data also teams with U.S. banks and other international institutions looking for a single processor that works across the continent, he says.
  "U.S. banks will come and seek us out," says Hawkins. "If they go to individual countries and seek partners, it's a nightmare."
  First Data says it is prepared for EMV, giving it an opening with domestic banks that may have put off investing in the technology. "Many banks, especially mid-size banks, are looking seriously at outsourcing" their card processing, says Hawkins.
  First Data is also making selective acquisitions of domestic processors. In March 2003, it bought Stuttgart, Germany-based TeleCash Kommunikations Service GmBH from Deutsche Telecom for $121.4 million. TeleCash, a payments network service provider, has installed over 170,000 point-of-sale terminals in the last decade. It primarily serves the German market but has alliances with similar operators in Austria, Switzerland and Italy.
  Hawkins believes the addition of Nova and Global Payments will help seed Europe with the outsourcing concept. But his experience suggests it won't be so easy to grow a company beyond its domestic borders. "(Executives believe) you will spread your wings in other markets. I don't think it's as simple as some think," he cautions.
  First Data's archrival, Total System Services Inc. (TSYS), declined to discuss in detail its European plans but points to deals with the Royal Bank of Scotland and the processing it does for Barclays Bank PLC's big Barclaycard program. TSYS services about 14 million card accounts in the European market, according to a spokesperson. The goal for Columbus, Ga.-based TSYS this year is to assist its clients in expanding beyond their borders, while it prospects for new business in Germany, Italy, Spain and France.
  There are some truisms that, for the most part, fit Europe. One is that credit cards are a relatively small market, with consumers favoring debit cards, or debit-like cards.
  London-based research firm Euromonitor International found that debit in 2003 held a greater than 60% share when ranked by volume of transactions. Credit cards had a 14% share, cards usable only at automated teller machines and charge cards each accounted for about 11%, store cards about 2.5% and electronic purse cards less than 1%. Euromonitor's survey tracked card markets in 13 major economies, ranging from the U.K. east to Russia and south to Italy.
  Europeans are fairly comparable to Americans in their degree of being plugged in or not plugged in, depending on the technology. About 80% of European consumers use a cell phone, while 31% have a personal computer, according to the European Union.
  Perhaps the most exciting markets in Europe today are on its eastern borders. In May, the EU expanded to include Czech Republic, Hungary, Poland, Slovakia, and six other Central and Eastern European countries.
  Good news came quickly as card transactions rose 11% in Poland that month, according to PolCard, the largest debit and credit card processor in Poland.
  Financial card markets in Poland grew over 1,000% from 1998 to 2003, Euromonitor found. In Czech Republic the growth rate was over 800%. While that growth may be coming from a much smaller base than those countries' western cousins, it indicates consumers are eager to embrace card use.
  Processing executives say that Eastern Europe offers rising consumer purchasing power, a consolidating banking industry, business leadership open to the idea of outsourcing, and a slew of international banks opening their checkbooks to make alliances with or buy locals.
  PolCard's new majority owner, GTech, is a tech firm that may be best known in the U.S. for processing systems and ticket services for lotteries. GTech, which reported $1.1 billion in fiscal 2004 revenue, has moved into international waters while expanding its transaction-processing capabilities.
  In May 2003, it paid $35.9 million for 63% of PolCard, which handled 51% of the 152 million card transactions in the country in 2003, according to Patel, who is also GTech's senior vice president and chief financial officer. GTech was already in Poland, processing transactions for the national lottery and operating a tech center in Warsaw with about 300 employees, Patel says.
  'A Ferrari'
  PolCard services magnetic-stripe and smart card transactions on MasterCard, Visa, and private-label cards. It operates over 600 ATMs for 13 banks, while its point-of-sale network covers 34,000 terminals. PolCard generated $21.4 million in revenues for GTech in its fiscal year ending last February, according to Securities and Exchange Commission filings.
  Meanwhile, Atlanta-based Global Payments is concentrating on the Czech Republic. It sent a shot across the bow of the competition last December when it paid Komercni banka a.s. $34.7 million for 53% of Muzo a.s., the largest processor in the country with a 50% market share.
  Paul Garcia, Global's president and chief executive, said when the deal was announced that Muzo's EMV-compliant technology offered a springboard for expansion into Slovakia, Hungary, Poland and Russia. "This is a Ferrari just waiting to be let go here," Garcia exulted to analysts.
  In 2003, Muzo generated revenues of $27 million through its processing of about 100 million transactions, two thirds at ATMs and one-third at the point of sale. Prague-based Muzo operates 1,212 ATMs and 19,138 merchant POS terminals, and manages three million cards.
  This May, Global reported it had paid another $30 million and held 98% of Muzo's outstanding shares. Global wouldn't comment further about its European ventures, saying it is in a "quiet period" related to Canadian Imperial Bank of Commerce's divestiture of its 22% share of Global's stock.
  U.S.-based firms aren't the only processors eyeing the east.
  EuroProcessing International ASA is an Oslo, Norway-based third-party processor that has aggressively added domestic processors in the Baltic States and Central and Eastern Europe to its quiver. In 2000, it acquired Latvian BankServiss, followed in 2001 by Vilnius, Lithuania-based UAB Mokejimo Korteliu Sistemos. This January EPI closed on its purchase of Transacty, a Slovakian processor with a 50% market share. Prior to the Transacty buy, EPI reported it processed 62 million transactions in 2003. It operates in Latvia, Lithuania, Slovakia, Serbia, Montenegro and Macedonia.
  Expansion
  EPI is owned by Reiten & Co. Capital Partners, a Norwegian private equity fund, and Creati AS, a holding company owned by EPI executives and other investors.
  John Reinsli, EPI's CEO, notes that the firm is not a merchant acquirer but manages about two million cards for its bank clients. The revenue goal this year is 20 million euros after reaching about 17 million euros in 2003, says Reinsli.
  EPI plans to expand both through market growth and continued acquisitions. By the end of the year, EPI will be in another three countries through acquisitions or major client contracts, says Reinsli, who declines to disclose specifics.
  Reinsli predicts that Eastern Europe will see its domestic banks spin off their processing units. Further, the international processors will be on the prowl for country-specific processors that are owned by a consortium of financial institutions.
  "This is a new industry in the east. Domestic players have not been exposed to this kind of competition," Reinsli says.
  While opportunities for new competitors are growing, the atmosphere in Europe is not entirely wide open. First Data has challenged the rule that requires acquirers also to be issuers, contending it restricts competition and is a barrier to trade.
  "Historically, (the rule) was appropriate but now it is restrictive. It makes it difficult for third-party processors to operate in new markets," says Hawkins.
  Merchants particularly are galled at what they consider tough requirements for accepting cards and the lack of competition for Visa and MasterCard.
  Europe still has honor-all-cards rules that require a card-accepting merchant to accept all Visa- and MasterCard-branded cards. In the U.S., such rules were effectively eliminated by the settlements of the big class-action lawsuit between merchants and the card associations last year ("The Retailers' Home Run," July, 2003).
  The bone of contention is commercial cards, a relatively new product in Europe and one that carries interchange rates that some merchants believe are excessive.
  "A merchant agrees to (honor-all-cards) 20 years ago at one price. Now they introduce the commercial card with a higher price and the merchant must accept it," says Xavier Durieu, secretary general of EuroCommerce, a trade organization of five million merchants that employ 29 million workers.
  Like their U.S. counterparts, European merchants grouse about the interchange fees that they pay for card transactions. Durieu contends some of the costs that issuers recover through interchange, such as expenses for fraud control and some other services, might be less if merchants were allowed to buy services from other providers.
  "We are willing to pay a fair price for services that benefit us. That demands competition," says Durieu.
  Brussels-based EuroCommerce is welcoming U.S processors entering Europe. It also would like to repeal the no-acquiring-without-issuing rule.
  Take the Plunge
  There is a chance that interchange will fall. In 2002, Visa agreed to reduce its fees on cross-border transactions where the card-issuing bank is based in another country from the merchant location. Cross-border debit card payments were cut 50% to 28 euro cents. Visa also agreed to further reductions into 2007, and to a demand from the European Commission that it post its prices publicly.
  Durieu notes these reductions don't affect the intra-border interchange fees that are set by individual countries' payment organizations or their domestic banks.
  There's a chance those fees may be reduced in the U.K. when its Office of Fair Trading makes a decision on MasterCard's interchange rates. The regulator made a preliminary ruling last year that the fees were too pricey. A final decision is expected this year.
  Interchange doesn't directly affect processors as they typically pass on the fee to merchants as part of their cost of accepting cards. But processors' bank clients are watching the action closely. And logic suggests that more merchants would take the plunge into being card acceptors if costs were reduced. In this dust-up, processors are trying to stay quietly out of the fray.
  In the last few years, much of the international community's attention has been on the expanding Asian economies. In many ways Europe is a more mature, slower-moving market. But cards once again open up exciting opportunities. For processors, Europe is proving to be a new world.