Monday, August 3, 2009

Sizing Up the Opportunity

Recent economic headlines have desensitized us to very large numbers. “A billion here and a billion there” has become “a trillion here and a trillion there”.

Numbers that large tend to lose real meaning to us whether they represent government spending proposals or distances in interstellar space.

When I talk about The Receivables Exchange to people, eyes tend to glaze over at the TRE “headline” market size number of $17 trillion to $18 trillion. It’s just too big to get your arms around.

So I’d like to do a little rough reality check on the size of the TRE opportunity. These are my thoughts, not those of TRE, which might actually consider me a little conservative.

The Federal Reserve Board publishes a quarterly analysis of the constituent segments of the US economy. Table B-102 on page 103 of the Fed’s July 11 report contains its 1Q 2009 analysis of the “Nonfarm, Nonfinancial Corporate Business” segment of the US economy.

I’d reproduce the Table here for the readers’ convenience but I’ve already wasted hours unsuccessfully trying to format it in this blog software! So I’ll have to try to tell you what it says rather than show you.

At the end of Q1 2009 the total “Trade Receivables” of the nonfarm, nonfinancial corporate business segment of the US economy was $2,165.8 billion.

The average of the five prior year-end figures was $2,095.9 billion. (The range was from a low year-end figure of $1,831.3 billion in 2004 to a high of $2,263.1 billion in 2007.)

To convert a point-in-time balance to an annual volume we have to apply an estimate of receivables turnover i.e. how many cycles of payment are there in a year. Most estimates of payment velocity fall between 30 and 60 days with a central tendency in the 40 to 50 day range.

A 40-day turnover rate produces a multiplier of (365/40) 9.1 and a 50-day rate produces a multiplier of (365/50) of 7.3.

If we apply that range to the 5-year average of the Fed’s numbers we get an indicated total annual figure of $15.3 trillion to $19.1 trillion.

This shorthand calculation bears out the TRE estimates. The size of the aggregate corporate receivables market DOES actually appear to be in the vicinity of the $17 trillion annual figure the exchange uses in its materials.

But that’s just a starting point for estimating actual market potential.

There are many categories of receivables that are not eligible for posting on the exchange: a large volume of such ineligible receivables represent the progress payments typical in the construction industry, for example. Other significant excluded categories are related-party transactions and receivables of businesses too small to be TRE Sellers.

It’s tough to quantify the values of the various classes of receivables that are ineligible for TRE posting but, since we’ve managed to roughly verify their overall volume figures, it feels a bit safer to accept, for argument’s sake, their estimate of the actual addressable market i.e. what’s left after excluding all of the ineligible items.

A range of $2.5 trillion to $3.0 trillion is used in various TRE sources, which is about 15% of the total. Excluding 85% of the total market seems, on its face, to be conservative. But is there a way to get a quick confirmation of that?

Well, the government’s Bureau of Economic Analysis publishes a quarterly report on national income accounts that can give Ambien a run for its money.

It might be reasonable (or at least interesting) to compare the income attributable to “proprietors” as a proxy for the TRE-ineligible small, non-corporate sector of the economy, to that of the “corporate” sector.

The “proprietors” income, according to the BEA, represents about 41% of that total (see p15/D-16 Table 1.12 “National Income by Type of Income”)

If we accept that about 40% of the 85% might be represented by the small, non-corporate sector, it doesn’t seem unreasonable to attribute the balance to the other ineligible categories. Again, it seems OK on that basis to accept the TRE-estimate of the net addressable market. We’re just looking for broad-brush confirmation here, in any event.

Now, the next step.

If we assume that the average duration of TRE-eligible receivables roughly equals 45 days, the average outstanding eligible receivables balance at any point in time would be between:

$2.5 trillion / (365 days / 45 days) = $308 billion, and
$3.0 trillion / (365 days / 45 days) = $370 billion.

And, if we further assume that available capital can be actually employed about 85% of the time, the range of capital needed to serve that market would be between about $360 billion and $435 billion.

To pick a point in the middle, we can estimate that the market might have the potential to employ about $400 billion in capital on an ongoing basis. That assumes, of course, that the entire addressable market is captured, which is not reasonable.

So, one more step.

What level of potential TRE business opportunity does that really represent?

Let’s start with another report, this time from the Commercial Finance Association. The CFA reports that receivables factoring volume in 2007 amounted to $135 billion. And let’s convert that figure back to ongoing capital requirement using our same parameters i.e. a 45 day pay period and an 85% utilization rate. The total capital required to support the 2007 actual volume was roughly $20 billion, or just 5% of the indicated potential.

So the indicated potential market is 20 times the current volume of receivables factoring.

Now, some businesses obtain working capital financing using means other than factoring receivables. There are bank lines available to many businesses and various asset-based borrowing facilities. The CFA estimates 2007 asset based lending amounted to nearly $500 billion. If (and this is just a wild guess) about half of that figure is backed by receivables, and we apply the same parameters to calculating ongoing capital needs, the indicated ongoing capital requirement would be about $30 billion (rounded).

We’ve now accounted in a very rough way for about $50 billion of the estimated addressable market.

Many of the better-quality businesses that have wanted to use their receivables as a source of accelerated liquidity have had the opportunity to do so. But many businesses that have been able to liquify their receivables in the past have now lost their funding facilities. And some will undoubtedly find the TRE platform more convenient and attractive than the options they currently employ.

Just for fun, let’s say that 20% of the current factoring and receivables-based asset lending market can be enticed to TRE. That would generate an ongoing capital need of about $10 billion. (Some of the customers of those existing platforms will want to stay with them for a variety of reasons including the “full AR service” that traditional factors provide.)

And let’s say that 12.5%% of the currently un-served market can be enticed to the TRE platform. That would generate an ongoing capital need of about $45 billion (rounded).

So, based on the current volume of economic activity, the total capital deployment opportunity might be about $55 billion (rounded) and the total gross volume of transactions would be between $500 billion (40 day average turn) and about $400 billion (50 day average turn.)

Let’s, again, just pick a point in the middle and call that $450 billion.

If TRE could generate $450 billion in annual transaction activity that would represent a bit over 2.6% of the total volume of annual nonfarm, nonfinancial corporate receivables generated in the US.

A projected market penetration of less than 3% with a platform as unique as that of TRE does not seem to strain credulity.

A market with an ongoing capital need of over $50 billion demands the attention of anyone involved in the receivables-finance business.

It’s not only likely to entice customers away from traditional market participants but it’s likely to impact pricing, packaging and process throughout the market.

TRE certainly won't reach its potential overnight. It will take some years. It will probably also take some changes in rules, format and process. But the traditional players in the business need to be looking over their shoulders.

TRE cannot be ignored.

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