Do Banks Overpay For P-C Agencies?

But are these rumors accurate? Do banks really overpay for agencies or have they been portrayed unfairly? Are the price multiples attributed to bank buyers based more in fact or fiction? For answers to these questions, lets consider a few facts.

Last month, the American Bankers Insurance Association released its sixth annual "Study of Leading Banks in Insurance." A total of 407 banks from throughout the United States participated. Of these, 52 reported on their most recent agency acquisition. Most of these transactions are current, including 58 percent that closed in either 2002 or 2003. Among the findings from the analysis of these transactions are the following:

Price multiples paid by banks are in line with the current market.

In todays market, agencies typically sell within a range of 5.5-to-8.0-times pro forma EBITDA (earnings before interest, taxes, depreciation and amortization). A majority (53 percent) of the transactions reported by banks were priced below 7.0-times EBITDA–well within the current market range, and 45 percent were priced below 6.0-times. Only 12.5 percent of theses deals exceeded 8.0-times EBITDA.

Translated into a multiple of revenues, 47.9 percent were priced below 1.5-times agency revenues and 65.3 percent were priced below 1.75-times revenues. Only one in 10 (10.9 percent) of the selling agencies was paid more than 2.0-times revenues.

Banks often require sellers to share the future performance risk.

Not only are price multiples paid by banks more conservative than speculated, but nearly half (45 percent) of these deals include an earnoutthat is, a component of a deal structure which makes a portion of the proceeds contingent upon the future performance of the agency. For most of the reported deals, the earnout held between 15 percent and 25 percent of the total proceeds, with a payout schedule of three-to-five years.

Why are earnouts used so extensively? Because value is largely a function of future earnings. Lacking a crystal ball, buyers value acquisition targets based on reasonable projections of future earnings. The earnout allows the buyer to adjust the ultimate price closer to true value if actual earnings fall short of projections.

What if earnings exceed projections? Many of these transactions allow for upward price adjustments as well.

Tax-deferred transactions are the exception, not the rule.

Okay, maybe banks arent paying wildly aggressive multiples for agencies, and maybe they are requiring the sellers to assume some of the future performance risk through an earnout provision. But at least theyre structuring the deals as an exchange of stock so the sellers can defer their tax liability, right?

Wrong. Cash was the predominant currency in 79.1 percent of the reported transactions, and the exclusive currency in 72.9 percent.

Why are banks reluctant to part with their stock? Some banks view their cost of capital as simply too high. Others are compelled to buy the agencies assets (rather than stock) to get some tax relief on the amortization expense, otherwise their return-on-capital requirements are out of reach.

Bank buyers will continue to acquire agencies.

So, how successful are banks as acquirers of insurance agencies? Are they so discouraged by the results of their acquisitions that they plan to stop acquiring, perhaps even divest?

Not exactly. In fact, of the 52 reporting banks, 46 (88 percent) have plans to acquire additional agencies. These plans are supported by the finding that 45.6 percent of these banks have experienced actual results that exceed their pre-acquisition expectations, and another 32.6 percent have met expectations.

So, if banks are structuring sound deals and achieving solid results, why have they developed a reputation as na?ve acquirers of agencies?

The answer probably lies in a combination of factors. First, some banks have overpaid. In particular, some of the earlier transactions were overpriced due to inflated cross-sell projections and general inexperience in the industry.

But second, and perhaps more significant, banks have demonstrated a willingness to occasionally stretch to do the right deal. In other words, banks are often looking for high-performing agencies that provide a platform on which to build or that add significant depth to an existing operation.

These agencies are typically larger, have relatively young leadership, a true sales culture and a history of consistently strong growth and profitability. And these agencies are more valuable than most.

An indication of this trend is evident among our 52 banks. Specifically, only 40.7 percent of the reported acquisitions of agencies below $5 million in revenues were priced above 7.0-times revenues. But for larger agencies, 75.0 percent were priced above 7.0-times revenues. Simply put, premium pricing is reserved for the exceptional agencies.

So, perhaps its time to reconsider the story of bank-agency acquisitions. Despite their relatively short history in the insurance distribution business, banks are financially sophisticated organizations and experienced acquirers. Most are conservative, disciplined capital investors that are accountable to boards of directors and to shareholders.

As a growing component of the insurance distribution system, banks will continue to rely on agency acquisitions to drive their commercial lines strategies. And most will continue to acquire agencies in a thoughtful, strategic and disciplined manner. The expression "win-win transaction" is overused and often misapplied. But successful acquisitions enable both buyer and seller to realize their objectives.

James M. Campbell is a principal and senior vice president of Reagan Consulting Inc., an Atlanta-based financial and management consulting firm that serves the insurance distribution system, including agents, brokers and banks. He may be e-mailed at jim@reaganconsulting.com.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, November 21, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.