Even as soft insurance market conditions and a weak economy continue to pound agencies' and brokers' revenue growth, mergers and acquisitions are flourishing again.
Valuations, which chased falling revenues in recent years, also have rebounded.
And 2011 likely will not mark a temporary spike in deals and valuations following a 2-year falloff, experts said.
But while the M&A landscape is more lush than it has been in recent years, it's a changed environment. Because of recent tough market and economic conditions, some sellers have not reinvested enough in their businesses to generate even the modest growth that would attract buyers. And many—though not all—buyers are heavily discounting sellers' books of small-group health care business.
Still, buyers are buying again, and sellers are receptive.
"Right now, it's by far the most active it's been in the past 10 years," observed John Wepler, president of consultant Marsh, Berry & Co. of Willoughby, Ohio.
M&A activity
How significant is the turnaround in M&A activity?
Agency and broker consultants' figures vary somewhat because only a fraction of the deals are publicly disclosed, but their figures underscore that 2011 already has been the most active year since 2008. Indeed, the number of deals initiated by publicly traded, privately held and bank-owned agencies and brokerages this year is on course to top 2008's total.
According to OPTIS Partners LLC of Chicago, the number of announced and closed deals through the first 3 weeks of September—205—already exceed the full-year totals of 192 last year and 173 in 2009. The 2011 figure was only two shy of the full three quarters' total for 2008. That year, 289 deals were completed all year.
According to MarshBerry, the number of deals this year through the first week of September—161—exceeded the total for the same period last year—131—by nearly 23 percent.
Over the 12-year period beginning in 1999, the number of deals in 2010 tied for fourth-lowest—207, according to MarshBerry. If the number of announced deals continue at the same pace through year's end, the projected 254 deals would rank as the fourth-highest since 1999.
Atlanta-based Reagan Consulting projects that between 225 and 250 deals will close in North America by year's end, eclipsing its calculation of a 10-year average of 218 deals. The consultant anticipates an even more robust 2012, projecting 250 to 275 deals.
Buyers also are paying more for agencies and brokerages this year and valuations are expected to continue rising.
Reagan Consulting projects that the total expected price for an agency or brokerage this year will average 7.5 times EBITDA, or earnings before interest, taxes, depreciation and amortization. The consultant expects valuations will strengthen to 7.75 times EBITDA next year. While both estimates fall short of the 8.0 and 8.5 multiples that buyers paid in 2006 and 2007, respectively, they meet or beat the 7.5, 7.0 and 7.25 multiples buyers paid in 2008, 2009 and 2010, respectively.
Consultant Dowling Hales projects that pricing will average 8.25 times EBITDA in 2011—the highest multiple since buyers paid 8.5 times EBITDA in 2007. Multiples bounced to 7.75 in 2008, 7.5 in 2009 and back to 7.75 last year, according to the consultant.
"It's good for sellers, but it's also good for buyers that can wring expenses out of (an acquisition) and make money," said Bob Pettinicchi, the Farmington, Conn.-based executive vice president and chief lending officer of InsurBanc, a bank designed for insurance professionals.
"Some sellers have been on the sidelines for the last few years, but now there's a new reality that's made a number of agents and brokers realize the current valuations are the new reality and so it's time to act," said insurance industry consultant and investment banking advisor John Wicher, principal at John Wicher & Assocs. in San Francisco.
But Tim Cunningham, a principal at OPTIS, said that those multiples are "outliers" and apply only in the most "strategic" deals. He said 6 times EBITDA "is a solid median" that has not varied much over the years. Still, agency and brokerage values have dropped 20 percent because sellers' earnings have fallen, he said.
"I think it ends up being very deal- or target-specific," Pettinicchi said.
Even over the last few years, well-run organizations "were still very valuable," he said. "Those organizations were still commanding a premium."
The spark
What has ignited M&A activity? Among buyers owned by private-equity groups, there is about $300 million of uncommitted capital that has to be put to use, Wepler. said. That so-called "capital overhang" resulted from record fund raising from 2005 through 2008 followed by the drop-off in deals in 2009 and 2010.
Another factor driving deals is a new "notable" broker, AssuredPartners Inc. of Lake Mary, Fla., that is very active, Wepler noted. Assured, headed by two former Brown & Brown Inc. executives who acquired and integrated agencies, targets small and midsized retail property-casualty and employee benefits agencies.
In addition, publicly owned brokers now can more easily afford to make deals than in the past several years, Wepler said.
As premium volume shrank in 2008 and 2009, so did the publicly traded buyers' own share values—a critical development because buyers use their own stock as a material component of the compensation paid to the owners of their acquisition targets. According to MarshBerry's figures, buyers' profits over earnings ratio fell from nearly 22 percent in 2006 to near or below 17 percent for the next few years before reversing and hitting 20 percent last year and topping 21 percent during the first quarter this year.
"So they're willing to pay more for an acquisition because there's positive arbitrage" for them in a deal with an acquisition that has been able to grow, Wepler said. The buyer's own valuation increases as a result, he said.
Even some large bank-owned agencies and brokers, which had retrenched from the M&A environment to focus on their core business after the economy began souring in 2007, "have come on as agency buyers," Wepler said. Those buyers are driven by the loss of some significant sources of revenue in 2010 as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Wepler said.
Meanwhile, acquisition targets are looking stronger and are more receptive to courting.
The property-casualty insurance market certainly has not hardened, but experts said it has stabilized. While revenues are not soaring, agencies and brokerages with strong management have found a way to eke out some profits by focusing on niche business, investing in strong producers and cutting expenses, experts said.
With strong management, some independent agencies have managed to organically grow revenues 4.5 percent and turn a profit, demonstrating they can succeed independently of the P/C market cycle, said Ken A. Crerar, president of the Washington, D.C.-based Council of Insurance Agents and Brokers.
Meanwhile, the economy remains sluggish, depressing business activity that in headier times would generate increased commissions for agents and brokers.
"But at least it's bottomed out," Cunningham said.
On the other side of the ledger, agency and brokerage owners finally have right-sized their expenses, bringing them in line with their reduced revenues, Wicher said.
Some experts also speculate that uncertainty in 2010 over whether the Obama administration would extend the 15 percent capital gains tax rate or allow it to revert to the previous 20 percent rate sparked sellers' willingness to cut a deal by year-end. When the expiring rate was extended for another 2 years late in 2010, sellers who had not completed their deals pressed forward with them this year, several experts said.
But Pettinicchi said he does not think that uncertainty prompted agency owners to sell, because owners did not rush to find buyers in late 2010.
Wicher said that while the tax issue did not drive sellers to make deals last year, "it was an additional consideration" and did accelerate the closure of some transactions to ensure they would be completed and subject to the lower tax in 2010.
Other factors also are at work, making this year and 2012 a period of opportunity for buyers, experts said.
Insurers are pressuring smaller independent agencies to increase their sales volume, and some agency owners see selling out to a larger agency as their best perpetuation option.
At some larger agencies, valuations are significant enough to create financing issues for partners who have to line up capital to buy out a retiring partner, Crerar said. Selling to a larger organization eases those financing issues, he said.
But some agency and brokerage owners who pulled out of the M&A market in recent years rather than sell far below the price they could have commanded before the P&C market softened and the economy tanked do not realize that valuations have rebounded, Wepler said.
Other potential sellers have decided against joining forces with any buyer and instead have developed a perpetuation plan, he said.
One aspect of a merger or acquisition that sellers often fail to focus on adequately is their quality of life after the transaction has been completed, Wicher said.
"There is nothing more miserable than being a former owner locked into an employment agreement and not really liking where you are," he observed.
As part of the transaction, the buyer and seller should agree on their business objectives for the agency and the former owner's level of authority and how he or she will continue to be professionally challenged and feel comfortable in the new business model.
"It's really important," Wicher said.
Wepler observed that an owner with a "strong, high-performing business" also could be better off remaining independent. "You'll build wealth infinitely faster than by selling," he said.
The caveat, however, lies in the answer to the question every potential seller has to answer honestly, he said: "Do I have the horses" to remain independent?
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.