Articles
Is the M&A Market Heating Up Again?
by Jim Campbell, April 2011
National Underwriter
The agency acquisition market was red hot in 2007 and continued that way throughout most of 2008. Later that year, however, as the U.S. economy went into free fall, the acquisition market began to cool. In 2009, deal activity fell by more than one-third, by far the largest year-over-year decline in recent memory. And it recovered little in 2010.
But is the market heating up again? Perhaps. In fact, the data suggest it already has. A total of 71 agency acquisitions were reported for the fourth quarter of 2010, the highest quarterly total in two years. Another 65 deals were reported for the first quarter of 2011, resulting in a two-quarter total of 136 deals and an annualized total of 272.
To put this in perspective, the last two quarters have been the most active quarters for deal activity since January 1, 2009 (a total of nine quarters).
And perhaps more surprising, annualized, these last two quarters represent more deal activity than was produced in all but one of the last 10 years.
On the surface, these numbers suggest that the agency acquisition market has returned to its pre-economic-crisis fervor. But before jumping to conclusions, let’s consider potential mitigating factors. And there’s a big one. Throughout 2010, the pending increase in capital gains tax rates loomed over potential sellers. The threat was clear. If you were planning to sell your agency, get the deal closed by December 31, 2010 or be prepared to give Uncle Sam an extra 5% of your gain. Though this threat didn’t flood the market with sellers, there is no doubt it encouraged some to accelerate their schedules, thereby contributing to the uptick in fourth quarter deals.
But if anticipated tax law changes contributed to the number of fourth quarter deals, that doesn’t explain why the market remained robust through the first quarter of this year. Or does it? In early-December of last year, President Obama and Congress reached agreement to extend the current tax rates. Suddenly, the pressure was off. Many buyers and sellers rushing to get a deal done by the December 31 deadline took a deep breath. Some deals that would have otherwise closed last year were allowed to slide into the first quarter of this year. Bottom line, tax policy likely contributed to an increase in deal activity in both of the previous two quarters.
At this point, it’s difficult to discern how significantly tax policy affected the market. Whether the current trend is more of a harbinger or an aberration is unclear and it may take another quarter or two before the data will answer this question. But there are reasons to believe the recent increase in deal activity will be sustained. Consider the following.
Buyer interest remains strong. After remaining on the sidelines for much of 2009, buyers began returning to the market in 2010. Not only has this demand for deals continued, it appears to be strengthening. This is due in part to its breadth. Current buy-side interest is not limited to one or two primary buying groups but extends to all of the traditional buyers. Public brokers have seen a sharp rebound in their share price, strengthening their deal currency. Private brokers, representing the most active buying group of 2010, are motivated by a slight pullback in deal valuation multiples. Suddenly able to be more competitive on price, they don’t intend to waste the opportunity. A growing group of private equity buyers, large and small, are scouring the market looking to put their capital to work. And even the banks, significantly diminished as a buying group the last two years, are making noise again. Community banks in particular are looking to agency acquisitions to offset threats to existing fee income. With all of the buying groups engaged, demand for deals looks to remain strong for the foreseeable future and will apply upward pressure on deal valuation multiples.
Seller reluctance is easing. Despite the strong and growing buy-side demand, however, it takes two to tango. And lately, sellers have not been in much of a dancing mood. A weak economy and a soft property and casualty market have resulted in negative to flat growth for many agencies over the past two years, and a challenging growth environment does not motivate sellers. Concerns about lowered valuations and the difficulties of achieving growth-based earn-outs have kept many potential sellers on the sidelines. Effectively, seller reluctance has dampened deal activity and until seller optimism is restored, the market can’t fully recover. But seller optimism may be staging a comeback. The Organic Growth & Profitability Survey, conducted by Reagan Consulting, found that agents are forecasting median organic growth of 4% for 2011. Though 4% may not sound robust, it suggests most agents believe the worst is behind us. Additionally, sellers may be enticed by improved pricing as strong buy-side demand nudges guaranteed deal multiples slightly higher.
Time will tell how much recovery the agency acquisition market has actually experienced over the past two quarters. Regardless, the market appears to have regained strength and will likely continue to do so. There remains a broad range of interested buyers, and growing optimism will return sellers to the market. Discussions are underway and deal pipelines are filling. Though we may not yet be back to the red hot market of 2007, the temperature is rising.