Is the Agency M&A Craze Coming to an End?
by Kevin M. Stipe, June 2007
National Underwriter
The sellers' market for insurance agencies got another jolt of momentum during the past six months as USI and Hub both announced they are being acquired by private-equity investors. The prominence of the investors involved (Goldman Sachs and Morgan Stanley) and the aggressiveness of the multiples of historical EBITDA they paid (roughly 10.5 and 12.5, respectively) have sent shock-waves through the industry. Today speculation is rampant that one or perhaps several of the other public brokers will soon announce their own private equity deals.
What does all of this mean for agency owners? On May 6-8, Reagan Consulting held its bi-annual Mergers, Acquisitions & Internal Perpetuation Workshop in Atlanta to discuss the state of the marketplace and the future for independent agents and brokers. A record crowd of 175 of the industry's best and brightest leaders assembled for the workshop, including representatives from 40 of the 100 largest brokers in the U.S. What follows are some of the key questions (and attempts at answers) that were discussed during the workshop.
1. What is driving buyers to be so aggressive in pursuing acquisitions? Buyers are flush with capital - and their investors expect them to deploy it - now! This is especially true of private equity investors who are receiving record levels of investor dollars and are chasing a limited number of investment opportunities.
Within the insurance brokerage sector, the brokers are facing an additional challenge. Their investors want 15% earnings growth year-in and year-out, regardless of property & casualty market cycles. With the marketplace currently in the fourth year of soft pricing, the publicly traded brokers struggled mightily in 2006 to generate 5% organic (e.g., non-acquisition) growth.
Well, 5% organic growth isn't going to cut it for investors! The 10% gap between 5% organic growth and investors' required 15% earnings growth represents an "acquisition imperative" for the public brokers - i.e. the percentage of their annual revenue that must be acquired to keep their investors happy. The table below shows graphically the "acquisition imperative" faced by the public brokers over the past five years, which has averaged 9% of revenue per year, since organic growth has averaged only 6% per year. Going forward, if the soft market continues, public brokers will be forced to continue to supplement their weak organic growth with acquisitions if they want to keep their investors satisfied.
2. What is driving so many privately-held agencies to sell? There is a misconception in the marketplace that most deals are driven by greedy agency principals who want to capitalize on today's high valuations.
Certainly valuations are a factor, but the real driver in most deals is basic ownership demographics. Studies have consistently shown that the average agency principal is in his/her mid-late 50's. Many of those owners have been unsuccessful in building another generation of talent in their agency. Others have brought in talented younger employees only to find out later that those younger employees did not want to take the financial risk necessary to perpetuate ownership internally. Either way, as these agency owners approach retirement age, their only real option is to sell their business. There is an entire generation of baby-boomer agency principals out there that will likely sell their businesses over the next five years.
What agency owners need to keep in mind, however, is that the valuation multiples delivered for USI and Hub reflect entry premiums paid for large, nationally-established publicly-traded insurance brokerage operations. For smaller local firms, there has been some upward pressure on valuations, but valuation multiples for those agencies have been nowhere near those paid for USI and Hub. For most agencies, the old range of multiples of 5.0 to 8.0 times pro forma EBITDA still applies. The two primary drivers of where in that range a particular agency will be valued are buyer synergy and expected future agency growth.
3. With so many hungry buyers trying to acquire, won't they soon run out of agencies to buy? We hear this question frequently - and it seems to make a lot of sense. After all, if one calculates the loosely defined "acquisition imperative" for the five brokers Arthur J. Gallagher, Brown & Brown, Hilb, Rogal & Hobbs, USI and Hub for 2006, it requires the collective acquisition of roughly $400 million in annual revenue! Given that only a small number of large agencies sell each year, there's simply no way to get there, right?
Wrong. While it is true that the acquiring brokers love to find large, marquee agencies to acquire, many of their transactions these days are smaller agencies - and there is a mind-boggling number of those agencies still out there. Reagan Consulting recently put together its own estimate of the universe of agencies in the U.S., as provided in the chart below.
We estimate there are approximately 33,500 privately-owned agencies in the U.S. today, of which perhaps only 300 generate more than $10 million in annual revenue. Assuming those 300 average approximately $13.5 million in revenue, then the largest agencies represent acquirable revenue totaling only about $4.0 billion - which isn't enough to satisfy hungry buyers for long.
But observe the groups below $10 million - specifically the three groups that range from $0.5 million to $10 million in revenue. Those three groups total 18,250 agencies and they control a whopping $28.6 billion in annual revenue. For perspective, USI reported revenue of $551.6 million in 2006. This means that there are 52 USI's out there waiting to be aggregated by hungry buyers. Or stated another way, this group could satisfy the national brokers' $400 million "acquisition imperative" for another 71 years or so!
So if you're waiting patiently for the marketplace to return to "normal" it may be a while. In the meantime, you can take heart in the fact that another group of industry "outsiders" has decided the insurance brokerage industry is a great place to invest.
Kevin Stipe is a senior vice president and principal of Reagan Consulting, Inc., an Atlanta-based management consulting firm that developed and produces the "Independent Insurance Agents and Brokers of America Best Practices Study." Information about the Reagan Consulting can be found at their website www.reaganconsulting.com. Kevin may be reached at (404) 233-5545 or by email at Kevin@reaganconsulting.com