AGENCY VALUATION, MERGERS & ACQUISITIONS: IS IT A NEW DAY?
by Robbie Smith
The significant loss of surplus from the 9/11 catastrophe, together with an already compelling need for rate relief for carriers, has led to frenzy in the marketplace. In this document, Robbie Smith describes the problems and opportunities for brokers and independent agents in the merger and acquisition arena.
The tragic events of September 11 accelerated changes in the insurance business that had begun months earlier. Increases in Property/Casualty pricing, combined with the softening in the general economy, were already impacting insurance carriers, agents, and brokers.
The problems created by the marketplace for agencies derive from the significant work needed to find replacement coverages with adequate limits and appropriate coverages while trying to control consumer costs. Re-marketing activities, coverage analysis and comparisons, and the search for alternative solutions have created a significant increase in the workload of the typical agency.
Opportunities are created by the enhancement of income from selling commissionable products at higher prices. Enhanced commission income can provide the cash flow needed to fix problems that many agencies have failed to address: hiring new producers, upgrading automation, expanding office space, and so forth. These changes could also have a positive impact on agency profitability, increasing the agency’s attractiveness to a buyer.
Will these problems and opportunities increase in the level of merger and acquisition activity, or serve as 'red flags' to buyers to pull out of the market? Let’s look at the historical motivation of buyers and sellers and draw some conclusions about the future.
AGENCY BUYERS
Agency buyers have generally fallen into three categories:
- Banks attempting to diversify their sources of income and product offerings;
- National brokers seeking to enter new geographic areas, enhance growth by combining offices, or gain expertise that can be franchised throughout the broker’s organization; and
- Regional agencies/brokers planning to enter new areas or grow large enough to ensure long-term viability with clients and carriers.
The stock price and market capitalization of many banks have suffered significantly during the past 12 months with the softening economy and the reduction in interest rates. The soft economy has reinforced the need for banks to diversify their revenue sources. At the same time, the recession has depressed the primary currency that banks have used to purchase agencies: their stock. Banks that were trading at 18-19 times earnings a year ago are now trading at 13-14 times earnings. This means that a bank must offer significantly more stock in exchange for the agency shares to achieve the same valuation. Bank CFOs are reluctant to offer deflated currency when they believe the price will recover in a short period. Bank senior management is also being pulled away from such ancillary business activities as insurance to refocus on their core business — banking.
The net impact of these changes will vary from bank to bank. Most will continue as active acquirers of agencies, even if there’s a short lull in the pace of activity as banks concentrate on their core operations, while letting the rapid changes in the insurance business settle down.
While the stock price of banks has generally declined, the stock price and market capitalization of the alphabet houses, especially those who are active acquirers of agencies, have gone up significantly. Brown & Brown, HRH, and Gallagher have all enjoyed huge increases in their market cap since January 1st. During the same period, the S&P 500 has decreased almost 20%. Although some of the increases in these valuations are due to superior management skills, it’s clear that investors believe that the higher insurance premiums and revenue increases for the alphabet houses will more than offset the reduction in payroll, receipts, and values that reflect a soft economy.
A number of publicly held brokers have used their enhanced currency (their stock) and the reaction of investors to acquire quality agencies. However, these brokers seem more selective in their acquisitions, recognizing that a failed acquisition of any size will impact their share price.
Many of the same factors impacting the alphabet houses are affecting regional brokers
as well. Rate hikes are providing a clear 'revenue lift.' However, the regional brokers (whose stock can’t be valued daily in a public market) won’t enjoy the immediate enhancement of their stock, which is less liquid than that of banks or alphabet houses.
Nonetheless, regional brokers remain a good alternative for many sellers. Some selling agencies don’t have the type of operations that will result in a successful bank-owned agency. Others seem unwilling to give up the autonomy that the alphabet houses often require. Still others might believe that they need to join a larger firm to gain access to carriers, but aren’t ready to sell. The regional broker can be a good way for the seller to ensure access to markets while maintaining its private ownership.
AGENCY SELLERS
As these changes are taking place with buyers, what’s going on with the sellers? All businesses go through a predictable life cycle that includes addressing the succession of ownership. In 2000 and 2001, many principals accelerated their plans for selling because the valuation of their business, as a multiple of revenues and earnings, reached 15-year highs. A recent study by the American Bankers Insurance Association in conjunction with Reagan Consulting reported that of agency acquisitions by banks in the prior 12 months, 63% were completed at multiples of 1.5 times revenue or more and 27% were completed at multiples of 2.0 times revenues or more. Pricing at these levels has convinced many agency owners to sell their business.
While valuations have reached record levels, the formation of new independent agencies has reached new highs. A recent study by the Independent Insurance Agents and Brokers of America (IIABA) suggests that as many as 15% of today’s agencies have been formed since 1995. These statistics indicate a reversal of a nationwide trend toward a decrease in the number of agencies.
The 2001 Best Practices results (available online at www.reaganconsulting.com) completed annually by the IIABA show significant increases in agency revenues, profits and productivity. That’s no surprise: Good agencies are working harder, are more productive, and enjoy better growth and higher profitability than at any time in recent history. These factors will result in one quantifiable outcome — greater value.
CONCLUSION
What does the future hold for buyers and sellers of agencies? All buyers, whether publicly traded banks, alphabet houses, or privately owned regional brokers, are sensitive to earnings. This means that selling agencies must deliver to the buyer predictable revenues and earnings that will grow over time. Organizations that can achieve growth in revenues and earnings will achieve the greatest valuation.
Finally, whether a particular agency is considering selling in the next 12 months or never, this market creates great opportunities to re-invest in its business. Agency principals should take great confidence in the value of growth oriented, profitable agencies:
- Now’s the time to add new producers.
- Now’s the time to make significant automation upgrades.
- Now’s the time to increase the quality of your staff.
- Now’s the time to consolidate premium volume with companies critical to your long-term success.
If the Independent Agency System takes advantage of this unique opportunity, it can ensure its viability for years to come.
Robert C. Smith, ([email protected]) is a senior vice president with Reagan Consulting, an Atlanta-based management consulting firm that serves the insurance distribution system. Visit Reagan Consulting at www.reaganconsulting.com. This article originally appeared in the National Underwriter and is reproduced by permission.