Do bank stockholders benefit from acquisitions of P/C agencies? The answer? Yes, if there’s appropriate due diligence, perfect implementation, and the price meets realistic expectations. When these three conditions come together, as so many players seem to expect, banks can make fantastic returns by acquiring P/C agencies. However, the results to date strongly suggest that these conditions rarely — if ever — occur simultaneously. This last in a four-article series will focus on the attractions of bank-agency purchases. (Part III, here.)
With all these problems and such poor results, why are so many banks buying so many insurance agencies? Sometimes the grass is simply greener on the other side of the fence. Or the herd mentality might be too hard to resist: because everyone sees everyone else buying agencies they think they must buy one (or many) too.
What’s more, the 'buzz' about easy success can be misleading. Beware of any banker who boasts about how well they’ve done in owning an agency. These people usually stress the operation’s soaring sales, healthy growth, and wealth of assets. Bear in mind that high sales are meaningless unless they generate earnings. Rapid growth is useless if it’s not profitable. Assets need to be measured against liabilities: in 2001, Enron had the fifth highest assets among the Fortune 500.
Another reason for the buying frenzy is that many consultants and investment bankers paint rosy pictures of these acquisitions. For significant fees, these experts are more than willing to tell their banker audiences what they want to hear: that they can make a lot of money by acquiring insurance agencies.
To fuel the fire, many agents and bankers looking for a deal ask the wrong question: 'Can you help me do a deal?' The easy answer is 'Yes.' However, the more appropriate question is 'Should I make this deal?' or 'Using realistic projections, will this deal make us as much as we need it to make?' A J.P. Morgan advertisement from the late 1980s put the issue this way: 'What does finding the right price mean if it isn’t the right thing to do? In mergers and acquisitions, failing to make the distinction between price and value is like turning your back on reality.'
DEFINE SUCCESS
Many banks are looking for business models employed by other banks that have successfully entered the insurance agency business. Although this strategy makes sense, unfortunately, the definition of 'success' is flawed. For some reason, most people tend to believe that if one company is buying another one, the buyer must be successful. In fact, the opposite holds true: the seller almost always gets the better deal.
Don’t take a bank’s (or any other firm’s) success at buying a business, or especially many businesses, as a sign of success. It’s all too easy to do plenty of acquisitions and hide the poor results for many years: consider Tyco, WorldCom, etc.
Focus on the difference between the results realized and those promised — and the gap between actual earnings and pro forma profits. These differences are essential. For example, I recently reviewed the financials of a buyer whose EBITDA was almost 10%, even though their cash flow couldn’t cover operating expenses, much less principal payments.
That’s why I recommend copying bank acquisitions of agencies that have achieved organic growth of 10%+ and pretax (not pro forma or EBITDA) profits of 15%+. By this standard, the majority of bank-agency acquisitions have failed. Consider BB&T: the poster boy for banks acquiring insurance agencies. Put BB&T’s seemingly impressive results in the context of the number of acquisitions required to generate sales, the size of the bank relative to commission income, and its poor market penetration of its own customers — and it’s clear that the bank hasn’t reached its potential in the insurance business.
THE BOTTOM LINE
Banks can make money by buying P/C agencies if they’re willing to invest in thorough preparation, hard work, effective due diligence, and hands-on implementation, based on expectations that are both reasonable and in the best interests of the bank’s stockholders.