After a few years of rejecting the idea, the timing was finally right for Amerisc to be acquired. Presented with synergies that included nationwide marketing, a range of new services and capital to mount its own acquisitions, the agency’s principals reached the decision to sell the business to USI. In turn, Amerisc became the nucleus of the acquirer’s Long Island, N.Y., operations. But, why sell now?
“As we looked forward to what we anticipate the economy to be in the next three to five years, we saw opportunities to expand,” says Phil Samuels, co-president (with Frank Abbatiello) of Garden City, N.Y.-based Amerisc. “While we were growing at a 15% to 20% clip, it takes tremendous resources and capital to keep up that pace. We needed a cash infusion from someone else to do our own M&A deals, and realized the best way to do this was to be bought.”
Amerisc is one of many agencies involved in recent mergers or acquisitions, after several years of lukewarm M&A activity. According to research firm Conning & Co., the number of announced M&A transactions involving agencies and brokers last year was up 38% to 243 deals, from 176 deals in 2009. At the same time, the aggregate value of the announced transactions nearly tripled, from $615 million to $1.7 billion.
Industry observers and participants foresee similar M&A activity this year. They point to a variety of factors spurring intermediaries to buy or be bought, including stronger agency valuations, owners’ fears over anticipated increases in capital gains taxes, poor agency succession planning and, as Samuels’ tea leaves told him, expectations for the economy to continue on the upswing and maybe—just maybe—property-casualty insurance rates to harden.
No Bandwagon Just Yet
No one is predicting a huge upsurge in deal activity. Banks, beset with post-financial crisis problems and regulatory pressures, are not expected to binge on insurance agencies like the old days. Also, the urge for one agency to acquire another simply to own the customer base has lost some steam in the soft market. “In the past, there was more stickiness to deals,” explains Ed Schreiber, president of GEM Insurance, a medium-sized agency in Houston. “The marketplace is so competitive these days you can’t expect to have the same retentions you had 10 years ago. You need to have a strategic reason for the deal, rather than just buying the book of business.”
Finding the right strategic fit seems to be driving buyers in their acquisitions. Some acquirers are buying agencies to add or bolster expertise in specialty underwriting areas like medical malpractice or markets like employee benefits. Several are looking to expand their geographic reach, and in the case of foreign acquirers, to expand globally with a foothold in the United States. Many buyers are hoping to benefit from continuing improvement in the economy, which bodes increases in the exposure base and payrolls. And others are forecasting some firming in the p-c market, which bodes greater commission income. Add it up and you have increased M&A dealmaking.
Eye to Eye on Price
The uptick is a far cry from two to three years ago, when M&A activity slowed to a crawl. Jerry Theodorou, vice president of research at Conning, says the chief impediment back then was the valuations of agencies. “In 2009, the sharp difference between the highest price buyers were willing to pay and the lowest price targets were willing to be sold for—what we call the valuation gap—prevented the execution of many transactions,” he explains. “Sellers were reluctant to sell at fire-sale prices. They were used to multiples of 10 to twelve times earnings, and in the post-financial crisis environment they were being offered five and six times earnings, which was unacceptably low. They remembered the good prices of the past and held out.”
The result was stalemate. “Neither buyer nor seller were ready to jump into deals, due to uncertainty over future prospects,” says Brian Deitz, a principal at Reagan Consulting. “Buyers faced capital constraints and sellers saw their performance deteriorate and figured this wasn’t the right time to sell. An impasse was created.”
This impasse was the chasm between what buyers are willing to pay and what sellers were willing to be bought at,” says Julie Herman, associate director of insurance ratings at Standard & Poor’s. “In a soft market, the tension between buyer and seller will slow M&A activity, but when there are glimpses of the market hardening, buyers are more willing to take the potential risk of paying more,” she adds.
Chris McShea, a partner in Big Four accounting firm Ernst & Young’s insurance practice, agrees that the combination of the soft market and the dour economy took the wind out of the sails of M&A dealmaking. “While the economics of paying a premium to acquire a business is more attractive than going tooth and nail against it in a soft market, the difficulty is that buyers and sellers have these range of expectations in terms of how much the business is worth, which fluctuate back and forth,” he says. “That makes it hard to get a deal done. The question becomes, ‘Will the economy and the market rebound quick enough to make the deal worth it?’”
Done Deal
That question seems now to have been answered, at least among the firms making deals. “As the economy gradually improved and valuations inched up, reluctant buyers and sellers became less so,” says Theodorou. “All that pent-up demand, with agency principals, many of them baby boomers nearing retirement or worried about the impact of possible capital gains tax increases, finally let loose last year. Stronger valuations and multiples supported the closure of numerous sales.”
The most acquisitive buyers were Brown & Brown, Arthur J. Gallagher, Hub and Marsh & McLennan Agencies, which snapped up regional platforms as part of its national agency strategy. But, smaller intermediaries also played the game, as did mid-sized brokers backed by private equity like Ascension and Higginbotham. “By 2007, we’d built the largest privately held firm in North Texas and believed our business model was something that should expand across the state,” says Rusty Reid, chairman and CEO of Higginbotham Insurance Group in Fort Worth. “We took what had essentially been a strategic organic growth model and added M&A activity to it. Since then we’ve closed about six or seven deals, bringing our commission revenue to the $60 million range.”
Higginbotham is not alone in its M&A plans. David Simmons, national leader of insurance M&A services at Deloitte, another Big Four accounting firm, says agency M&A “is the hottest segment in terms of M&A activity right now. We’re working on more agency/broker M&A transactions than any other type of insurance M&A transaction.”
What Makes It Stick?
The types of deals are different than those in the past. As Schreiber from GEM Insurance pointed out, stickiness—holding on to customers post-transaction—is a key concern in all deals. This helps explain why many recent acquisitions involved the purchase of specialty operations, where competition for customers is less cutthroat than customary markets. “If an agency or group of agents has expertise in a particular market like the medical, construction or public entity industries, there is less of a chance of it being marketed to someone else [who] doesn’t have that expertise—hence it will be stickier business,” Theodorou explains.
Stickiness isn’t the only reason for buying outside one’s wheelhouse. Some distributors are being bought by carriers to expand their portfolios—which was the case with ACE’s acquisition of Rain and Hail, a managing general agency specializing in crop insurance. “They get a line of business with hopefully better margins, and at the same time gain distribution,” says Theodorou. “Buying specialty businesses is the name of the game, even stronger than geography in terms of promoting deals. If someone has expertise in servicing schools or hospitals or technology companies, and you lack this, you obtain it by buying it. Quality is more important than quantity—buying an agency to acquire its book.”
Simmons shares this view. “Foreign firms are starting to buy agencies and brokerages in the U.S., where distribution is king,” he says. ”If you’re looking to grow in a soft market, you need to grow distribution and distribution channels. Someday the market will turn and commission income will rise. Timing is everything and there are good deals to be had now.”
While the tax rate is a factor in deals, it is not a major one, Deitz says, explaining that “sellers are more confident in the economy and their future performance, and are back in a big way to make transactions.”
Whittling Down
Despite the uptick in M&A activity, no one anticipates massive or even moderate consolidation of the industry. As Theodorou puts it, “There are about 35,000 independent agencies and the number of transactions last year at 243 represents less than one percent of the total number of players. That’s pretty nominal. I don’t think people should be concerned that a period of mega-consolidation is in the offing.”
At the end of the day, agency business is local business, says Deloitte’s Simmons. “It’s always the Main Street agent who will have the direct client contact,” he explains. “To the extent we see more roll-up transactions by larger regional and national players, it’s the agent who owns the relationship. Without that relationship, the acquisition is vulnerable to failure.”
Deitz concurs that over the short-term there should be no fundamental changes in the industry’s consolidation. “The industry is extremely fragmented, with 35,000 agencies and most of them with less than $1.5 million in commission revenue, that it’s a logical thought to imagine fewer players down the line,” he says. “But, this isn’t going to turn into Coke versus Pepsi any time soon.”
Russ Banham (russ@russbanham.com) is an IA senior contributing writer.
Impact of Capital Gains Guessing
Sellers for the most part comprise agencies where the principals are nearing retirement and want to cash out, or have the opportunity to guide a much larger operation post-transaction. Many principals also are concerned about the impact of anticipated, though not guaranteed, increases in capital gains tax rates. “Those who expect the tax rates to rise see now as the better time to sell before they do rise,” Simmons explains.
Schreiber agrees: “People rushed into deals last year to beat the tax man and then they were given a two-year reprieve. Now they’re sitting on the sidelines thinking about the future and are more apt to get the deals done.” He foresees continuing deal activity through this year into early 2012, and has even identified a few prospects.
Deitz from Reagan Consulting has a slightly different perspective. “There was a big capital gains scare last year, where expectations were for rates to go up at the end of 2010,” he says. “I think that caused some deal activity by agencies that were looking to sell anyway, bringing the deals to the table a bit earlier than planned to avoid the repercussions. When word got out in mid-December that Congress and the President would provide a stay of execution on the capital gains rate, some of those deals leaked into 2011.”
—R.B.
Too Hungry To Wait
During the recession, several independent agencies engaged in M&A dealmaking when most of their compatriots sat on the sidelines. A case in point is Bill Skeeles, president of PointNorth Insurance Group in Atlanta. “We’ve made nine acquisitions in the last 10 years, and most of this volume occurred in the past two,” Skeeles says.
The strategy behind the M&A transactions is two-fold—to acquire revenues and talent. “In one of our recent deals, the principal had a background in sales management with HRH, and he has now taken the role of our sales manager to help generate organic growth,” Skeeles adds. “We’ve also picked up agencies with specialties in benefits and program business like professional liability and home health care practice. We’re picking up talented, young producers in these deals that we may not have been able to attract otherwise.”
Nat Calamis, president and CEO of Starkweather & Shepley, a 132-year old agency in East Providence, R.I., also was involved in several M&A transactions during the recession. “We saw the period as a ‘perfect storm’ for some agencies to sell,” he says. “You had the bad economy and soft rates that were going down on the commercial lines side. In personal lines, you had continuing pressure from direct writers. And on top of it all you had contingencies going down from the carriers. People were struggling, and that gave us opportunities.”
The agency has acquired three firms over the past three years—one a year, Calamis says. “That seems to be our rate—in the last 20 years, we’ve acquired 20 agencies,” he notes. “Right now I’m talking to another one. This is our strategy. I don’t see it ending any time soon.”
—R.B.
