M&A: Yesterday, Today & Tomorrow
Today featured M&A: Yesterday, Today & Tomorrow - a retrospective on full-year 2019 and first quarter 2020 results, the current challenges facing the M&A market during the COVID-19 crisis, and commentary on what one might expect for the remainder of 2020.
The bottom line: much remains unknown about the speed and strength of an economic recovery in the U.S., and therefore the volume and strength of insurance distribution M&A for the remainder of 2020. Having said that, much of the dynamics that drive high valuations and record deal making pre-pandemic are still in place and could result in a very active M&A market reemerging over the next several months.
“Yesterday – All My Troubles Seemed So Far Away”
The first line of this Beatles’ classic aptly sums up the insurance distribution M&A market pre-pandemic. New valuation highs were hit each quarter from 1Q19 through 1Q20. MarshBerry recorded 651 announced transactions in 2019, up 12% from the prior year. Based upon early 2020 volumes pre-pandemic, MarshBerry believed that 2020 would produce 750 announced transactions.
Then COVID-19 hit and the market shut down for around 60 days. Even with 163 announced transactions through April 2020, the M&A market has slowed due to a number of factors. This includes buyers who were faced with a new work-from-home reality, which needed tweaking and perfecting. In addition, buyers were initially reluctant to integrate a new acquisition completely remotely.
Nonetheless, transactions were completed even during these uncertain times, primarily by the most active buyers. The top 10 buyers through April 2020 accounted for approximately 56% of all announced transactions, or 92 of the 163. Specialty distribution M&A also continued to be active, likely as the Excess & Surplus Lines industry is experiencing its “hardest” rate environment in years. Coupled with smaller specialists seeking larger strategic owners to offset operating cost increases, and specialists hoping to add carrier capacity to support premium growth, it is not surprising to see such an active deal market for specialist brokers.
Finally, average valuations for 2019 increased ~8% over 2018 average levels and were up an additional ~3% in the first quarter of 2020 (as compared to 2019).
Today – Now It Looks as Though They’re Here to Stay
When the world changed in Mid-March, the rate of change was dramatic. The analogy of a raging river is appropriate, with all untethered objects rapidly moving downstream at a torrid pace. In fact, the only consistency in today’s insurance broker M&A market is inconsistency. Specifically, every buyer is dealing with this situation slightly differently, even within their own organizations. At the same time, sellers are also being affected very differently by the pandemic, some significantly affected in negative ways, some not at all, still others appearing to benefit.
It is worth amplifying this last point; nearly all buyers are focusing some part of their due diligence on what the following twelve months might look like in terms of revenue and earnings. Clearly, this crystal ball gazing is nearly impossible, but buyers are trying, nonetheless.
Finally, buyers’ cash liquidity to complete deals is much greater than during the last recession. Most private equity-based buyers refinanced their debt in 2019 or early 2020. As a result, most have ample cash to complete deals in the near term. In fact, the amount of high yield issuances in April 2020, after a very slow March 2020, speaks to the ability of most sophisticated buyers to access debt capital to continue M&A activities.
Tomorrow – Oh, I Believe in Yesterday
What does the future hold for insurance brokerage M&A for the remainder of 2020? For starters, internal perpetuations are not likely to take the place of third-party sales. While the average owner of an insurance broker continues to get older (average age is ~56 years), ownership at the average brokerage remains concentrated in a few hands. Even for brokers with revenue of $10 - $20 million, there are four or fewer owners at this type firm. Couple this lack of ownership diversification with what is likely to be a disparity of valuation expectations between older generation owners and younger generation owners within a single organization, it is unlikely that many firms will perpetuate internally in the near term.
As to valuation changes, MarshBerry has not witnessed material changes in valuation multiples since the pandemic started. In fact, in the last several years, the spread between average performers and top performers has narrowed substantially. Having said that, MarshBerry expects to see spreads widen between average performing and top performing brokers going forward. MarshBerry also expects to witness more structured transactions that provide more risk sharing among buyers and sellers. Specifically, buyers may demand more downside protection while simultaneously offering sellers more upside potential.
Ultimately, the laws of supply and demand should drive the insurance broker M&A markets. By MarshBerry’s count, there are 30% more active buyers during the 2017-2019 time frame than during the 2006-2008 time frame. MarshBerry believes that this increased buyer community might push some reluctant buyers, seeking lower multiples, to remain aggressive or be forced to the M&A sidelines (which most private equity-backed brokers would find unacceptable).
Finally, the uncertainty of federal tax law change could potentially drive an active M&A market for the remainder of 2020 and into 2021. There is a growing consensus among CEOs that capital gains taxes are likely to increase no matter who occupies the White House in 2021. Therefore, if demand continues due to this increase in active buyers, and the uncertainty as to net proceeds available to sellers after the Tax Man takes his/her share, the M&A markets could see a resurgence where upwards of 500 transactions are announced in 2020. One thing is certain, however: lack of clarity on market dynamics will continue unabated for the foreseeable future.
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If you have questions about Today’s ViewPoint, or would like to learn more about the Evolution of M&A and Succession Planning, please email or call Phil Trem, President – Financial Advisory, at 440.392.6547.
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