The recently announced acquisitions of two of the world's largest brokers by two private equity firms highlight how attractive the broker industry is for investors, experts said.
More M&A activity is expected, and the deals may also boost the valuations of smaller brokers, said Chris Hughes, director of insurance distribution for Merger & Acquisition Services, an investment bank focused solely on the insurance sector.
"I like to think these deals have driven up valuations by 20% in the middle market," Hughes said. "It's a great environment to be in right now, especially for deal makers."
On Nov. 23, Kohlberg Kravis Roberts & Co. L.P. said it would acquire Newport Beach, Calif.-based Alliant Insurance Services Inc., from another private equity firm, Blackstone. Terms were not disclosed. On Nov. 26, Onex Corp. said it would acquire Briarcliff Manor, N.Y.-based USI Holdings Corp. for $2.3 billion, from Goldman Sachs. This came on the heels of a transaction between AmWins Group and New Mountain Capital, a New York-based private equity firm. AmWins said it would not agree to a merger, but was recapitalized in a deal valued at about $1.3 billion by partnering with New Mountan.
An earlier broker acquisition, the $395 million buy of Arrowhead General Insurance Agency by Brown & Brown Inc. late last year, did not involve private equity, but private equity companies were among those who had bid to acquire Arrowhead, Hughes said.
"Arrowhead and AmWins set the stage," Hughes said. "Now with the acquisitions of Alliant and USI, they are going to continue to drive more activity and higher pricing in the marketplace."
For large transactions like those, the brokers were priced as high as 10 to 11 times EBITA earnings before interest, taxes and amortization, which is higher than 12 to 18 months ago, he said. Smaller brokers that may have been priced at six times EBITA last year are now being priced at seven times EBITA, he said.
"There's a lot of pent-up capital in the marketplace, and the demand is very strong," Hughes said. "For every middle-market company we put up, we get multiple bids in the range we are looking for."
Private equity firms favor investing in businesses that offer strong EBITA and a good cash flow, said Spencer Hoole, managing partner of Salt Lake City-based Diversified Insurance Group, a broker and consultant.
"It's not a surprise that insurance brokers are becoming a target," Hoole said. "It's a natural progression of private equity finding another business model that fits their model."
During the financial crisis in 2008, companies held back on investing, but the M&A market is thawing out now. "There is still so much private equity money on the side lines. I think we'll see a lot more private-equity activity over the next 12 months, and would not be surprised to see more private equity firms getting into insurance brokers," Hoole said.
Brokers are an attractive investment because they offer a stable, reoccurring revenue base, without the loss risk that insurers face, Hughes said.
Also, with talk that the property/casualty market is hardening, now is an especially good time to buy an insurance broker.
"The perception is if it's a good deal today, given the current pricing, then it's going to be a great deal if the slight hardening of the market continues," said Mark Goodman, an attorney with Chicago-based Freeborn & Peters.
Buying a broker allows private equity the chance to participate in the insurance industry without facing the scrutiny that's necessary when buying an insurer, he said.
"It's a lower regulatory hurdle," Goodman said. "Regulators require a lot of financial information from the buyer of an insurance company, and private equity are very private. They don't want to reveal what their other investments are."
Private equity "understands it's a complicated industry and a highly regulated industry, but brokers do not have to play by the same rules as insurers," said Kimberly A. Yelkin, an attorney with Gardere Wynne Sewell. "Hedge funds and private equity funds think we if we can get in there, even if we don't know anything about insurance, if we keep the management we can prosper with high rates of return. I think you'll see private equity as investors in the insurance industry as a whole continue to grow."