By Brad Unger
FINDING VALUE IN A SELLERS’ MARKET
When bargain hunting, think about financial value separate from strategic value
It’s probably a ridiculous waste of time, right? Looking for good deals in today’s merger and acquisition market is like looking for a needle in a haystack; like winning the Powerball right after being hit by lightning; like watching the Cleveland Browns and thinking … never mind … I digress. Even in one of the hottest M&A markets we’ve seen, where valuations are easily double what they were in 2008, there are still good deals out there for those willing to put in the time and think about them the right way.
Any assessment of strategic value must start with “why“ and “what,” as in “Why do we want to do this?” and “What do we get out of it?”
Bargain-hunting is not about paying a cheap price; it’s about getting a good value in return for your price. So, to think properly about bargains, we need to think about financial value separate from strategic value.
A purely financial purchase is what many people think of when they view the M&A market. Some people think of this in terms of payback, asking: “How many years will it take for me to get my purchase price paid back?” Others think of the financial purchase in terms of Discounted Cash Flow (DCF), where one can account for the time value of money. Market value is generally described in terms of a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), which is a handy way to assess the payback and DCF using a straightforward heuristic assumption.
The first and most important step in understanding financial value is to assess the target business on its own. You need to understand its earnings power on a stand-alone basis, then use that number as the basis for your valuation analysis. The second and perhaps more complex step is to calculate the expected growth of the target’s earnings going forward. Growth will increase the DCF value or, in payback terms, it will decrease the amount of time it takes to get paid back on your purchase. Generally, in the insurance brokerage market, we would consider it reasonable to assess growth over the forward-looking five years, then make a general assumption of a terminal value at the end of those five years.
A strategic purchase gives the buyer something that has unique value to that buyer, rather than to the market at large. In other words, the buyer gets something more than just the stream of earnings that the target generates on a stand-alone basis. The strategic value may be in the form of a new product line that can be cross-sold into the buyer’s current platform (think about a property/casualty firm buying an employee benefits platform) to boost combined revenue, or it could be in the form of a service model that reduces the cost of the buyer’s daily operations.
Any assessment of strategic value must start with “why” and “what,” as in “Why do we want to do this?” and “What do we get out of it?” Once you’ve discussed these questions internally and with the leadership of your target partner, the discussions need to be converted into financial projections for revenue synergies (new revenue net of its related expenses) or expense synergies (expense reductions net of any effects they may have on revenue). Both need to be expressed net of any investment that will be necessary to achieve them.
Here’s an example: You own a P-C firm, and you’re buying a benefits platform. You project annual new EB revenue of $200,000 from current P-C clients. You’ll need to pay commission on this new revenue at 40% in the first year and 25% in all subsequent years. Also, to kick off the campaign, you’ll need to spend $50,000 in advertising and client-related expenses (e.g., travel and entertainment) over the first year plus $25,000 in each subsequent year. You would then factor these changes into your base model to estimate the financial impact of a strategic acquisition.
A public service announcement
This is a good time for an important warning: Assessing the financial value of strategic changes is a risky proposition and a major fail point for deals. It’s far too easy for even experienced professionals to get caught up in the emotion of a deal and overestimate the value of potential synergies. Incorrectly assessing the value on paper is not the issue—but paying too much for a firm because you determine that a value increase is “guaranteed,” or “easy,” or even “possible” can be a significant issue.
Now, think about yourself and your partners—the producers and account representatives you know well. How balanced and conservative are they? Maybe they’re not … maybe they’re aggressive, optimistic, confident (overconfident?) go-getters who “don’t take no for an answer.”
Here’s the truth: You need to get help, and you need to help yourself. First, you need to identify a good target that makes sense for your firm. You need to make sure that the culture fits and figure out the “why” and “what” referenced above. You need to make sure that the target principals are interested in a deal and let them know that you’re willing to pay a fair price, but that you need to do your homework first. Then pick up the phone and call for help.
Hire a dispassionate professional who can advise you on what the financials look like and what synergies are likely, probable, possible and totally crazy. Then work with that advisor to build your offer. The up-front purchase price is based on the likely scenario. The realistic earn-out is based on the probable scenario, and the target can earn more if it helps you get into the possible or totally crazy levels. You want an advisor who can help you get a deal done, and who also is willing (and incentivized) to say no. You need someone who will tell you to stop when your ego is taking over the rational part of your brain.
So what are you waiting for?
Brad Unger joined Marsh, Berry & Co., Inc. (“MarshBerry”) in 2015 as a vice president on the mergers and acquisitions team. He also is involved with the firm’s financial consulting business. MarshBerry helps insurance agents, brokers and carriers as they work to maximize their value through a variety of industry-specific services. Contact Brad at Brad.Unger@MarshBerry.com or (440) 220-5435.
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As of May 31, the 2019 year-to-date (YTD) total stands at 241 deals. While it may appear that activity is waning because the number of YTD deals announced is up only 3% compared to the same period in 2018, transactions continue to be retroactively announced and there are no signs that the M&A market is cooling off.
Buyers continue to close the gap between Patriot Growth Insurance Services, LLC, which has announced 19 transactions YTD. Close behind are Hub International Limited and BroadStreet Partners, Inc., which have announced 16 and 15 deals YTD, respectively.
Private equity-backed brokerages have been among the top buyers for the last several years, and all indications point to that trend continuing for the foreseeable future. There are numerous well-known and established PE-backed acquirers, but several new ones have entered the market this year. In 2019, five new
PE-backed brokers have announced transactions, which account for 25 of the 241 announced deals YTD.
Notably, in May, The Hilb Group announced its acquisition of St. Louis, Missouri-based Keane Insurance Group, Inc. Keane will maintain its location in St. Louis and is now Hilb’s westernmost location, suggesting that Hilb may be interested in expanding its geographic footprint beyond its concentration in the Eastern states. Hilb is currently a top 100 brokerage with over 700 employees across 60-plus offices.
Disclosure: All deal count metrics are inclusive of completed deals with U.S. targets only. Scorecard year-to-date totals may change from month to month should an acquirer notify MarshBerry or the public of a prior acquisition. 2019 statistics are preliminary and may change in future publications based on additional deal information that is received. Please feel free to send any announcements to M&A@MarshBerry.com.
Source: S&P Global Market Intelligence; http://www.insurancejournal.com; http://www.businessinsurance.com/; other publicly available sources and MarshBerry Opinion & Experience