The acquisitions of two large, privately held insurance brokerages underscore the attractiveness of the brokerage sector to investors and the role of private equity firms in providing it with capital.
Briarcliff, N.Y.-based USI Insurance Services and Newport Beach, Calif.-based Alliant Insurance Services Inc., the ninth and 12th largest brokers of U.S. business, respectively, according to Business Insurance's 2012 rankings, were acquired by private equity firms last month.
While Toronto-based Onex Corp.'s $2.3 billion acquisition of USI from Goldman Sachs Capital Partners and Kohlberg Kravis Roberts & Co. L.P.'s purchase of Alliant from the Blackstone Group for an undisclosed sum are notable, they are not unexpected, said Bruce Ballentine, New York-based vice president and senior credit officer at Moody's Investors Service. Both firms had large loan obligations due in 2014, as a result of previous changes in ownership several years ago, Mr. Ballentine said.
“What's going on here is the refinancing or buyout of firms whose debts are coming due,” he said. “There was a wave of brokerage buyouts in 2007 and those are typically done with at least one component of financing as bank loans that run for six or seven years.”
Mr. Ballentine said the highly leveraged nature of funding used by many private equity firms to acquire insurance brokers leaves the owners with four primary options as the loan maturation deadline approaches.
“For brokers owned by private equity firms, the normal alternatives as you approach the end of your debt schedule are to refinance with your existing owner, sell to a new sponsor, sell to a strategic buyer, or have an initial public offering,” he said.
The timing of the deals makes sense given the long-term strategies of private equity firms involved, said Timothy J. Cunningham, managing director of Chicago-based Optis Partners L.L.C., an investment banking and financial consulting firm serving insurance intermediaries.
“I would view these transactions in the natural progression of private equity ownership of brokerages,” Mr. Cunningham said. “While there is no concise standard, the typical acquisition by the big private equity groups is structured, so that they capitalize their value generally within a five-year period.”
John Wicher, principal at John Wicher & Associates in San Francisco, agreed that the deals were widely anticipated. “The only question regarding USI and Alliant was who, not when,” he said. “GS Capital Partners and Blackstone had been in these positions for over five years and it was time.”
Mr. Cunningham said many private equity firms are flush with capital that needs to be invested and are feeling the heat from their investors to generate healthy returns. “Investors don't commit capital to private equity firms to get T-bill-sized returns,” he said of the minimal yields.
Moreover, improving economic conditions have made insurance brokerages increasingly enviable acquisition targets, said Julie Herman, associate director at Standard & Poor's Rating Services Inc. in New York.
“It's a modestly favorable economic picture for the brokers now as compared to a few years ago when the rate environment was impacting brokers negatively,” she said. “That trend has switched to neutral to slightly positive depending on the area they focus on.”
This improved economic and market climate, coupled with the expected boost in demand for employee benefits consulting in light of the U.S. Patient Protection and Affordable Care Act, means that sellers may be able to extract a premium from buyers, Mr. Cunningham said. “The multiple that USI sold at, which was north of four times revenue, is a pretty big premium,” he said. “However, if I'm a buyer, even if I do have to pay a premium, I seem to have bought on a rising tide.”
Mr. Wicher said the high valuations attached to brokers being acquired augured well for more private equity backed deals going forward.
“Private equity is a meaningful and growing factor behind what has become a mini surge in mid-market transactions,” he said. “It is also interesting to note that, in these two transactions, one might assume that a larger valuation was achieved in a private transaction as compared to an IPO.”
Mr. Ballentine said economic and market conditions aside, insurance brokerages offer a compelling value proposition to prospective buyers. Insurance brokers have a relatively stable business with steady cash flow through good and bad economies, he said, adding that brokerages are not required to hold a lot of capital to satisfy a regulator as an insurance company would. Moreover, insurance brokerages do not have a lot of the inherent risks like other types of financial institutions, such as bad investments or underwriting.