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Lack of organic growth boosts M&A activity

Lack of organic growth boosts M&A activity

After sitting on the sidelines of the mergers and acquisitions playing field in 2009 and early 2010, insurance brokers eager to score external growth are getting back into the game, brokers and M&A specialists say.

M&A activity picked up midway through 2010, increased this year and looks to continue on pace through 2012, they say.

The transaction arena will yield some solid teams, as sellers strong enough to wait for improved market conditions and buyers with an eye for quality join forces.

“Deal activity begets deal activity,” said Timothy J. Cunningham, principal and co-founder of OPTIS Partners L.L.C., a Chicago-based insurance industry consultant. “As the active buyers have come back, everyone is getting back in the game.”

The reason for the increased activity is the need to pursue external growth in a market in which organic growth is difficult to achieve, noted John Wepler, president of Marsh Berry & Co. Inc. in Willoughby, Ohio. “Acquisition is not optional,” he said. For that reason, 2011 is “the most robust mergers and acquisitions market (Marsh Berry has) ever experienced,” he said.

Mr. Wepler cited figures from SNL Financial L.C.: In 2007, there were 261 broker M&As. That increased to 296 in 2008. In 2009, when the Great Recession was under way, the number of M&As dropped to 180. In 2010, there were 207 deals.

So far this year, there have been 192 broker M&As, according to SNL Financial, a number Mr. Wepler projected will surpass 250 by year's end.

Mr. Cunningham also noted a rebound. Using a benchmark of reported or announced deals, OPTIS Partners tracked 289 M&As in 2008, 173 in 2009 and 192 in 2010. With 273 deals through the third quarter of this year, he said this year's total likely will exceed 2008. 2011 “is coming back like gangbusters,” Mr. Cunningham said.

Both internal and external growth are necessary for success in the current economy, brokers and consultants say. Brokers that were strong but interested in being acquired to thrive in the future have waited while the markets have been weak.

“Valuations of public brokers came down, equity firms didn't have credit for leveraged transactions, and banks were focusing on their core business” in 2008 through 2010, said Marsh Berry's Mr. Wepler. “So it wasn't a good time to sell. A number of deals collapsed. But the pendulum swung too far,” he said, and brokers began to look for deals that would support their businesses.

One such broker is Hub International Ltd.

“Acquisitions are a focus for Hub right now and will continue to be in the future in this slowly improving economy, because many businesses have stopped shrinking and it's a smart time to be seeking new opportunities,” said Clark Wormer, director of mergers and acquisitions for Chicago-based Hub.

Arthur J. Gallagher & Co. in Itasca, Ill., strives “to grow organically as a company because we're a sales organization,” said Bill Bohstedt, corporate vp of mergers and acquisitions for the retail property/casualty side of the broker's business. “We complement that with finding merger partners,” Mr. Bohstedt said.

Another broker back in the M&A market is Burns & Wilcox Ltd., based in Farmington Hills, Mich. The wholesaler was built through acquisition, noted Chris Zoidis, vp of corporate development and director of its special risk division. “We're looking to do a lot more acquisitions in 2012,” Mr. Zoidis said. “We think there's going to be a lot more opportunities.”

The managing general agent, underwriting manager and wholesale brokerage segments of the industry are “still very fragmented,” he said. “Small independent local brokers that for the last few years thought the market would turn around and go back to 2006 levels of revenues and earnings have come to realize that the hard market is not coming back anytime soon, so now they are ready to sell,” Mr. Zoidis said.

Acquisition “is an important part of growth, but we also want to grow organically,” said Norman Malter, president of Chicago-based Mesirow Insurance Services Inc. “We haven't done a transaction in a few years because we haven't had the right fit,” he said.

But now the management committee of Mesirow Insurance, a unit of Mesirow Financial Holdings Inc., is interested in acquisitions and would like to establish a presence outside Illinois, Mr. Malter said.

Alliant Insurance Services Inc. will announce one or more transactions before year's end, and additional deals in 2012, said Greg Zimmer, the broker's president and chief financial officer. Mr. Zimmer said internal growth remains the broker's primary strategy in a market in which “the only way a firm can grow is to take market share from others.” Alliant is “not a serial acquirer,” he said. “We really look for our spots.”

At Marsh & McLennan Agency L.L.C., “We don't time it to some economic event,” said Dave Eslick, chairman and CEO of the Marsh Inc. subsidiary. “We make long-term, very important strategic decisions,” he said. “An agency will sell to Marsh if we can show some organizational leadership to the ownership of the agency; if we can show that we can do more for their current clients, give them a great chance of gaining market share, a future for their up-and-coming leadership, and the capital to invest in growth.”

The goal, he said, is to grow acquisitions' value-added capabilities and boost organic growth.

In most instances, buyers are seeking partnerships rather than a seller with one foot out the door.

“We want the leadership to be engaged and join us,” said Gallagher's Mr. Bohstedt. “We are not interested in being an exit strategy.”

Mesirow's Mr. Malter agreed. “We want to acquire to partner,” he said. “We're looking for principals who want to stay.” Because of that desire to partner, “the cultural fit” is a top priority, he said.

“The No. 1 thing we look for is the quality of the people,” said Burns & Wilcox's Mr. Zoidis. “That trumps everything else. We're bringing in talent.”

“Buyers are looking for brokers that play a more consultative role,” Marsh Berry's Mr. Wepler said. “They are looking at the culture of new business production, sales forces and sales meetings.” Also important “is a favorable age dispersion of employees.”

Another important consideration for buyers is a seller's specialty.

Mr. Zimmer said Alliant is highly specialized, and “we offer expertise and advantaged products” for special industry groups. For example, he said, Alliant has 200 people in its public-entity practice. “When we walk into a public agency, we know their business,” he said. “If you know an industry better than your competitors, and you have a better product to offer, you grow internally.”

Any firm acquired “needs to be clearly in sync” with that strategy, Mr. Zimmer said.

On the seller side, two key motivating factors are the investment in resources that the market demands for growth and crafting a succession plan, brokers and consultants said.

These reasons are “why a local or regional broker may want access to markets we have on a nationwide basis, the technology and expertise,” said Alliant's Mr. Zimmer.

“Agencies that are well-positioned in infrastructure will fare much better going into the future,” said Mr. Malter. “Insurance buyers look for specialized people, specialized products and specialized infrastructure,” he said. Smaller agencies might need to be acquired to meet those demands, he said.

Many independent agencies “are owned by (baby) boomers,” who are near retirement age, said Gallagher's Mr. Bohstedt. They may want to join another firm to recoup some of their investment at this point in their lives, he said. They also may perceive that without an influx of resources, they will plateau and their employees won't have a career path, he said.

Marsh & McLennan Agency's Mr. Eslick said that on the employee benefits side of the business, opportunities are plentiful to acquire smaller brokers that are selling because they are unsure of their roles once more provisions of the Patient Protection and Affordable Care Act are implemented, such as state exchanges.

OPTIS' Mr. Cunningham said brokers usually are sold for a multiple of their annual earnings before interest, taxes, depreciation and amortization. The range is five to seven times EBITDA, he said. Generally, 60% to 70% is guaranteed and paid at the closing, with the balance paid in an “earn-out,” which is based on future performance after the acquisition is complete.

The quickened pace of mergers and acquisitions in the brokerage industry is expected to continue at least through 2012 when there is a chance that the capital gains tax rate will increase to 20% in 2013. The 15% rate, signed into law by President George W. Bush, was scheduled to sunset this year, a factor in the increase in deals that began in the second half of last year. It was renewed until 2013, so consultants say they see M&A activity staying strong at least until then.

Additionally, Mr. Wepler said, aggregate property/casualty premiums have increased about 2% year-to-date, and that improvement helps brokers' bottom lines, which in turn fuels M&A activity.

“Insurance companies have a gun to their heads,” Mr. Wepler said. “They are going to have to start raising rates” to increase profits.

In Mr. Wepler's opinion, market conditions have forced “everyone in the value chain to be better at what they do and add more value to customers.”

This article appears in a special editorial feature 'The Business of Better Broking,' which includes profiles of the most productive agents and brokers, exclusive rankings and more. Download a PDF version here.

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