Although M&A activity took off during 2024, acquisition targets – many of them smaller and specialized brokers – remain.
“It is a difficult and emotional decision for any broker to think about selling their business, regardless of the environment or pressures at play,” says Jamie Lyons, president and CEO of Westland Insurance. “However, we are in an environment where the recipe exists for continued consolidation over the short- and medium-term.
“On the buyer side, eager capital likes the space. On the seller side, often-challenging factors like owners/principals who are ready to retire, lack of interested successors, the need to make big bets on technology, and the growing importance of building [and] supporting trading relevance with insurers [promotes interest in M&A].”
If you overlay still-attractive valuations for broker businesses, “you’ve got a situation where it’s compelling for buyers and sellers to come together,” Lyons says. “Based on this, it is not unreasonable to expect 15% or more broker market share to consolidate in Canada over the next five years.”
Fewer fragments
At the current pace of consolidation, the market is continually becoming less fragmented, but there’s still a place for independent brokerages, says Alex Wong, a partner at Smythe LLP in Vancouver.
“The independent brokerages we talk to are enthusiastic about their growth opportunities. They have carved out niches in their markets and are filling gaps underserviced by the national brokerages,” he says.
Larger brokerages are becoming more selective in their acquisition targets. “Picky, specialized M&A is what they’re focusing on,” says Andrew Mathias, senior vice president at KPMG Corporate Finance. “Very, very specific M&A is happening now, versus before it was just geographic.
“I think for the next few cycles, we’re going to see very particular M&A and a very niche focus.”
Picky buyers
Lyons says Westland’s “approach has always been disciplined, but I would say we’ve been increasingly selective in the current environment. For us, this means putting an even greater focus on the quality of the business and the people, as well as ensuring the mutual fit is strong, strategic, and rooted in cultural alignment.”
Lately, some acquirers are aggressive for certain opportunities but less aggressive for others, Wong says. “Whereas prior to the elevated interest rate environment, many acquirers were aggressive, irrespective of the type, size, or focus of the brokerage.
Wong says he’s seeing “similar valuations across the board, but not as many offers at the top-end as before. In general, purchasers are placing a greater focus on brokerages that are showing real growth.”
Profit potential sells
The industry is exiting a long period of hard markets, when brokerages could rely on premium increases to generate revenue growth without bringing on new clients, Wong says. But as markets soften, brokerages need to show they can grow their policies-in-force counts to hit revenue growth targets.
There remains a wide gap between valuation multiples and the amount of debt lenders are willing to provide to execute a deal, regardless of interest rates, he adds. Valuations are generally more than 11 times EBITDA (earnings before interest, taxes, depreciation and amortization), while most lenders will not lend more than five to six times EBITDA.
When he started in the industry 13 years ago, Kenny Nicholls, former president and CEO of Western Financial Group, says valuation multiples were six to eight times EBITDA. “After the pandemic…many brokerages are going for more than 15 times, and we know for a fact some actually went higher — even as high as 20 times.”
Such valuations have created false expectations for many brokerage owners, he says. “If you don’t come in with a multiple of anywhere between 15 and 20, they’re not listening to you…”
That means a large number of smaller brokerages on the market may not receive offers, be ready to sell, or find it difficult to keep up with the pace of modernization and increased sophistication of insurance products.
It’ll be interesting to see if investors’ returns are as expected when they’re reviewing their portfolios of investments in several years’ time, Nicholls tells CU.
“These investors are going to have some very good reflection to make in a couple of years’ time when they start looking at what the return is,” he says. “I think those are some of the reasons maybe where we might have some groups that have decided to stay low a little and don’t want to play the game of these higher-than-normal — and frankly, I call them overinflated — prices.
“They don’t want to play that game because they actually know how it’s going to end.”
This article is excerpted from one appearing in the October-November 2024 print edition of Canadian Underwriter. Feature image courtesy of iStock.com/mediamasmedia
