A couple of years into The Squeeze on levered brokers, things are getting worse.
A weakening outlook for returns has cooled private equity interest in buying private broking platforms at or above the levels that their current owners have them marked in their funds.
A lot of private equity capital is bogged down in the broker trade, and while there are exits, they all come at a cost.
And the amount of capital backed up on the jammed PE conveyor belt is eye-wateringly large given the amount of private capital that has flowed into the segment over the last 15 years.
Some sources estimate that there is as much as $200bn+ of trapped capital across the 40+ US private equity-backed platforms, and the smaller number of European platforms, that will need to find liquidity in the next few years.
The levered brokers and their current PE backers have been playing “pretend and extend” over the last two years or so, with a number of different methods employed to partially refinance these businesses and offer at least some liquidity to investors.
But in time, they will need to deliver full liquidity for existing backers. Unless something reawakens PE animal spirits, many of these brokers – and particularly those at the larger end of the spectrum - will need to find an off-ramp from the PE recap cycle over the next couple of years.
One cohort of firms will make the offramp via the Everest climb of an IPO, with Acrisure, BroadStreet and Hub International likely names.
Others will follow AssuredPartners – which this week sold to AJ Gallagher for $13.5bn – or NFP in seeking sales to strategics. This looks likely to be the major source of liquidity in the system, although crucially there will not be enough bandwidth for all levered brokers looking for an exit to sell out via this route. (For our detailed take on the Gallagher-AP deal, click here)
Some levered brokers may even break themselves up, as Carlyle-backed MGA platform NSM is currently doing.
In the meantime, they will be obliged to integrate and firm-build as they seek to create maximum optionality for themselves against the backdrop of a highly uncertain environment. These will be hard yards for businesses built on cheap money, cut corners, breakneck M&A, and – for many – promises that selling agency principals would be left alone.
There are important exceptions, with smaller US businesses, London market brokers, continental European brokers, and firms with well-above market organic growth much better placed for optionality.
Lower returns and challenges around securing liquidity also threaten to expose the fault lines between the previously united triptych of sponsor, executive leadership, and agency principal shareholders.
In the more congenial Boom Times of the decade up to 2022, all three parties could win in the same deals. Now, with these businesses under stress, there is increased scope for divergent interests to leave the latter stages of deals fractious.
Unjamming the conveyor belt could result in some workplace injuries.
The Squeeze
As previously written, the levered brokers have been suffering from The Squeeze over the last two years following a 400-500 bps increase in the cost of debt, as well as a reduction in maximum debt levels for deals.
Alongside the increased cost of debt, brokers have faced the erosion of merger arbitrage on tuck-in deals as over-fishing bid up multiples on smaller deals, while platform multiples started to slip.
Organic growth has remained at historically elevated levels longer than anyone has expected, and even now there is not uniform evidence of deceleration, with some data points including the recent Reagan figures pointing to another reacceleration. Nevertheless, the outlook is for a normalization of growth to broadly in line with nominal GDP, and this is a further drag on PE interest.
At the same time, the sins of the past are coming home to roost with massive integration deficits due to a focus on rapid M&A. Gruelling and margin-sapping integration work is now in front of these brokers.
All of these issues are squeezing returns and reducing the attractiveness of a segment that has previously been a place where you pretty much just had to show up to win.
Sentiment has been further eroded by Risk Strategies’ late summer/fall minority process that yielded only lukewarm interest in what was perceived as an above-average asset, and which has now effectively reached a stalemate on finding an additional sponsor to join the shareholder register.
Private equity sources have said that at mid-to-high teens Ebitda multiples, it is all but impossible to underwrite broking deals to a 20% internal rate of return or higher in the current debt environment with prevailing market organic growth.
There are important exceptions to this analysis. US businesses that are below $100mn of Ebitda are perceived as well-placed to deliver outsized growth. International businesses, particularly those with German operations, can also secure valuations above this primarily due to higher merger arbitrage on tuck-in deals and the perception that consolidation has more road to run.
London specialty/wholesale businesses are relatively well placed given the strength of recent growth, and their position as the gateway to an international strategy.
The other exception is brokers that are perceived as capable of delivering high single-digits or even double-digit organic growth over the next whole cycle. These are few and far between, however.
Sources told Insurance Insider US that some private equity houses have now started to face reality and have started to walk down their marks on the levered brokers in their quarterly reports to their investors.
However, there is a lot of work to be done to get businesses that can be marked as high as 17x or 18x down to the 13x-15x multiples where they would be likely to attract interest from other sponsors.
For this reason, full PE recaps for US brokers above $150mn-$200mn of Ebitda are likely to be rare.
Pretend and extend
Levered brokers and their backers have employed a wide array of moves to pretend and extend, allowing them to bring in growth capital or deliver liquidity to investors and soldier on in the hope of a favorable turn in dynamics.
It can be sliced and diced different ways, but we think about six different strategies:
Minority sales <Hub International>
Preference share issuance <Keystone, Galway>
Structured equity deals <World>
Dividend recaps <Alliant>
Continuation vehicles/fund transfers <Hub International>
Private mergers <TBD>
A range of recent broking developments point to how challenging the environment is out there, and build on what has been seen with Risk Strategies challenges.
In particular, there have been a number of continuation vehicles in the market as private equity houses look to their LPs as a safety valve to provide liquidity.
Altas Partners is also understood to be fundraising for a continuation vehicle for its stake in Hub International, six years after it bought in. Relation was also moved to a multi-asset continuation vehicle a few months ago by Aquiline, it is understood.
GTCR also went quite far down the road on a single-asset CV for AssuredPartners, with Apax exploring a multi-asset CV that contained its AssuredPartners stake, before pivoting to this week’s Gallagher sale.
A number of names in the $100mn-$300mn Ebitda weight bracket are understood to have been speed-dating on potential mergers, although nothing has gained traction yet.
As previously reported, Howden was quietly engaging with investors over the summer as it looked at the possibility of adding a fourth investor to its roster to bring additional firepower to its US retail M&A ambitions. But to date it has not pulled the trigger on a full process, or taken one of those discussions forward on a bilateral basis.
Meanwhile, deals that were expected over the last 12-24 months have still not come to market, ranging from Galway to Hilb to The Liberty Company to OneDigital to Relation to Alkeme. Each of these businesses is a slightly different story, but in all cases the lack of earlier tailwinds is complicating the path to exits.
Off-ramps from the PE cycle
If PE appetite does not return – and at the margin falling interest rates would help – ultimately, these brokers will need to seek an off-ramp from the cycle of PE flips either via the Everest climb of an IPO, or through a strategic sale.
For the biggest broking firms, it is increasingly clear that the path will be to IPO.
There is a long and growing list of large US retailers that are perceived as potential IPO candidates over the medium term.
These include Acrisure, which has long harbored ambitions of going public.
BroadStreet’s current minority raise, previously revealed by this publication, is being made as a staging post on the way to its own eventual IPO.
Hub is perceived as an IPO-ready enterprise, and will ultimately have to walk that path in order to give its investors full liquidity, although the timetable is unclear.
If all three of these names were to IPO over the few years, the combined value could be closer to $100bn than $50bn.
AssuredPartners was also running hard to give itself the optionality to pursue the IPO track in a couple of years before its sale to Gallagher.
We have covered the major challenges the levered brokers face in going public before including integration, delevering, securing executive buy-in, winning staff hearts and minds, and the difficulties of building a compelling equity story. (For full background see: “Listing a levered broker: An Everest climb”)
Strategics: The major source of liquidity in the system
The major liquidity in the system at this point is coming from the listed brokers, and indications are that this will accelerate over the next couple of years.
These firms are trading well, with Ebitda multiples that run ahead of those of the private names. They have big balance sheets, lots of cashflow, the ability to issue shares as deal consideration, and access to cheaper debt. (Importantly, public and private multiples are not comparable because public company Ebitda is much stricter on add-backs. So a 10x private Ebitda multiple could translate to 8x in the public space.)
In addition, they are operationally advantaged from an integration perspective, albeit to different extents.
Gallagher dramatically signaled its intent earlier this week with its move on AssuredPartners. The firm has long been an M&A company to its core, but the deal represents a step-change in acquisition size as it goes bigger to move the needle as a ~$12bn revenue firm.
Aon signaled that it was evolving its approach to capital deployment with the $13bn acquisition of mid-market platform NFP, and is likely to be ready to make a second major move in its mid-market strategy in as little as 12 months, it is understood.
After skillfully riding the brokerage supercycle for organic growth, Marsh McLennan last quarter trained some of its unequalled firepower on McGriff, acquiring the retail brokerage via its mid-market unit MMA for $7.75bn from TIH, confirming this publication’s reporting.
WTW’s decision to bid for McGriff represents proof that the listed broker has returned to the M&A lists, as this publication previously called for. It is yet to ink a deal, but this is a matter of time, and it’s possible that when it does, it will be a statement deal.
Brown & Brown too has been highly acquisitive, and that is likely to continue with a major push underway to build out a UK and continental European business via deals including GRP, Nexus, BdB, and Quintes.
With organic growth harder to come by, the acquisitiveness of the listed retail players is only likely to intensify. The wisdom of MDP, HPS’ and management’s decision to sell NFP to Aon has only become more apparent over time, and it will not be the last PE-backed platform to be sold to a strategic.
Importantly, however, it is difficult to see sufficient deal-making bandwidth and available cashflow/debt headroom for the public brokers to absorb all of the broking inventory currently on the jammed PE conveyor belt.
Integrate for optionality
Their current predicament creates an imperative for all firms of $150mn-$200mn Ebitda or above to engage in real firm-building, which is typically skirted over with the single word of integration.
Some of this work is the nuts and bolts of integration – moving agencies over to a single agency management platform, strengthening financial reporting, imposing controls, and properly resourcing functions at the center.
But it is also the more ambitious work of creating something that is worth more than the sum of its parts. This is building training programs, creating centers of excellence for products, establishing a central placement function, weaponizing data, leveraging technology – all of the things needed to create an organic growth engine, and to build a true platform to drive margin over time.
Of course, this stuff is crucial to execute a successful IPO. But it’s also absolutely essential for a strategic sale. A big part of Aon’s decision to buy NFP not AssuredPartners was NFP’s much higher level of integration.
Other strategic acquirers looking at broking assets will also weigh whether they are far enough along in their integration work to be viable targets.
Of course, it’s easy for brokers – many of them run by people with a professional background in sales – to tell anyone who will listen that they’re integrated. The talk track is easy enough to compose. But the issue is that they will need to prove it to buyers in due diligence, and to regulators/investors in order to IPO.
Perhaps good storytelling will be enough to run the gauntlet of the IPO. But Marsh McLennan’s due diligence team will find out if a selling business is a spreadsheet, not a franchise – no matter how good the management presentation is.
One of the funny things about Aon’s NFP-AssuredPartners choice (which, of course, came down to more than just the integration yardstick) is that Aon was the original unintegrated broking business.
Back in the mid-2000s, Aon notoriously operated across a hundred different countries in a hundred different ways on a hundred different systems, after it was built through a bold succession of acquisitions. This was a time too when its margins were unimpressive, dragged down by major parts of its business which actually lost money.
Where it is today shows both what can be achieved with unintegrated businesses with time and management wherewithal. But you need your Cases, Davies, McGills, and Andersens to get the job done.
The fault lines between PE, leadership teams and other staff shareholders
Lower returns and challenges around securing liquidity could also bring out the fault lines in the coalition of interests that constitute these private brokerages.
Management teams may find that their sweet equity deals are not triggering, or not at the levels expected, and be incentivized to delay liquidity events.
They may be forced to practice guerrilla resistance against unattractive exits like IPOs and strategic sales in the hope that they can secure another go-round on the PE merry-go-round with its less onerous oversight, chances of wealth creation, and avoidance of merger synergies.
On the other side of that, PE houses may have to try and sell businesses out from under their management teams in order to secure liquidity for their LPs, or oblige them to IPO if all else fails. While they will be trying to maximize returns just as management is, sometimes other considerations like fundraising imperatives create the need for crystallization of gains.
For staff equity owners, there is a risk that the pot of gold at the end of the rainbow is smaller than promised. Scenarios could include the common equity being squeezed on refinance if value growth has trailed the coupon on preference shares. Or, preference share conversion into common ahead of liquidity events could dilute common equity holders. Some of the structured equity deals with downside protections could also hurt staff equity holders if those deals underperform.
The other obvious fault line is the different time horizons. If you’re a management team wanting to make a multi-hundred-million dollar investment to integrate the firm and your PE firm is thinking about heading for the exit, you have scope for major misalignment. The owner is incentivized to underfund the work, spin the story and hope for the best.
Harmony has mostly characterized these relationships over the last 15 years. But as private equity tries to unjam the private equity conveyor belt, the levered brokers are set to be tested like never before.