Deal or No Deal?

Your firm, Barclays, recently handled a couple of transactions—The Partners Group investment in Foundation Risk Partners as well as Truist’s acquisition of Benefit Mall. Do you have any interesting takeaways for us?

I would start by congratulating both of those management teams and those sponsors and those buyers too for two fantastic assets. As you know, in M&A these are long journeys over the course of a couple of years to get us to these kinds of outcomes. We’re very happy with both of them. What I’d tell you is they’re a continuation of two broader themes that we’ve consistently talked about. One is private equity’s continued interest in the sector, especially on the retail side, but also growing, and we expect to see more of that. On the other side, it’s interesting, a strategic transaction where Truist has been a longtime consolidator of these assets and someone who sees long-term value in insurance distribution to supplement their broader business continuing to acquire. So I think that also opened the door for many people to think about strategic conversations, which we’re seeing as well.

Definitely a couple topics that we’re going to dive further into. I understand the Foundation Risk Partners transaction had some impressive stats around it. Can you share some of those?

It certainly did. I’m not in a spot to talk a lot about the numbers—that’s not public information. But what I can tell you, which I think is relevant, is why that resonated for folks and for buyers in the community. First of all, we spent a lot of time with the company and with their sponsors and others, setting the stage and creating an environment for the management team to tell their story. I think that is super important. Secondly, it was the nature of that story; it was a very different story than others had told in the past. It was one of integration, technology, operations, culture. That really resonated with many of the folks around the ecosystem, especially new folks looking to enter the ecosystem. By that I mean the private equity players…this looked and felt very different than someone just aggregating…there are other elements to it that have become more and more important and with this macroeconomic backdrop will be more important. Then thirdly, this was a team that really showed quite impressively in the context of what they’ve been able to achieve over four years. While I can’t get into all the numbers, I think the “why” is probably more important to be candid about how they got there and what they did.

Let’s go into those macroeconomic conditions a little bit more. Inflation, interest rates, the broader market—what are your thoughts about what’s happening and how this is affecting our space?

There is a fair amount of uncertainty in the macro backdrop. We’re coming out of a global pandemic, and that resulted in a couple of different things. There was an incredible increase in the money supply with checks written to people, government spending. Politics drove a lot of it and [there are] justifications for a lot of it, but you had just a tremendous increase in the money supply. You had a somewhat material withdrawal of labor, with folks either choosing not to work or deciding it wasn’t worth it, so you have this reduction in the labor force. Then I think there’s a third trend going on, a bit of a longer-term trend, which is the onshoring of production, which for many years we had moved to places like China, India, Southeast Asia… But onshoring of labor and production is a lot more expensive than offshoring it. In my view, you put increased money supply, you put a reduced labor force, and you put onshoring of production all together, and it’s no surprise that you face real inflationary pressures in the economy.

The Federal Reserve has a mandate to maintain price stability. I don’t blame them for what they’re doing. They actually need to be doing what they’re doing, given the mandate. It is a consequence of the dynamics we went through over the last couple of years. Let’s just hope it’s all managed in a way so that we have the proverbial “soft landing” as opposed to the hard landing. But we are going to be in this environment, I think, for at least a few more months and into ’23.

How do you think this will affect the brokerage buyer marketplace, both for large and smaller deals?

In my view, it’s going to be a little mixed. I think for the larger platforms or larger businesses that are maybe sponsor-owned, you have quite sophisticated capital partners for these firms. They’re aware of the backdrop, and they’re monitoring their companies and the situation quite closely. I think they’re being more and more conscious of what they own, but they’re also being much more conscious of where they deploy capital and their portfolio companies deploy capital… They’re going to be cautious, and we’ve seen that more and more in large processes…where the typical XYZ private equity players are just more cautious.

On the smaller tuck-in side, I think a more cautious environment is starting to emerge. Q1 was slow for M&A this year, [but] it has picked back up and it looks like we’re going to run through the tape again. But people have been using cash on balance sheet, debt and other facilities they have to fund M&A. As those run their course and people have to come back to the market to raise capital to do more of those tuck-ins, that higher cost is going to be much more apparent. I think that really plays into the market to some extent in ’23.

Earlier you said you think that we will see more caution out of private equity, potentially. Does that mean just being more thoughtful and specific about what they’re looking for in a deal, or does that mean fewer deals because they just have less to work with? Also, do you think this economic environment will change the private equity dynamic within M&A going forward?

I think the answer to both of those is I don’t think it really changes it but I think it does raise the bar across the board. A few folks have come to me and said, “Oh, this could be the end of it. It’s Armageddon now.” I say it’s far from that. This is still a required product for people, it’s a highly stable industry, it’s got great margins and great long-term growth and great free cash flow. So let’s not divorce ourselves from the fundamentals of every business here. But yes, we are in a slightly different macro environment. All of us can generally do simple bond math, which is when interest rates go up, asset values come down, because I’m discounting the same cash flow by a higher number, so that’s just part of math. I would argue, though, the opportunities are still plentiful and there’s still a lot to do. I still think there’s plenty of folks, whether it be new entrants or others, to consolidate. But I do think the bar is higher across the board for folks to think about it and where they’re going to deploy the capital.

What are your thoughts going forward with large consolidators?

You and I have been debating this question over the last couple of years. Every year, I say it has progressed a little bit. This year, I think it has progressed a little bit more. Historically, the hurdle was high to get all the stakeholders around the table to align on the economic and social issues for the merits of a transaction, because I could go buy something big, and it was a big integration bet to get that right, or keep doing what I’m doing and that’s worked out really well so far so why take that risk?

I think what’s interesting to debate is does this macroeconomic and interest rate environment at least open the door for people to have more of a conversation. Do they say, “Hey, look, my Plan A might still be my Plan A, but should I at least understand what Plan C could look like? And should I have a conversation or not? Should I see if there are social things that matter, and should I explore if, in this different macro backdrop and this different interest rate environment, the economics of Plan C or Plan D might actually be compelling?” So I do think there’s more conversation. I cannot predict anything happens, because Plans A and B still look very attractive for many people. But I think many senior management teams are much more open and receptive.

We’ve also seen a number of transactions in the MGA market. Any observations there?

It’s obviously been a much busier segment in recent years. I think a little bit stems from, you’ve had a lot of capital, private equity or otherwise, that has invested in retail brokerage. I think they see great thematics and trends within that part of the ecosystem. They say, “What are the other ways I can get exposure to that?” I think this is largely a function of that, where they say, “I know this stuff. I’m good at it. I’ve had some history in it. What else can I do?” I think that has really had a lot of folks think pretty interestingly about broadening their set of capabilities and where else they can go. So I do think we continue to see more of that.

Then there’s a whole little merry-go-round of carriers acquiring MGAs, or even sometimes there are teams within carriers that want to leave and then want to set up their own companies. They’re getting capital from people to set up their own businesses, and then they start to consolidate. So it’s honestly working both ways.

On a similar note, we do hear a lot of talk of increased interest in specialty transactions. I think we’ve seen their valuations go up. What are your thoughts there?

Similar to some of the thematics I mentioned before, I think the consolidators, given there’s a lot of them, are looking for ways to differentiate themselves in the market…or actually ways for them to grow across their book of business. You can have Consolidator Y or Platform Y say, “I have a bunch of producers in this market and they know all these people who own trucking companies, but I don’t have subject matter experts. If I could go buy someone who has a real niche and expertise and can either build programs or is smart enough to do that, (1) I get to differentiate my business by having something special that has more barriers to entry around it to protect my business and to make it look good, but (2) I have the ability to cross-pollinate those skills across my broader book and leverage the producers that I have that might know all these trucking people but will never give me business because I don’t have enough of a play or scale or I don’t have enough of the specific knowledge and expertise they need to do that.” It can help drive organic across my book if I can do that. So there’s really a couple dynamics: how do I differentiate myself, how do I build more of a competitive lasting advantage, and does it help me from a growth perspective?

Let’s go to insurtech. Are we seeing a sea change in the way investors are evaluating insurtechs?

The insurtechs over the last couple of years have had a really rough go of it. I think the market is looking at them very differently. When I talked to you a couple of years ago, we talked about growth, we talked about customer acquisition, we talked about changing the way people interact and deal with their insurance companies. I think the meaningful decline in valuations for some of the public folks has really recalibrated that conversation for many. The real focus now isn’t growth at all costs, because you and I as industry veterans of insurance know that growth at all costs is easy—just lose as much money as you want. That’s the best way to do it. But there’s a real focus now on unit economics, LTVs, customer acquisition costs, building a business that has scalable loss ratios and expense bases that you can grow into, and managing your exposure to reinsurance. We haven’t talked about it yet, but everything I’m hearing is Jan. 1 is going to look brutal. When you put that in the context of what challenges these businesses are facing, investors are very focused on trying to navigate that broader thematic because capital-light is great when reinsurance is cheap but capital-light is going to be difficult for some of these players going forward.

But I think there are a couple of really interesting places to play in it. I like cyber. I like some small commercial stuff. I think there’s real opportunities and people building long-term differentiated platforms that provide value. I also see a lot—less in my world, maybe this is more technology focused—but on the plumbing within insurance companies and the APIs that connect; there’s a lot to be done from an efficiency perspective there.

Last question for you. Looking to 2023, any additional thoughts on what we can look for in brokerage M&A?

I think a couple of things. As I’ve already mentioned, I think the tuck-ins will continue to be a little bit more challenging for folks. By that I mean buyers will be more discerning in quality of the assets that they want to acquire and be more picky. I think that also will ultimately then play into valuations for those businesses. Secondly, I think we might see something larger or something more transformational. Again, no bets on it, those things are very uncertain, and they are low probabilities, but there’s more of that conversation.

You mean in the retail space?

Yes, I think you might see some more stuff there. But you have investors who are generally very patient and will do the right thing for them and their business and their shareholders when it all makes sense.