Analysis: New Towergate group has much to prove

David Ross was barely able to contain his excitement about the creation of KIRS Group, a new UK broking powerhouse formed by merging Towergate with the Nevada group of companies, which he now heads up.

Speaking to Insurance Times the day after the creation of new Towergate group was announced, Ross says: “The journey that we will be able to tell in a couple of years’ time is a business that grew up in the regions, moved into London, moved out of the UK and took over the world.”

He thinks you should be excited about it too. He says: “Whether they compete with us or not, people should be fizzed up about this. The market should be right behind this. This is a good thing for everybody.”

But while there are many positives to the deal, others are not quite as excited as Ross. The deal looks good in theory, but much will depend on how the new combined business executes its plan in practice, and in particular whether it can cross-sell effectively and pull off its expected cost savings.

A big deal

It’s easy to see why Ross is so enthused. The combination of SME broker/MGA Towergate, digital motor broker Autonet, health insurance broker Chase Templeton, international wholesale broker Price Forbes and claims management and insurance services firm Direct Group creates a powerful whole.

With its collective revenues of £487m, KIRS would have ranked 7th in the 2016 edition of the Insurance Times/IMAS Top 50 Brokers. Towergate alone, the biggest component of the group, ranked 8th last year.

The combined entity’s £2.8bn gross written premium in theory should also allow it to exert a bigger influence over insurers.

In its initial assessment of the new group, rating agency Moody’s says that one of its strengths is “significant influence over carriers”.

It is not just about the big numbers and insurer influence. The combination of the six companies gives KIRS a presence in many important segments of UK general insurance distribution, from international wholesale broking with Price Forbes, down to digitally enabled motor insurance broking with Autonet and most things in between.

In theory having the companies in one stable should improve cross-selling opportunities. Ross claims: “We could double the size of the company just by meeting ourselves – just by introducing one part of the company to another part.”

The group’s multiple distribution channels and the presence of the digitally savvy Autonet in the group could help insulate it from the forces of disruption and disintermediation, according to rating agency Fitch.

The company also has committed backers. The four core investors in KIRS, the biggest being HPS Principal Strategies and Madison Dearborn Partners, have collectively injected £680m, and are going to want a return.

Shifting focus

Perhaps best of all for Towergate, the move gives it the financial power to continue its repair work while simultaneously shifting the focus away from its travails and onto the wider group.

While Towergate has made a great deal of progress on fixing itself since its near-collapse, and results had shown early signs of starting to stabilise in the fourth quarter of 2016 and the first quarter of 2017 by some measures, the continuing cost of restructuring is still taking its toll (see Pass Notes).

As a stand-alone entity Towergate was unable to shrug off concerns about its level of indebtedness and how long it could continue to spend more money than it was making.

The KIRS deal takes some of those concerns off the table. The new £890m of funding – made up of an £800m bond issue and a £90m revolving credit facility – will pay off Towergate’s existing £500m of bonds and £30m Project Lunar loan as well as paying for the acquisitions of Direct Group and Chase Templeton.

And because the debt is just spread across the entire group rather than just one part that is still working to right itself, the debt burden should, in theory, be more manageable.

Rating agencies have been critical of Towergate’s debt metrics in the past, and both Fitch and Moody’s had their ratings of TIG Finco, the part of Towergate where the debt sat, on negative outlook, which meant they are at risk of a downgrade.

While both agencies have assigned the same rating to the new debt-bearing entity, KIRS Midco 3, as they did the old TIG Finco, at B3 for Moody’s and B- for Fitch, both agencies have positive outlooks, which means the ratings could be upgraded.

No guarantees

But this does not mean that Towergate is out of the woods yet, or that the new KIRS group is a guaranteed success. GRP broking chairman and one-time Towergate chief executive Andy Homer says: “David Ross and his team may well have the capabilities to integrate these different businesses and get some positive growth, but I think the current market conditions are still very tough, so getting true organic growth without an acquisition warchest is going to be very difficult.”

AXA UK chief executive Brendan McCafferty says: “On paper it sounds like a great strategy and I wish them well.”

But he adds: “The journey that Towergate are on makes some strategic sense for them, but I also know how difficult the implementation will be. Whilst the strategy is very attractive, the test will be in the implementation.”

The rating agencies agree. While praising the new group’s standing in the market and the diversity of its units, Moody’s flagged up KIRS’s “limited track record of operating as a combined group”.

Fitch said that despite the knowledge and skills displayed by the management team in bringing KIRS to this point, “risks remain in delivering this plan in a highly competitive insurance and brokerage market”.

KIRS is targeting £56m of cost savings at Towergate by 2020. Of this, it in the first quarter of 2017 said it had achieved £34m of savings over the past five quarters and was targeting a further £17m over the next 12 months. But this will take time to show through in the results. And while there is certainly potential for cross-selling to boost revenue, it remains to be seen whether the company can pull it off.

Homer says: “While in theory there is a big opportunity, it has proved difficult for all market players to do cross-selling. It takes an awful lot of marketing effort and skill. Whilst there is a big potential, realising the potential is by no means a walk in the park.”

Moody’s adds: “At this juncture, the magnitude of earnings benefits from cross-selling remains uncertain, and may cost more or take longer than anticipated to fully materialise.”

Then there is the debt. While it is now spread across the group, the relative indebtedness is still high. Moody’s described KIRS’s financial flexibility profile as “weak” and said that pro-forma debt-to-EBITDA would exceed eight times according to its calculations, excluding run-rate savings.

But it adds: “Moody’s acknowledges the material run-rate savings the group expects to realise and expects gross leverage to reduce towards 6.5 times over the next 18 months.”

KIRS might be able to take over the world one day, but it still has plenty of work to do closer to home first.

 PASS NOTES

The three EBITDAs

What are they?

Towergate reports three main types of earnings before interest, tax, depreciation and amortisation (EBITDA): Adjusted EBITDA*, adjusted EBITDA (without the asterisk) and EBITDA. Adjusted EBITDA* is the most flattering, and is used as the headline number for results press releases and investor presentation slides.

What do they all mean?

EBITDA is what it says on the tin: operating profits with depreciation and amortisation charges added back in. Adjusted EBITDA (without the asterisk) removes the effect of any one-off costs, which produces a more flattering result but allows a user to compare more easily between years and see how the company is running on a ‘business as usual’ basis. Adjusted EBITDA* takes it a step further, giving Towergate credit for cost savings it expects to make, but have not yet fully earned through.

Does this affect results?

In its first quarter 2017 results, Towergate hailed its third consecutive quarter of year-on-year adjusted EBITDA growth. This is true when you look at both adjusted EBITDA* and adjusted EBITDA, but the unadjusted EBITDA number itself shows that Towergate deteriorated in the first quarter of 2017 to a loss of £1.8m from a profit of £2.8m.

Does this still matter?

In presenting the pro-forma EBITDA numbers for the combined KIRS, the company has used the adjusted EBITDA* number – the most flattering version – for Towergate. And Towergate is the biggest single component of KIRS.