Despite being viewed as ‘neither very hot nor very unpopular’ by private equity firms, the broking community is still ‘the darling of the financial services sector’ when it comes to M&A, say experts
Investment bank and financial services firm Goldman Sachs’ investment in intermediary business The Clear Group has the broking industry buzzing.
Amid all the doom and gloom around the UK economy, it appears that broker M&A remains buoyant.
Goldman Sachs is the gold standard of investment banking - its backing of The Clear Group will lure other investors to look at insurance, hoping to make big returns on UK brokers.
M&A expert Ian Clark, director of Mighty Quin Consulting, said: “At the moment, the insurance broking sector is still the darling of the financial services sector.
“You only have to look at Goldman Sachs and Clear. There are plenty of transactions still and Howden and Ardonagh are spending big, big bucks.”
The market is now wondering whether Goldman Sachs’ private equity (PE) deal is a sign of strength for broking M&A, or whether rising interest rates and high inflation will cool deal-making.
Seeking to combat inflation, the Bank of England pushed interest rates up to 1.25% in June 2022 - the highest recorded level in 13 years.
However, research and forecasting firm Capital Economics speculated in May 2022 that the Bank could raise rates even higher – up to 3%.
The risk this poses for broker M&A is that funding for acquisitions could slow down as deal-making becomes less attractive due to higher interest rates.
Peter Allen, co-head of financial services at RSM UK, told Insurance Times that there are already signs that credit conditions are tightening, particularly around the more chunky deals sitting between £25m and £40m earnings before interest.
He said: “In those transactions that rely on syndicated debt - so not provided by one lender, [but] provided by a series of lenders - we believe that credit conditions are tightening as some lenders decide not to be quite [so] easy going.
“That has not yet hit in the mid-cap. In the mid-cap, if you have a fund, the fund has a couple of bankers [that] it is used to using and the bankers’ terms don’t change that quickly.
“So, unless the banker literally pulls out of the sector, you will carry on being able to support the deals you are doing.”
Mid-cap, or mid-capitalisation, refers to companies with a market value between $2bn (£1.6bn) and $10bn (£8.3bn), according to Investopedia.
Allen continued: “The second point is there’s some anecdotal evidence that lenders are getting more nervous about sectors where they were already nervous.
“Sectors where everyone was keen are still very hot. So, IT, pharmaceutical [and] business services arguably are very hot sectors for PE and the lenders.
“They remain very hot, possibly a little less hot than previously, but they’re still pretty hot.
“To set against that, there’s some evidence that sectors [that are] already unpopular - like consumer products or casual dining - are even more unpopular now then they were six to 12 months ago.”
However, Allen noted that “insurance brokers are neither very hot nor very unpopular” in lenders’ minds.
“It is now a relatively well established sector for PE,” he added. “Most people understand it. It’s not particularly complex.
“It’s not the case that insurance broking will suddenly become an unprofitable sector.
“But this is again a sign that maybe people’s enthusiasm for investment is ticking away slightly.”
Then there is the question of inflation. The nightmare outcome for brokers is one where wage inflation goes up faster than prices.
This would dampen profits, making insurance broking a less attractive sector for M&A investment.
Clark remains bullish on broking M&A, but does acknowledge that investors might be a “little bit more wary”.
He said: “I just think generally people are getting a little bit more wary about the current financial market status.
“It’s more of an inflation issue because interest rates are only a cure for inflation. Inflation is undoubtedly causing problems across the place, particularly wage inflation.”
No deterrent for investment
Meanwhile, Olly Laughton-Scott, co-founder at M&A consultancy Imas, believes brokers have the resilience to ride out these problems.
The critical question for Laughton-Scott is whether brokers can continue to grow their top line revenue.
“The insurance broking industry has been remarkably resilient for many years. And, of course, with an annual premium, the premium will naturally increase every year,” Laughton-Scott said.
“You’re not locked into a fixed rate. The demand for the product will decrease a bit, unquestionably, because there’ll be a recession. But fundamentally, the terms of trade will adjust to account for inflation.”
Insurance veteran Ashwin Mistry, who sold his business Brokerbility Holdings to The Clear Group in September 2020, is even more optimistic.
He believes there is still “an abundance of cash” flowing into UK broking M&A.
He explained: “Interest rates are what they are, but they’re still at record lows [compared to] historic ways. I think it’s still a very viable position.
“And as long as investors get their 7%, 8%, 9% return on capital year in, year out, I don’t think they’re going to flinch an eyelid as to what is going on.
“My prognosis for the next two to three years, minimum, is that M&A will continue.
“Interest rates are not going to be a deterrent, even if it doubles up from today’s rates, because the returns are very healthy in the face of global volatility. It’s still a very safe place to invest.”