For consolidators the party seems to be over and new entrants are building sophisticated propositions to weather the storm of recession. Oliver Laughton-Scott of IMAS gives his opinion.
Timing is everything. And times have changed. Last year the land grab was in full swing. Now many of the partygoers have gone home to recover from the binge and it is not clear when they will accept another invitation.
However, it is not all doom and gloom. The disappearance of the lager louts has left the floor open to those with distinct strategies to find appropriate partners. We are now receiving inquiries from outside the industry from businesses that are looking to build sophisticated customer propositions as vanilla financial services become increasingly dominated by the large internet brands and financial supermarkets.
Gloom is also comparative. While we have seen stock market valuation of general insurance business fall, brokers have outperformed the FTSE All Share index. Quoted companies typically have significant dollar exposure and, if this element was stripped out, it is likely that brokers would have performed far more strongly. At the time of writing, in the US Aon is up 10%, Marsh is 7% lower and only Willis is down significantly by some 27%.
Insurance brokers are defensive stocks. Recessions typically see rates harden as capital becomes scarce and we are seeing the insurance industry picking up credit-related losses; this will continue. Increasing moral hazard further supports rate hardening. Brokers hold cash and this is now earning a substantial return.
When awarding Towergate 2nd Equal for shareholder value creation two years ago, we commented on the need to be able to demonstrate an exit strategy. One of the magic ingredients holding the Towergate empire together is the carried interest that many of the past vendors and managers hold in the business. A very small percentage of a gigantic number is still worth having. If the number is far smaller and the timing of realisation far less certain this glue is considerably weakened. Other consolidators face the same issue though the quantum is far smaller. All will be under pressure as insurers try to swing the terms on which they trade with the brokers back more in their favour.
The year ahead remains full of challenges as business confidence may fall further and we will probably fall into a full blown recession. However, the fundamentals for brokers remain strong and quality businesses will continue to add shareholder value.
The perennial whipping boy of the industry comes good. With none of the pedigree of Marsh or a Big Joe to lead them, Aon has been getting down to the hard graft of making what was a disparate collection of businesses into a money making operation. Margins of 18% are by no means the highest in the industry, but increasing UK profits from £37.5m to £93.5m is a real achievement, done in part by pursuing margin at the cost of revenue.
As mentioned above, while all other brokers have seen their share price fall over the year, Aon has seen its share price increase significantly. Smaller brokers no doubt could argue that their relative figures are just as good if not better. However, turning a huge ship around is far harder, hence Aon deserves recognition as adding hugely to shareholder value in the last year
A close run between Swinton and BGL (Budget). Budget scooped first place last year so Swinton’s sharply increased margins get it into second place. Defying conventional wisdom has worked well. It has allowed Swinton to acquire with limited competition, so kept down the prices it has been paying. Using advanced telephony technology it has routed inquiries to offices local to the caller to build rapport and used its high street presence to differentiate itself. The personal lines market has undergone huge changes with the advent of the aggregators and without a differentiating feature many distribution propositions are now struggling. Well done to Swinton for thriving.
In the Lloyd’s market it is was a close race between Windsor and RK Harrison. RK Harrison achieved 2nd place last year so Windsor has it this year with its margin of 28% as compared to Harrison’s 22%. In March 2007 Windsor undertook an management buyout. The shares are now widely spread among its management so generating a healthy profit is key to paying down the debt which, in part, explains why profits increased some 28% in the year to £6.8m. A number of Lloyd’s brokers have a far higher exposure to US business, and the weakness in the dollar in 2007 had a negative effect on their businesses. If the dollar strengthens significantly then we will see strong performances from some of those who have featured less prominently this year.
The best of the rest
The following have all produced results that any management team would feel proud of. Insurance broking is a mature market and every pound of profit has to be fought for. They are listed in descending size order.
“The disappearance of the lager louts has left the floor open to those with distinct strategies
This is the fourth year we have done a Top Shareholder Value award and this year is the first time that Towergate has not appeared on the winner’s podium. However as ever it warrants a mention in despatches as brokerage still increased a whopping 50% in the year. Given the change in the general market sentiment, the inability of private equity to leverage transactions with the consequential knock-on effect in valuation and the insurers’ desire to tighten trading terms, the price at which Towergate might expect to make an exit now is probably down significantly from the numbers being banded around 12 months ago.
Another great performance which shows what a focused business model can do.
While not immune to the pressures that the other consolidators have been subject to, and rather publicly putting the brakes on acquisitions, it has acquired some good businesses in the last 12 months and sharply increased profits.
Another strong performance with a 33% increase in profits. This gives margins of 25% which is excellent for a personal lines broker.
Almost on the winner’s podium. Profits up sharply and in May it purchased Heath Lambert’s aviation, wholesale and reinsurance divisions, so growth next year is guaranteed.
Behind the headline grabbing quotes is a shrewd businessman who persuaded a private equity house to put a big number on the business. The timing of the transaction was immaculate, a few months on and it could have all been a bit more difficult.
Quality operation showing the bigger boys in EC3 how it should be done. They will no doubt be a strong contender next year and for many years to come.
We have looked at the following as our key indicators:
Clearly a key factor. We are however interested in increases in shareholder value; so if a deal costs more to finance (by debt and equity) than it adds in value, then the increased turnover will have actually destroyed value. So we are focused on organic growth and value added transactions, not simply growth in the top line.
We look at the actual level achieved but equally importantly at what the improvement during the year has been.
If a sector is putting in excellent results across the board, then this suggests the underlying driver is cyclical in nature; that is, the rating environment. The stock market is skilled at recognising the impact of cycles and tends to discount them accordingly.
We are unlikely to pick the same company as the winner two years in a row. What we are looking for is the company that has added significantly to shareholder value in the current year.
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