Risk Strategies M&A chief: Broker buyer field has become “narrow”
The head of M&A at top-20 retailer Risk Strategies says the dramatic shift in funding conditions has led to a significant pull back in acquisitions in the sector, telling The Insurer the number of players who will be able to execute deals in 2023 “is becoming a narrow group”.
John Vaglica, the chief M&A officer at Boston-based Risk Strategies, and formerly the firm’s CFO, said that higher interest rates have pushed up debt servicing costs and leverage ratios for some of the industry’s most acquisitive brokers, in turn cutting the number of firms that can still do deals.
“Really, the issue is the number of players on the insurance brokerage football field in 2023 is now a much narrower group… that can actually execute on a deal,” Vaglica told The Insurer in a joint interview with the firm’s CEO John Mina.
The executive’s comments come after The Insurer broke the news last week that PCF Insurance Services – second-most acquisitive intermediary of the last two years – has suspended all M&A activity and laid off staff after exhausting its borrowing resources.
A number of sources said they expect PCF to be out of the M&A market for the foreseeable future.
Vaglica and Mina said they had seen an increasing number of M&A deals fall through, telling The Insurer they had at least two deals in recent weeks where the seller came back to them after Risk Strategies was lost the deal, initially, on price.
“Capital structure is really what's driving this issue now,” Vaglica explained. “How you were structured [from a capital standpoint] and whether or not you've already pulled the financial value creation – sort of internal rate of return levers – or not, is what puts you in the power position today,” he added.
“Probably” 12-15 buyers in the market in ’23
Risk Strategies has completed somewhere in the region of 60 deals in the last two years that have amounted to roughly $150mn in acquired EBITDA, and Vaglica said the firm was not the highest bidder on any of those transactions.
Vaglica said Risk Strategies’ culture is a distinguishing factor that lets the firm get deals done, and a conservative approach to managing its capital.
“I don't think we've ever been in the top 10-buyer on an annual basis,” Vaglica said, before adding that he expects his firm to crack the top-10 of most acquisitive retailers next year, as the number of buyers in the market scales back.
“Because I think out of the 30 or so firms that are doing some semblance of what we're doing at any scale there's probably 12 to 15 that are actually going to be able to execute on deals next year.”
Risk Strategies struck a deal for a fresh $1bn-lending facility this past spring, with its’ strong lender group on 2021 terms – before the US Federal Reserve began aggressively raising interest rates – and the broker has a single economic class of stock Vaglica says is “aligned right next to our private equity partner”.
“That puts us in a position that no other PE-backed firms are in right now,” Vaglica said of the funding Risk Strategies secured in the spring. “And I mean not one of the top-30 private equity-backed firms are going to have that kind of war chest today with that advantageous pricing.”
Middle-market private equity firm Kelso and Company first took a majority stake in the Mike Christian-founded firm in 2015, before leading a recapitalization process in early 2020.
Among the guiding elements of Risk Strategies’ M&A playbook is to only buy businesses where the agency’s principals stay on and join the firm, and acquire firms with management teams that buy into Risk Strategies’ “single-firm culture”.
“You have to believe [in] that one company culture as opposed to a siloed culture is the answer to beating your competitors,” Vaglica said. “That’s what we profess and it’s put us in a very different spot.”
Vaglica contrasted that approach with that taken by some other intermediaries that have honed in on a strategy of management buy-outs, where deals are heavily saddled with debt.
“Which is fine if you're making acquisitions, growing organically and delivering an IRR in the range of 25 or 30 percent a year,” Vaglica said, “but as soon as you hit the debt ceiling and can't service your debt, you’ve got a problem.”
Risk Strategies’ M&A chief pointed out that beyond just having access to funds and being able to come to terms on valuation, the business models of highly-leveraged brokers are likely to come under pressure in a more subdued economic environment, where it may be harder for sellers to earn upside on equity that gets rolled over in a sale.
“The question is, ‘How is that [highly-levered model] story going to resonate, and how are those sellers going to view the equity opportunity?’” Vaglica explained, referring to agency principals that may have sold sometime in the last two years.
“Given where interest rates are today, that equity could become effectively worthless,” Vaglica explained.
“Because if you sit behind a huge tranche of various debt vehicles that require a certain return on an annual basis, that you’re not going to be able to deliver – because you can’t do acquisitions or grow organically – now you've got value transference,” where more of operating income is paid to service debt.
Organic growth becomes even more critical
Vaglica says his firm targets deals that deliver value not only on an arbitrage basis, but those that can turn Risk Strategies into “an organic growth machine”, and that his team evaluates its success not based on deal count, but how acquisitions in recent years have contributed organic growth.
“That's the real measure of quality that you're adding to the firm,” he said.
Mina also emphasized how critical it would be for consolidator broking platforms to deliver organic growth in the current environment.
“I think those firms that are primarily focused on acquisition as a growth strategy – they're going to be challenged in the current environment,” Mina said.
“Implementing an organic growth strategy is not something that can be done quickly, and even once it is implemented, it takes time to bear fruit,” he continued.
“And that means there's going to be a lot of margin pressure on those firms in the short-to- medium term, while they either figure out what that organic growth strategy is or implement it,” Mina added.
“I think that's where you end up with some [businesses] having to make some difficult decisions, unfortunately,” he said.
Mina said building out that organic growth capability has been his firm’s focus in recent years, citing investments Risk Strategies has made in captive management and actuarial expertise, and despite sitting in a strong position amid the current downturn, it wouldn’t deviate much from that strategy.
The chief executive noted that his company takes a longer term horizon when developing both its funding and acquisition strategy
“I do think we are very thoughtful,” Mina said, saying he and his management team spend time gaming out a variety of scenarios that could unfold over an extended period, both in terms of industry market conditions and the economic landscape more broadly.
“I don't know that there's a lot of that going on,” Mina said. “I think there's a little bit of living in the moment and assuming this will continue on forever.”