Inside the MGA M&A boom
The US market is seeing a remarkable surge in M&A activity in the MGA space.
Inside P&C has reported on three MGAs in recent weeks looking to monetize, following Constellation's sale to Truist at the end of May. And it is further understood that the total number of MGAs for sale is in the double digits.
The same phenomenon is evident in microcosm in the UK, where cyber sector darling CFC, Markel's Volante Global and Eaton Gate are all making moves to seek new financial backers.
So, what's going on?
There are three key drivers on the sell side and three on the buy side. These boil down to an attempt from sellers to time the market to maximize their returns on exit, and, on the buy side, to a huge amount of deployable capital combined with reduced opportunities elsewhere in insurance and (critically) increased faith in the model.
Sell side – the rationale for selling
First, the selling management teams and institutional owners are looking to capitalize on a multi-year ride-up in valuations, which have reached a new peak over the past few months.
Banking and private equity sources said the valuation for a "platform" MGA has risen from around 10x Ebitda five years ago to 12x-13x a couple of years ago and now 14x-16x.
Smaller MGAs with $5mn-$10mn of Ebitda that can be tucked into large operations have also seen a ramp up in multiple to 10x-12x.
Second, owners are looking to exit now based on the sense they are in the growth sweet spot.
One senior source said the public brokers are a rough proxy for the organic growth of MGAs, although they added that growth for many of these businesses is slightly hotter and currently running in the high single-digits to low-double-digits range.
Another said the figures can be comfortably beyond this range, particularly with MGAs often benefiting from the combination of a firming market and the tidal flow into E&S.
By selling based on the current growth trajectory, MGA owners are hoping they can persuade buyers they will be able to "grow into the multiples" they are being asked to pay.
Third, some owners are hoping to sell out ahead of potential tax changes from the Biden administration that could reduce their net gains.
President Biden's tax plans have been spurring M&A activity for some time, with owners trying to secure liquidity ahead of a proposed increase in the capital gains tax rate from 20% to 39.6%.
There is also concern the Democratic administration will curb the carried interest exception, which lowers the tax burden for PE and venture capital funds.
Buy side – the rationale for buying
First, there is significant amount of dry powder, both from under-deployed private equity houses and strategics benefiting from the same dynamics as the MGAs themselves.
Bain's 2021 global private equity report noted that dry powder was at record levels, with buyout funds holding around ~$1tn of undeployed capital. It also pointed out that the average age of this capital climbed by three months during 2020 to 22 months.
Private equity funds also continue to have access to historically cheap debt, with the Moody's Baa corporate bond yield at 3.37% compared with a 4%-5% range from 2016 until the temporary Covid spike.
Strategics are drawing on either the same capital resources, if private equity-backed, or strong cash flows driven by the hardening cycle and the bounceback in macroeconomic growth.
Second, the opportunity set to deploy funds has shrunk across retail broking, wholesale broking and carrier start-ups.
With around 20 private-equity-backed retail platforms already in the market and several above the $500mn-revenue mark, the early game of sector consolidation is over despite the huge numbers of small agencies still available to buy.
As such, the chance for smaller private equity houses to make a successful play in retail broking by buying a platform and pursuing the aggregation model is pretty much at an end.
In addition, the wholesale broking sector is highly consolidated following deals to take out the likes of Worldwide Facilities and All Risks, encouraging wholesalers to look towards MGAs and binding authority businesses for their next deals. This has already been made evident with CRC's surge in MGA M&A, and through Ryan Specialty Group's strategy statement in its S-1.
Meanwhile, the door has effectively slammed shut on fundraising to back insurers as part of a cycle-driven play.
The reduction of the opportunity set has displaced capital looking to find a way to play the sector towards the MGA space.
Third, there is increased conviction in the MGA model based on the parallels with retail broking and its success in weathering insurer remediation drives.
Private equity has succeeded in generating IRRs in the 20s via successful retail broking consolidation plays over the last decade. And if you squint hard enough, an MGA kind of looks like a retail broker.
Like retail brokers, MGAs are also insurance fee businesses. They are not capital intensive and have good cash conversion. They also take leverage well, although banking sources suggested a 4.5x-5.5x Ebitda range versus brokers which can be levered at 10x by an aggressive owner.
There is scope for some value to be created through consolidation, with the likes of NSM, K2, Align and Constellation proving it is possible to buy a few small MGAs a year and integrate them. This can also be achieved with the same inwards-outwards arbitrage retailers have been able to access.
They have also shown that teams can be taken from other companies to establish new cells.
Unlike most retail broking businesses, they can also run with Ebitda margins in the 30s.
One of the biggest sticking points in the past has been the MGA Achilles' heel: the potential for a loss of paper to disrupt trading and impair the business.
But there is greater comfort now that this doomsday scenario will not come to pass because most MGAs have been able to successfully trade through a period of intense underwriting remediation, even if they did have to churn their panels.
MGA < retail broker
With banking sources estimating that there are 50-60 obvious buyers to pitch the available assets to, it seems highly likely that sellers looking to monetize right now are timing their move well.
On the other side of these trades, buyers will have to be careful because some of the dynamics driving the sellers like pricing and the tidal flow to E&S are vulnerable to the pending cycle change.
MGAs, ultimately, are not retail brokers. Their M&A pipeline is smaller, their earnings are more volatile due to their gearing to profit commissions and they will not support the same level of leverage.
Moreover, it is still possible they will be hobbled if they lose support from their paper providers. In addition, it is unclear how well these businesses will operate at scale. Ryan Specialty described its MGA operation as the third-largest in the US despite having only $211mn of revenues in 2020.
There may be great returns to be had if the multiple expansion of the past five years continues to run, but the past is not always the best guide to the future, and a protracted soft market combined with a material pick-up in yields could well leave someone carrying the bag.