MGAs in the M&A Spotlight
With EBITDA (earnings before interest, taxes, depreciation and amortization) multiples regularly hitting new highs – commonly in the mid- to high teens – M&A interest in the MGA sector is intense. Both new and established parties are keenly aware of the market’s healthy fundamentals: MGA business is ‘sticky’, margins are excellent and infrastructure costs tend to be low. This has even continued, for the most part, through the pandemic.
MGAs bifurcate intellectual capital from financial capital, allowing would-be buyers to invest directly in high value assets, such as industry talent, underwriting processes, technology and a renewing revenue stream (retained policy renewals).
The Three Faces of MGA Buyers
Numerous buyer cohorts exist for MGAs, and it is important both for MGAs and potential MGA purchasers to find the right match before engaging in a transaction. The three primary purchasers of MGAs are private equity firms, wholesalers or brokers, and (re)insurers.
As the largest historical purchasers of MGAs, private equity houses typically focus on growing programs over a five- to ten-year period following the acquisition. The timing can vary widely depending on the individual firm, but most buyers we have spoken to, or worked with, are typically planning for a divestment period in this range. Buyers seek MGAs with high growth potential, and other characteristics including unique underwriting capabilities or an advanced technological component.
Firms in this group have broad incentives to purchase MGAs and utilize them as part of their overall risk placement value proposition. Wholesalers have retailer networks with large national firms, often comprising more than 10,000 retailers. Many MGAs participate on risks placed through the Excess & Surplus space, which is highly aligned with the areas in which wholesalers are active. Wholesaler acquisition of MGAs to create unique and exclusive (frequently E&S) solutions is highly synergistic. This is evidenced by significant M&A activity among the largest wholesalers.
Insurers and reinsurers usually focus on controlling a consistent annual premium volume with the least amount of potential execution risk. MGAs are a natural fit with insurers when the underwriting team, or a key technology that can be utilized at the insurer’s enterprise level, are core assets within the MGA. Typically, acquisitions take many years. An insurer may begin a relationship with an MGA and grow the relationship together, ultimately resulting in an acquisition. Other factors may drive potential insurer acquisitions. Defensive acquisitions might be executed to protect a program or, alternatively, an offensive play is made to strategically acquire one. Insurers will most likely refrain from purchasing MGAs if they can access the book of business without doing so.
Can EBITDA Multiples Continue to Rise?
A constant refrain across nearly all of our conversations with different market participants is: ‘Every year multiples go higher, and most people expect they have peaked. And every year, most people have been proven wrong.’
We believe it is entirely likely that the trend for increasing EBITDA multiples and high M&A activity will continue. There are two warning signs that the current level of M&A will prove unsustainable: reduced MGA inventory and record high valuations.
Simply put, there are fewer MGAs available to purchase. The ‘harvesting’ period over the past five or so years has seen the most desirable, specialized MGAs already acquired. Many potential buyers may turn to growing their acquired assets rather than purchasing new entities.
In the context of record high valuations, it is possible that MGA valuations (and M&A activity) will reduce because they have been too high for too long. Many would-be buyers want to know if there is another way. For instance, rather than purchasing an MGA, incubators can be formed in order to attract underwriting talent, frequently in exchange for equity in an underwriting cell.
Alternatively, many sponsors are considering ‘lift and shift’ schemes, which aim to draw underwriters from traditional carriers and drop them into a newly-formed MGA. The set-up costs for an MGA, if an appropriate team can be identified, are attractive to potential buyers, which otherwise face making an acquisition at 16x EBITDA multiples or higher.
M&A Outlook Uncertain
While we feel confident that M&A velocity will slow and EBITDA multiples will decrease over the long term, it is not clear if the deceleration will occur in 12 months, 36 months or longer. The timeframe might be tied private equity overhang or to the low interest rate environment, which has pushed asset prices upward in many industry classes.
A macro level shock, such as a change to M&A taxes, could also cause a rapid chilling of the MGA M&A market. What is certain, is that many buyers continue to bet against the EBITDA multiple increase ending any time soon.
Private equity firms, wholesalers and (re)insurers have found that insurance, and specifically, MGAs are attractive assets. This is due to a high-level of annual revenue retention, consistent growth and margins, minimal capital requirements and low infrastructure costs. Further, these fundamentals even held, for the most part, through the pandemic.
MGAs’ healthy earnings multiples will persist, and M&A activity will likely continue. However, the current high level of M&A will likely decrease due to reduced MGA inventory, record high valuations and possibly interest rate impacts.
Cost effective ‘lift and shift’ schemes appeal to potential buyers, which simply attract underwriters or teams from specialty carriers and drop them into a newly formed MGA or division of an existing MGA. This scheme will also expand as traditional standard-market insurance carriers strive to expand into specialty markets.
MGA market value is currently tied to the low interest rate, which has pushed asset prices up; the market could also be impacted by a change to M&A taxes.