BDO MERGERS & ACQUISITIONS INSURANCE BROKING MARKET UPDATE MAY 2018

Transcription

1 BDO MERGERS & ACQUISITIONS INSURANCE BROKING MARKET UPDATE MAY 2018

2 55 Baker Street London W1U 7EU May 2018 Dear Sir Welcome to the first of BDO s 2018 sector updates focusing on the insurance broking industry. This edition looks at the whole process of valuing brokers and a number of the key components that drive value in any proposed transaction. Alongside this summary we have attached our usual quarterly update on the BDO Private Company Price Index, which highlights the latest trends in pricing multiples being paid for both privately owned and private equity backed businesses. Our Corporate Finance M&A team at BDO has considerable knowledge and experience of the broking sector and has advised on many notable transactions in the mid-market. Our experience provides us with a unique insight and in-depth knowledge of the dynamics of the industry and the issues that brokers face. We maintain and build long-term relationships with our clients to support them in achieving their strategic goals. Ultimately our aim is to assist our clients in building value and at the right time, to maximise their capital value through an appropriate transaction. We look forward to the opportunity to work together. Yours faithfully, ADAM WHISTANCE M&A DIRECTOR +44 (0) adam.whistance@bdo.co.uk I lead BDO s sector focused M&A team which specialises in insurance distribution, broking and services to the wider insurance industry. I have a wealth of experience as a corporate financier focussed on the corporate midmarket, having worked for twenty years transacting MBOs, sale mandates, acquisitions, PE and debt fund raising and solvent restructuring. ADAM WHISTANCE M&A Director For and on behalf of BDO LLP A SELECTION OF OUR RECENT DEALS BDO were appointed to provide advice and support to the shareholders on the deal. The process was managed extremely well throughout and the quality of the advice we received was key to getting the right structure and to securing the best outcome for the shareholders. Their understanding of the investor and knowledge of the insurance market and the M&A world made a real difference. Whenever things got tough, BDO were there. I would not hesitate to recommend BDO. DAVID BESWICK Managing Director Saffron Insurance Holdings Limited SALE Sale of Saffron Insurance Holdings Limited to Broker Network SALE Sale of Churchill Insurance to Brokerbility

3 BDO M&A INSURANCE BROKING 2 THE BLACK ART OF VALUATION As anyone involved in the insurance sector knows, life is inherently complex and uncertain. There are no guarantees, no absolutes and just when you think that you have a full understanding of what lies ahead, life has a remarkable habit of creeping up behind you and hitting you over the head with a sock full of lead. It is the same in business and even those of us who are old enough to have been involved in the sector for more years than we would care to admit, must acknowledge that we don t know everything and in all likelihood will never have seen it all. If only things were straightforward and clear, then business would be so much easier however they aren t and it isn t. In today s world things change at a rapid pace and now more than ever, yesterdays accepted knowledge or wisdom becomes outdated or at least updated on a regular basis. With all things subject to interpretation, evolution and change, why should how a broker is valued be any different? A CHANGE IN APPROACH For many years the broking industry operated on a valuation model that was unique and different to most of the business world. Values were often quoted based on multiples of recurring income and whilst the multiple itself would change to reflect the specific circumstances of the deal, the methodology itself was common across the industry. However, over the years the gradual and persistent infiltration of accountants and financiers into the industry, with their eyes firmly focused on cashbacked profitability and chanting the mantra of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), has led to the industry re-appraising its approach to valuation and becoming more aligned to other trading businesses and industries. Whilst multiples of income can still be seen as a valid valuation methodology, specifically where the target is a smaller broker that is carrying a level of cost or proprietorial overhead that would not be required under different ownership, it is EBITDA and a relevant multiple that are now the starting point of most broker valuations. SALE Sale of Arc Legal Assistance Limited to AmTrust International ACQUISITION Acquisition of Keegan & Pennykid Insurance Brokers Limited INVESTMENT Investment by Carlyle Group SALE Sale of Perkins Slade to Hyperion Group

4 3 INSURANCE BROKING BDO M&A THE BLACK ART OF VALUATION THE FOUR ESSENTIAL COMPONENTS OF A VALUATION The EBITDA valuation model has four key components. Two are widely recognised, albeit commonly misunderstood, with the other two often treated as an afterthought, although they can have a significant impact on the overall value received from a transaction. 1. WILL THE REAL EBITDA PLEASE STAND UP? EBITDA is the first component and is essentially the profit generated by a business which is, in part, a proxy to cash generation. Whilst this would seem reasonably straightforward to calculate there are a number of things to be considered from a valuation perspective. Reported EBITDA per statutory accounts will often include costs and income that can be considered as either exceptional, non-recurring or simply not maintainable under new ownership. A common example is that many owners of businesses can be remunerated through a mix of both salary and dividends and the level of their total remuneration may not be commensurate to a commercial salary package. They are the current owners of the business and quite frankly they can pay themselves what they want, but this may not be what they would pay someone else to do the job or represent the future level of salary after the deal is done. These types of costs, along with other associated family members payroll costs, often need to be adjusted when considering the true underlying profitability of a business or Maintainable EBITDA. Other potential adjustments to costs could include for example, exceptional re-organisational costs, one-off legal or professional costs and office moves or relocation expenses. Then there is the question of the ongoing costs of the business under new ownership. However, it is not simply cost levels which need to be reviewed as part of assessing underlying profitability. One-off income cases, profit-share payments and other claims management ancillary income will often be the focus of scrutiny for any experienced buyer. Another aspect to be considered in calculating EBITDA is the period over which it is measured. The default positon is often the last financial year end. However, if a business has increased its profitability significantly, why should a valuation be based on a number that no longer reflects the true underlying value of the business? LTM, or last twelve months, can often be used as a more reasonable time period to measure EBITDA. But the last twelve months to when? If negotiations commence in January based on the EBITDA for the previous year to December, by the time the deal happens it will be June and increased profits will have been demonstrated, so what period of EBITDA should be used? Different views, different values and a range of factors which all need to be considered and carefully negotiated to reach a consensus on maintainable EBITDA.

5 4 INSURANCE BROKING BDO M&A 2. MARKET QUOTED MULTIPLES CAN BE MISLEADING Once a maintainable EBITDA is agreed it then needs to be applied to a multiple. This is the second component of the valuation. Unfortunately, there is no bible of multiples containing a matrix which can be referenced to value an individual business. Multiples move over time and are dependent on numerous factors including size of business, quality or volatility of its earnings, customer and employee dependency, business class and not least buyer appetite and seller expectations. The market is constantly awash with talk of multiples paid for businesses and recent deals. The truth is often different to market rumour with widely acknowledged multiples calculated using historic reported EBITDA which as we have summarised, is not always the most accurate representation of true business profitability. What is key to achieving an accurate valuation is understanding the true multiples being paid in the sector and the factors which drive a better result. One size does not fit all and as with EBITDA, the appropriate multiple to apply will be subject to presentation, interpretation and negotiation. 3. BALANCE SHEET BASED ADJUSTMENTS TO VALUE ARE OFTEN OVERLOOKED A multiple is applied to maintainable EBITDA to generate the Enterprise Value of the business. This is often the headline number which is quoted but is very rarely the actual sum that is received by the owners. Adjustments to Enterprise Value are extremely common but are not always considered upfront when first appraising the valuation of a business. These adjustments, which can relate to the financial position of the balance sheet and working capital requirements are often treated as an afterthought even though they can potentially have a significant impact on the net proceeds received by a selling shareholder. In terms of the balance sheet, the common adjustments relate to cash and debt held in the business at completion and these form the third component of the valuation. To the extent that surplus office cash is held in the business at completion this can be added to the value of the business, whilst debt is deducted from the value paid. The cash position can be relatively straightforward to agree, but there is no universal definition of what constitutes debt. Some examples of debt are easier to agree than others such as outstanding bank debt or hire purchase. However, the treatment of items such as advance commission deals, capital adequacy requirement, staff bonuses and deferred taxation are far from clear cut and can be the subject of different interpretation and significant negotiation with individual buyers. To compound the complexity of agreeing what constitutes cash and debt, each of these numbers can be subject to a further adjustment relating to working capital. Put simply, how much cash does the business need to retain in order to meet its everyday operational requirements? This area is often the subject of strong debate with no universally agreed market approach. 4. OTHER FACTORS CAN HAVE SIGNIFICANT IMPACT ON VALUATION Finally, it is not merely the recorded financial performance and current balance sheet position that drives valuation. It can be as much about what the accounts don t include as what they do. Contingent liabilities associated with taxation planning, potential property dilapidations and unpaid profit share arrangements often form part of the overall value negotiated for a business and are the final, critical element of any value calculation.

6 5 INSURANCE BROKING BDO M&A ESSENTIAL ADVICE FROM SEASONED PRACTITIONERS PROFESSIONAL ADVICE AND TRANSACTION EXPERIENCE IS VITAL Arriving at a valuation is often a complex process that is subject to extended negotiation. A clear understanding of what is involved from the outset is essential for any seller before embarking on a potential transaction. Professional advice and transactional experience is vital in this regard. Often, it is a life s work at stake. At BDO we have extensive market experience and understand the wide variety of approaches that are taken by different acquirers in order to value businesses. This experience and expertise puts us in a unique position to help our clients have an informed view on their business value, and more importantly, how to achieve a premium through targeting specific buyers and specific areas for potential negotiation. Valuation is both an art and a science. There are numerous methodologies that can be adopted to determine views on the value of a business, but the fact remains that any valuation is only an opinion and certainly not an empirical fact. Ultimately the valuation of any businesses is simply the meeting point between what one party will pay and the other accept and as always, this will be subject to interpretation and of course, skilled negotiation. BDO UK BDO INTERNATIONAL At BDO we have significant experience of helping brokers with their strategic funding requirements as well as advising on a wide variety of corporate transactions including both acquisitions and disposals. If you would like to discuss the potential valuation of your business, we would be delighted to meet with you and answer any of your questions.

7 BDO M&A INSURANCE BROKING 6 PCPI Q STRONG START TO THE YEAR AND CONTINUING M&A MARKET STABILITY BDO s latest analysis of M&A transactions reflects ongoing stability and unwavering confidence in the market with deal volumes holding firm in Q1 and valuations rising slightly. With a further 560 deals recorded in Q1 the UK remains a highly attractive marketplace for M&A. BDO s latest analysis of M&A transactions reflects ongoing stability and unwavering confidence in the market with deal volumes holding firm in Q1 and valuations rising slightly. With a further 560 deals recorded in Q1 the UK remains a highly attractive marketplace for M&A. PCPI V PRIVATE EQUITY I Q Q VOLUME OF DEALS COMPLETED I Q Q Source: Market IQ, mergermarket, Fame and BDO Research International buyers, particularly from the US and Europe, continue to invest in the UK market, completing a number of the largest deals seen in the quarter. The Building Products sector was a strong performer in the quarter with several large transactions reported and some impressive multiples paid. It appears that we are set for another prosperous year ahead for sellers, with an expectation of a continuing strong M&A market. MAKING THE MOST OF THE PCPI/PEPI The PCPI incorporates Enterprise Value to EBITDA multiples as the method of valuation, replacing the previously used Price to Earnings ratio. These changes have been made to incorporate the level of debt in deals and to use a less subjective measure of profitability. Historical data has been incorporated to ensure comparability and to identify trends. The PCPI/PEPI tracks the relationship between the Enterprise Value (EV) to Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) multiple (EV/EBITDA) paid by trade and private equity buyers when purchasing UK private companies. The private company EV/EBITDA is calculated from publicly available financial information on deals that complete in the quarter. At present, the Private Company Price Index (PCPI) indicates that, on average, private companies are being sold to trade buyers for 10.3x historic EBITDA. The PEPI indicates that, on average, private companies are being sold to private equity buyers for 11.9x historic EBITDA. As private companies are generally ownermanaged, reported or disclosed profits tend to be suppressed by various expenses that may be non-recurring under a new owner. This will have been factored into the price the purchaser paid, but may not be reflected in the profits declared to the public. The effect of this is that the EV/EBITDA paid as calculated from the publicly available information may be overstated. The PCPI/PEPI is calculated as the arithmetic mean of EV/EBITDA for deals where sufficient information has been disclosed. Over the four years to end of Q1 2018, the included deals for the PCPI have had a mean Enterprise Value of 89m and a median Enterprise Value of 14m. The included deals for the PEPI have a mean Enterprise Value of 149m and median Enterprise Value of 50m. The PCPI/PEPI is an average measure and a guide, not an absolute measure of value, as there are many other factors that can have an impact on value.

8 FOR MORE INFORMATION: ADAM WHISTANCE +44 (0) This publication has been carefully prepared, but it has been written in general terms and should be seen as containing broad statements only. This publication should not be used or relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained in this publication without obtaining specific professional advice. Please contact BDO LLP to discuss these matters in the context of your particular circumstances. BDO LLP, its partners, employees and agents do not accept or assume any responsibility or duty of care in respect of any use of or reliance on this publication, and will deny any liability for any loss arising from any action taken or not taken or decision made by anyone in reliance on this publication or any part of it. Any use of this publication or reliance on it for any purpose or in any context is therefore at your own risk, without any right of recourse against BDO LLP or any of its partners, employees or agents. BDO LLP, a UK limited liability partnership registered in England and Wales under number OC305127, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. A list of members' names is open to inspection at our registered office, 55 Baker Street, London W1U 7EU. BDO LLP is authorised and regulated by the Financial Conduct Authority to conduct investment business. BDO is the brand name of the BDO network and for each of the BDO member firms. BDO Northern Ireland, a partnership formed in and under the laws of Northern Ireland, is licensed to operate within the international BDO network of independent member firms. Copyright May 2018 BDO LLP. All rights reserved. Published in the UK. HB010684