Will rising interest rates kill brokerage M&A?

Reports of the death of brokerage mergers and acquisitions in an era of higher interest rates have been greatly exaggerated.

Back in early 2023, Canadian Underwriter’s National Broker Survey noticed a curious phenomenon: brokers’ interest in M&A growth had dipped despite a busy year of deals in 2022.

In a survey of 150 brokers across the country, respondents’ enthusiasm for M&A growth fell to 23%, below the normal range of between 26% to 31% over the prior three years. Several attributed the slackening interest at the start of the year to the higher cost of capital required to make deals.

About two weeks before the broker survey went into the field, in January 2023, the Bank of Canada feared inflation due to an overheated economy would spark a recession. So it raised its overnight lending rate to 4.5%. Now holding at 5%, the overnight rate sits in stark contrast to the 0.1736% rate seen during the pandemic in February 2022. With borrowing costs becoming so high, leveraging debt to make M&A deals became less appealing, and many predicted brokerage M&A activity would shrivel.

But a funny thing happened on the way to the deal table. Brokerage M&A did not stop. Bidding wars for high multiples of a brokerage’s EBIDTA (earnings before interest, depreciation, taxes, and amortization) continued.

Canada’s bullish brokerage M&A market, in fact, grew since the half-year mark, several brokerage buyers reported, although there’s been a subtle shift in the nature of the deals. Green lights and red flags remain the same during due diligence, but they shine a little brighter these days.

Value for money

Brokerages remain high-value, recession-proof commodities, noted a 2022 Smythe Advisory report on brokerage M&A. Brokers throughout Canada were in demand for their advice to help clients navigate the pandemic.

As a result, brokerages were reporting strong contingent profit commissions (CPC) received form their Canadian insurance partners. They reported attractive earnings, commanded high multiples at sale, and continued to draw interest from the P&C insurance industry’s largest consolidators and private equity.

“Given the state of the public markets and the high interest rate environment, acquirers — and I am really talking about private equity acquires, for the most part — are looking for safer, lower-risk profile investments. They want steady, predictable targets,” said Michael Stack, vice president of acquisitions at BrokerLink.

“And the Canadian brokerage space does seem to match that target profile in a rough economic environment. I think that’s why we’re seeing a little more activity than one might assume we would have seen.”

The bids are in

Sources have told CU the bidding wars are proceeding apace, with sellers seeing offers for four to seven times multiple of revenues and much higher multiples of EBIDTA.

Although buyers are more disciplined in the current environment, “you’re still going to find a buyer,” one M&A dealmaker said of the current market.

Auction environments are not ideal for certain buyers, some of whom are holding back on dramatically increasing their offers to outbid others. Such buyers said auctions prevent them from building personal relationships with the seller’s owner, restricting their ability to craft a unique deal that has value for both sides.

“We’ve seen quite a heated auction environment of late, and that’s a new trend,” said Joe D’Annunzio, president of BrokerLink. “That type of setup is not ideal for companies like [ours]. We don’t get to know the broker [who owns the selling brokerage] and craft the deal so there’s a win-win. You’ve seen some recent transactions in the market at price tags that frankly do not support our financial return objectives….

“We’ll continue to prefer to pursue acquisitions through those focused, one-on-one conversations, because we believe it’s best way to achieve the strongest outcome for all parties.”

This story is excerpted from one that appeared in the October print edition of Canadian Underwriter. Feature image by iStock.com/ADragan