Private Equity Has Met the Enemy

By Herb Greenberg, Empire Financial Research

Private equity has met the enemy… and it’s staring at itself in the mirror.

Think about it…

Before the bubble burst, private equity was buying anything and everything that wasn’t nailed down: car washes, dental offices, housing contractors, trash haulers, urgent care centers, hospices – the list goes on.

And maybe no industry epitomizes what’s really going on more than the insurance brokerage industry…

I’ve spent a decent amount of time on this one, via Brown & Brown (BRO), which is an open recommendation in my QUANT-X System newsletter. (Subscribers can read the full write-up right here… If you aren’t a subscriber, find out how to gain instant access to it – along with the entire portfolio of open recommendations – by clicking here.)

The company has been a great compounder for years and years… and years. That is, until the last two quarters, which I view as a setback in a longer-term story.

A big part of the Brown & Brown story for decades has been acquisitions…

I’m not generally a fan of “roll ups” – companies that generate much of their growth from acquisitions.

But the insurance brokerage industry is different, with acquisitions playing a perpetual and central role to the model…

It’s simply the nature of the industry, as small, family-run agencies – which are always popping up – look to sell…

Some deals are large, such as Brown & Brown’s purchase last year of Irish broker Global Risk Partners, which has revenue of about $340 million.

But most are considerably smaller, with a never-ending supply of targets. Thousands of agencies exist in the U.S… And for every agency sold, another is started with the ultimate goal of selling itself.

This is why the industry has been one of the most active spaces for private equity. As CEO Powell Brown said on an earnings call a few years ago…

There is a recognition, particularly among people who this is their single largest asset. The average agency owner in the United States is 54 to 57 years old. Sometimes, they’re either going to have to invest more heavily in those capabilities to compete, or they might benefit from partnering with somebody, whether it be a strategic, to enhance those capabilities or potentially sell to a [private equity firm] to monetize the assets.

Increasingly the answer had been to sell to private equity, which is what I like so much about Brown & Brown – the company didn’t get itself sucked into the bidding wars.

As far back as 2015, this is what CEO Brown was saying…

There’s definitely a walkaway price that we have, and we’re more than comfortable in walking away from a deal if we just think that price is too high that’s out there. And there’s a lot of them that are bid really, really high today.

The cheap capital that exists in this market today is driving, in certain places, some irrational pricing on certain deals, and that’s OK.

We’re comfortable with passing on any of those. We don’t think that there’s anything that’s out there that’s critical to our platform that we absolutely have to have. And so therefore, we don’t want to overpay.

Which gets us to where we are today…