Mystic’s Donoghue: Distribution M&A activity picking up “quickly” as conditions stabilise

Mystic Capital Advisors’ Kevin Donoghue has said the M&A and fundraising deal flow for distribution businesses such as MGAs and brokerages is picking up “quickly”, as investors look to put dry powder to work amid stabilising funding conditions.

Donoghue – who co-founded the boutique advisory more than two decades ago – was speaking with The Insurer TV at last week’s Target Markets Mid-Year Meeting in Tampa, Florida.

Mystic does transactional advisory and due diligence work covering a market segment that includes specialty groups, MGAs, program administrators, wholesalers, captive managers and third-party administrators.

“This year, it's picking back up. Interest rates have stabilised, there's talk about potential interest rate drops coming up. So people are starting to get more active in the market,” he said of M&A and capital raising conditions.

“And we're seeing that with our deal flow – our deal flow has really picked up a lot in the last three months,” he added.

More heavily leveraged brokerages – such as those with debt-to-Ebitda leverage ratios approaching the double digits – “are going to have a tough time on the flip”, Donoghue noted, but those with more modest leverage ratios should get a better reception.

“So if the flip is within the next year, I think people are going to be well-received in the marketplace. Twelve months ago, they weren't. Interest rates were moving, they didn't know where they were going,” he explained.

“Now there's a sense of stability in the interest rate environment, maybe it ticks up a little but there's more emphasis on it going down in the next 12 months,” Donoghue noted.

Pick-up in deal activity “happening right now”

Asked if he expects deal activity to pick up, Donoghue said “it's happening right now”.

“There was a 12-15-month downturn, but it's picking up now quickly. And some of that has to do with dry powder. There's a lot of these groups that have dry powder, they've got to put this money to work before they do their next recap,” he explained.

“If it stays on the shelf, it doesn't help you with your growth initiatives,” he added.

One trend Mystic has observed over the last 18 months as funding conditions have tightened has been a shift in the balance between cash and equity used as compensation in transactions, Donoghue noted.

Where deals previously included 10 to 20 percent equity and the rest cash, Donoghue said the proportion of equity is now more likely to be around 30 percent.

“So equity now is pushing towards 30 percent and, you know, that's a significant shift in risk and reward to the seller,” he commented.

Donoghue provided an overview of the distribution segment over the last decades, including the entry of private equity firms into the segment that “turbocharged” M&A activity and multiples.

“And last year, when interest rates started moving up, things kind of settled down a little bit, the number of transactions was down for the first time in 10 years,” Donoghue noted.

But he added that there continues to be a fresh new group of smaller consolidators that have a long runway.

Among the top themes Donoghue observed at the Target Markets mid-year event was smaller MGAs looking to get bigger by doing deals and more mature MGAs potentially looking to sell to big aggregator platforms.

“So there is both a balance of buyers and sellers, it's good,” Donaghue commented.

He also pointed out that rate increases in the underlying insurance market is a positive benefit to MGA valuations, with higher commissions falling to firms’ bottom lines and improving Ebitda.

Watch the full interview with Mystic Capital Advisors Group’s Kevin Donoghue to hear more about:

  • How a stabilisation in funding conditions and an expected easing is leading up in deal activity
  • How highly levered, privately held retail brokers are going to face tougher recap processes
  • Why more deals are getting done with a greater funding tilt to equity from cash
  • How higher underlying insurance rates boost Ebitda, valuations
  • The importance of being cash flow / Ebitda positive in raising capital