An Acquisition Machine

As retirement calls, many business owners look to harvest their life’s work and sell the proverbial farm.

If that farm is an insurance agency and you’re looking for someone to sell to, that partner may be Arthur J. Gallagher & Co. (“Gallagher”, Ticker: AJG1market cap: $34.2B; revenue $7.7B, return on equity: 14%), a global insurance brokerage, risk, consulting and administration services company.

Large firms like Gallagher dominate a US market of 1 trillion dollar health insurance budgets. Gallagher is one of the most prolific acquirers, with its acquisition machine running at 3 per month. “We completed and integrated 583 acquisitions from January 1, 2002 through December 31, 2020, most of which were within our brokerage segment2On culture “our strategy to drive shareholder value. Number one is organic growth. Number two is growing through mergers and acquisitions….” source: 2018 Q3 earnings call” Due diligence, paperwork, earnouts, cash wired. Retirement secured.

Many of the acquisition targets are predictable: regional brokers with $2-4M+ in annual commission revenue in property, casualty, and healthcare. Gallagher pays 2-3x revenue, with and implied effective EBITDA multiple3earnings before interest, taxes, depreciation, and amortization (not quite cash flow but a frequently used metric by some), while the market values AJG currently at 4.8x revenue. Rinse, incorporate, imprint the culture, and repeat.

The Investor Relations (IR) department recognizes the acquisition opportunity and the arbitrage in higher valuation multiples for bigger companies. “Branch managers and regional leaders are tasked with finding potential M&A opportunities, and each division also has a handful of M&A bird dogs looking for opportunities.  We do see opportunities from investment banks/deal brokers…the market tends to value smaller brokers at lower multiples, so there is an arbitrage.” As of October’s earnings release, they have “more than 50 term sheets signed or being prepared, representing around $400 million of annualized revenues.”

The multiples are justified by what the market will bear, and what they can pay to earn a reasonable return, at least equal to their return on equity of 14%. It’s a balance of valuing a business like a bond (cash flows) and partially like stock (future growth, innovation, allure). Here the discipline is tight and firms are valued more like bonds. Relationships and commissions that come with them are relatively sticky, lasting 6-10 years or more: ~$1 per employee per day, for a lifetime value (LTV) of $3,000 per employee. For a 1,000 employee firm that’s $3,650,000 in LTV revenue.


"[Stocks] are valued partly like bonds, based on roughly rational projections of use value in producing future cash. But they are also valued partly like Rembrandt paintings, purchased mostly because their prices have gone up, so far."   -- Charlie Munger

Software and data to attract clients and to extend the life of an existing one will continue to produce a high return on investment by extending the cash flows of the proverbial farms, and justifying a higher multiple when the time comes to sell or hand it off.

Disclosures: the author’s personal healthcare coverage is a $5,000 deductible4“member share per illness” is a better but less catchy term but it’s not really a deductible since it’s illegal for them to market it that way. cost-sharing plan (non-ACA). Healthcare investments: Cigna, Covetrus.

Photo by Michael Dziedzic on Unsplash