Business Breakdowns
· Matt Reustle, Aaron Cohen
[00:00:00] S0: Certainly healthy when you factor in what that means for free cash flow in terms of the investments or anything below the line that would be required. Putting aside leverage and the capital structure, what would go into other investments that need to be made, whether it's now or in the future that you think about as an investor. [00:00:00] S1: There are not large capital requirements in this business. This is a very, very clean cash flow. Besides capital structure, it's really just CapEx, which is a few percent of revenue growing a little bit faster than top line, probably because people are investing in technology and data and efficiencies. But it's a really, really clean business and that's why everyone's done very well in this industry and it's traded so well for so long. [00:00:00] S0: How do you view it to your point? I think we've laid out why the private equity market would love this particular subsector and I would imagine that's brought in more competition for you and your seat. What does that look like and how do you think about the go forward in terms of the opportunity set here to find these businesses and to continue the playbook?
· Aaron Cohen
[00:00:00] S1: So we have seen valuations grow pretty dramatically over the last 25 years. I think it's the result of a few different things. One is, I think before the financial crisis, insurance brokerage was not viewed that favorably from public market or private equity investors. They kind of viewed it as an industry where business was done on the golf course and there wasn't much value proposition there, and people were just wrong. And I think the world saw that during the financial crisis when every other industry in the financial services world got decimated—being dramatic to prove a point. And insurance brokers grew; they grew and I think it put a spotlight on the industry. So that brought in more competition, more capital. Then what we've talked about earlier in this call is I think pre-financial crisis and pre-turn of the century, a lot of the brokers were small, so they could not drive premium valuations because they couldn't drive their price. Even though they don't set price for the customer, they do set their commission rates with the carriers. And if the carriers didn't have large brokers that they were reliant on to bring books and books of business to, they didn't have to pay them much. So one, the spotlight from how this industry performs. And number two, as they got bigger, they were able to increase their commission rates either through variable or fixed commissions. Saw that this is an industry worth investing in. The private equity industry entered this industry. Then we went on a run of 20 years of low interest rates, which obviously helps when you're doing M&A if you could borrow very cheaply to buy these wonderful assets. So we've seen valuations not quite, but maybe doubled in the last 25 years. I'd say pre-financial crisis, this industry traded eight and a half times. And now great brokers and the public brokers trade at 17, 18, 19 times. And I think it's driven a lot by the cash flow characteristics of this business. Everyone understands the recurring revenue nature of this business and the M&A opportunity. There's very few industries that have such a plethora of M&A opportunities. And what's amazing is this industry is still fragmented and there's still thousands and thousands of brokers for people to buy and get those synergies and get that operating leverage.
· Aaron Cohen, Matt Reustle
And the funny thing now is you're seeing old brokers who, after running out their non-competes, start new businesses. So this industry still has a long way to go to get truly consolidated like we've seen in other industries. And there's still tremendous opportunity for value creation for investors. [00:00:00] S0: This somewhat overlaps with that question and answer, but you have a very interesting example with Assured Partners. A business that you invested in, exited and then got back involved and have since made announcements. Can you talk a little bit about that, particularly the initial exit and then investing back into the business again and how that comes around? And whether that is symbolic of the way that things can continue to operate in the future? [00:00:00] S1: Of course. But I'm going to correct your semantics, Matt, on one point. We didn't invest in Assured. We started Assured Partners. We formed that company. [00:00:00] S0: Okay. Yes.
· Aaron Cohen
[00:00:00] S1: So I'll go back to our leader strategy, which is we look to meet great CEOs, build relationships and find assets to buy or build with them. And Jim Henderson is the quintessential example of a leader strategy CEO. We built a relationship with Jim because he was on the board of another insurance business. We were invested in a carrier called Ironshore. So makes the meaning less clear. Jim is a legend in this industry. I've never met a CEO more well-liked. When you're a hard-nosed CEO, you always cross some people—not on purpose. Jim is the ultimate gentleman and he's been incredibly successful. He had a reputation and preceded him when he joined the board of Ironshore. My partner and I would change seats at dinner to be able to sit next to Jim. And we built a relationship with Jim over time. And after a couple of years, he was looking to do something different and he called us down to Orlando where he lives and we literally built the Assured Partners idea truly on the back of a napkin in his backyard. I mean, it's straight out of a movie. So Jim and we formed Assured Partners. GTCR committed several hundred million dollars to Jim to build this company. Obviously Jim was in the space for 30 years prior, so he knew the entire industry, both people and target acquisitions. And our goal was to build an insurance broker with him. And he wanted to learn from what he did in his career and build a better broker. All about clients and clients and brokers. And that was our goal. And someone like Jim, everyone was dying to work for him. So before we even owned an asset, we had about six people on the payroll that we were funding with equity. A president, a head of M&A, a CFO because everyone wanted to work for Jim. So we were just burning cash until we found a platform. Now, we're not a venture capital firm, so we didn't say go hire producers and start writing your first piece of business. We were looking for a platform. And our first platform was a company called Neace Lukens in Cincinnati, Ohio. And it was a small business, but it was big enough that had some basic infrastructure and the ability for Jim to professionalize the business. And we went off. So that is the quintessential GTCR story. Find a great CEO and a management team. Find a business, bring that team in to run the business.
· Aaron Cohen
So at the time, Neace Lukens was a very small business, but the management team we brought in, they were used to running billion-dollar businesses. And then on top of that, people wanted to sell, people wanted to work for Jim. I wouldn't say we were getting a discount, but we were winning ties because people wanted to be part of what Jim was creating. So we built a wonderful, wonderful business over five years. Unfortunately, in private equity, we do have to sell our businesses, even our great ones. That being said, we at GTCR like to own businesses longer than the industry average. So we were coming up on our five-year anniversary and we were more than three times ahead of our back-of-the-napkin plan. Our goal was to get to $40 million of EBITDA in five years. Like I said, we were well in excess of three times that. So we were excited. We spent so much time finding the right people, investing in the technology, investing in growth that we wanted to keep on compounding. And frankly, Jim, who was a wonderful partner, said, I recruited all these people, I promised them that in private equity they were coming to work for me, for the equity, the equity side of private equity. And we owe them a payday. So we sold the business and it was a wonderful success and one of the best deals in our fund. And of course we stayed in contact with Jim. Jim is a personal friend at this point and we were staying in touch. And I remember I was walking through Disney World, my kids were young then. And Jim called me up and said, let's do it again. And I said, Jim, do what? And he said his current sponsors wanted to sell and we should work together again. At GTCR, that's the best phone call you can ever get, which is when a CEO wants to work with you again. And if you think about private equity and getting to little geeky finance, risk and reward are correlated. Our biggest risk, especially as you hear us talk about the leader strategy, our biggest risk is finding a CEO where you think you're well-aligned, putting them in a business and you're not well-aligned and you have to change management and all the leakage that comes with that. That doesn't happen often, but that is a risk. And here we've worked together, we've seen eye to eye, we understood the strategy we wanted to continue to execute.
· Aaron Cohen, Matt Reustle
So all of a sudden we had asymmetric upside because we had the same reward potential with a significant risk chopped off our other side. So we were very excited. We partnered with Jim and the management team to rebuy the business almost six years ago. And now we built it to over a billion dollars of EBITDA into a wonderful, diversified, specialty-focused business. And it was announced last November that we're selling the company to A.J. Gallagher, just one of the absolute role models in the middle market insurance brokerage space and a family we have tremendous, tremendous respect for. [00:00:00] S0: That's an incredible story that really encapsulates all of the higher-level investment frameworks along with the nuance of the industry. I love hearing that and spelling out the details on the point of the exits which you need to think about. The scale becomes bigger and there's certainly in private markets various chapters where I think I know some smaller market PE folks that look and try to build businesses that they can sell to middle market. And once you get up to the size and scale that you operate in, it becomes a bigger challenge or there's less natural buyers. So how do you view the opportunity set for when you're exiting? Whether it's finding strategic public companies that could potentially be buyers, IPO'ing, I'm just curious how you think through those opportunities and evaluate them.