Broker consolidation - Is flotation such a capital idea?

Brokers considering the daunting prospect of floating could do worse than look at the example of the Jelf Group. Jelf, which incorporates a general insurance broker with health and IFA arms, launched on Aim in October 2004 at around 84 pence per share. Today, less than three years later, the stock is trading at closer to 260 pence.

The flotation has provided Jelf with the capital and the visibility to embark on a period of sustained and unrelenting growth through acquisition, as well as providing fantastic returns for its investors.

Others are keen to follow suit. Cobra Holdings, parent of Cobra Insurance Brokers and Cobra Network, is set to float on Aim this month in a bid to raise £10m for acquisitions. Protectagroup and Giles have expressed a desire to follow suit.

So in this period of unrelenting consolidation, where everyone is a potential target, is flotation really a panacea for brokers looking to expand and defend themselves against circling sharks?

Bankers who advise and facilitate brokers’ capital raising activities express caution. Flotation is one of several options available to brokers looking to expand, and the decision to become public needs to be carefully considered. Private equity and straightforward bank debt are also viable and in some cases preferable alternatives.

Take the example of THB, which first listed back in October 2002. THB harboured the same aspirations for sustained growth as stock market darlings Broker Network and Jelf, but has found the transition from private to public more difficult. The company floated at 124.5 pence per share and now languishes at 99.5 pence, with a particularly trying period in 2005 when the share-price fell to just 62 pence.

Admittedly, a large proportion of THB’s business is US-facing and the company has been badly exposed to the weakening of the dollar. But, as chief executive Vic Thompson testifies, the reality of flotation can be negative as well as positive.

“The main idea of floating is that you can offer shares as well as cash and in doing so become a much more liquid company. While that benefit has been apparent, we have not really been able to make use of the increased share-price to fund acquisitions like some others,” Thompson said.

The ability to offer a mix of cash and shares to potential targets allows brokers to make bigger acquisitions and more frequently, without saddling themselves with huge debts.

But to really benefit from listing, acquisition is not enough. Brokers must impress upon analysts and investors on a quarterly basis that they have a clearly defined and well-executed strategy for organic growth.

Thompson says: “The difficulty with being a relatively small company and listed, like us, is that the stock remains very illiquid. This restricts movement, and Cobra may face the same problem.

“But once the company grows and the stock becomes more desirable, there are higher volumes and more liquidity, which enables further growth. But gaining the trust of the market in the first place has been a challenge.”

THB has a turnover of £30m, profits of £4m and a market capitalisation of around £27m.

Capital raising

One banker, which specialises in helping brokers raise capital and has assisted many operations to come to market, says: “In terms of pure capital raising, becoming a public company involves a lot of hassle. Public companies need to report to the market, are subject to more rigorous accounting standards, and have to ensure their website is compliant. Then there are the (Aim/LSE annual) fees.

“The cost of the actual float can also be very high. You need to consider lawyers’ fees, advisers’ fees, PR, and the process of wooing institutional investors. Smallish brokers are sometimes not the most dynamic businesses and floating often suits fast-growing businesses which can prove themselves to the market in a short space of time. That is not always easy.”

A second banker, which specialises in financial institutions, points to Windsor as an example of how private equity can also help positively to facilitate growth.

“Some businesses have an irrational fear of private equity investment. They believe that investors will somehow strip the business of assets or attempt to squeeze control but that is usually not the case. Private equity can be far preferable for brokers on the trajectory from local players to listed entities.

“One good thing about private equity is that results are not assessed externally. There may be a plan in place for several years, but the stock market wants to see constant profit and growth. It can be easier to grow undercover and possibly float later.”

One chief executive said: “In the end brokers must decide whether they are ready for or even really want the increased visibility that comes with being a public company.

“It is good to have institutional investors as it adds credibility to the business and can improve its standing and how recognisable its brand is. Brokers find themselves covered by analysts for the first time and that’s great when things are going well, but it’s difficult to hide when they’re not.”

The decision to float is often driven by the personal motivations of a broker’s current owners. A placing on Aim, for example, is often a good way for family-run operation to cash-out of the business and achieve the best possible price for doing so.

“Floating allows management and legacy shareholders to make good on their initial investment without giving up autonomy altogether as part of a trade sale,” the financial institutions specialist said.

It is also a mistake to assume that brokers must consider floating once they reach a certain size. Market reports last month suggested that super-consolidator Towergate could fetch up to £3bn and yet the company remains determined to launch an IPO on its own terms in 2008.

According to chairman Peter Cullum, remaining private gives Towergate the ability to act quickly where others are forced to consult their shareholders. This fleetness of foot has seen Towergate acquire brokers at an unprecedented rate – a model it now intends to emulate for the IFA market.

As one banker says: “The decision to float should not be taken lightly. There are other, easier ways to raise capital and brokers must be prepared for the added responsibility and expense that being a public company entails. The stock market can be a fickle place.” IT