Consolidators – is the game up?

There has been significant comment recently on the broking “consolidator” model and what its future is. The headlines have related to the various issues always likely to provide the biggest tests for acquisitive businesses in the medium and long term.

I should declare my hand and say that I don’t think that the Lark Group gets close to falling into the consolidator category.

Ten acquisitions over the past 13 years have contributed substantially to our overall growth and have created a wider branch structure. Our acquisitions have been – with one early exception – on a smaller scale. The largest was about 10% of our own revenue.

Some recent financial results have caught the headlines for the wrong reasons. All of the consolidators will have built up substantial debt in order to acquire, and this has to be paid for. In addition, there can be substantial early-year costs for restructuring and integration.

The true performance of these businesses will become clear two years after the acquisitions, when a clearer picture will emerge of whether the strategy has been a success.

We are all aware of what has happened in the wider economy and the increased cost of debt. In light of this, there is bound to be more of a focus on paying down existing debt and not taking on more. This will have contributed to the cooling-off of prices paid and, consequently, merger and acquisition activity in the broking sector.

Insurers have certainly taken a tougher line with the consolidators as they have made efforts to return their books to profitability. It appears that some of the levels of commission were unsustainable.

Insurers seem to have become so concerned about missing out on the distribution “party”, that they entered into account deals that were unsustainable – especially when, in many cases, there seems to have been no reduction in the costs of doing business for the carrier. This was always likely to unwind at some stage, and the consolidators would have had alternatives lined up to limit the downsides. My view is that the reductions in commission earnings will not have been a threat to the model.

A smaller broking business is likely to have had a fiercely independent approach in the past. For a consolidator, marrying this independence (often staunchly supported by the principals of the acquired business) with a wider corporate strategy that inevitably involves considerable change has always been one of the biggest challenges.

If the change is not carefully and sensitively managed, staff will leave and join other companies, or set up on their own. The SME sector is very much a people business, with close relationships formed between brokers and their clients. If senior people leave, business will follow.

This management challenge is obviously easier to tackle if you can have real focus on the integration of a new company, and devote your best resources to that task.

If you have acquired 10 businesses in a year, then the task is made much more difficult, and the chance of fall-out and “failure” is much greater.

Consolidators are buying people as much as they are buying books of business or companies, and bringing teams together is a massive challenge that needs to be well managed. This is an obvious business risk, and the courts are always likely to be cautious about backing businesses against individuals in cases over restrictive covenants.

But there are some signs of the power of the consolidator model. Some have begun to get real pricing advantage through their size, and this is being seen by clients.

Is the model broken? I don’t think so. Top-class management will see the businesses through these tougher times.

There was always going to be a period when the numbers of acquisitions dried up, and attention had to be turned to sorting the financials and to the real integration issues. Strong and skilled management will be required to deliver on the plan. No one ever said that it was going to be easy.

To borrow a quote from the banking sector: as Warren Buffett said, “Only when the tide goes out do you discover who’s been swimming naked.” IT