Reading your fortune

The past five years have seen significant consolidation in the UK domestic broker market. This has been driven by a handful of key players, and has typically been enabled by external sources of finance, such as private equity or bank debt facilities.

While these consolidators have been less affected by the financial crisis and economic downturn than other sectors in the UK economy, limited rate rises and falling volumes have provided a rather testing trading environment. Unsurprisingly, this environment, coupled with large debt facilities, led to a number of banking covenant issues in 2009.

Our understanding is that these issues have all now been resolved. And successful resolution demonstrates a belief among the investor and banking communities in the underlying business models. In particular, the various management teams have shown an ability to deliver for customers whilst also managing insurer relationships.

With covenant restructures behind them, and provided they remain focused, we believe the key players are well positioned to trade successfully through the rest of the downturn. This stability of course poses the question: what next for the broker consolidator sector?

Given the heavily utilised debt facilities already in place, and a private equity sector only just awakening, it is likely that management teams will spend the next few months focused on their existing businesses. We expect a renewed focus on organic sales growth and a drive to deliver cost synergies.

Of course, there will always be new acquisitions, and there is mounting talk of vendors of potential bolt-on businesses reducing their price expectations. If this is found to be true – and with the familiar drivers of increasing regulation and ageing owners, it could be – we may see the current slow pace of acquisitions accelerate.

However, as management teams thrive on deal making, it seems probable that, before long, businesses like Towergate, Oval and Giles will try to reinvent themselves in a new and more significant phase of development. What form this development will take is difficult to say, although chatter about the consolidation of the consolidators never seems to be far away amongst the advisory houses.

In addition to management ambition, external factors could drive a reshaping of the sector. There are a number of existing private equity investors in the sector, and if one or more were to become restless and look for an exit this could be a catalyst for transformation.

Despite a backdrop of economic uncertainty, there are signs that a new phase of development could be financed as early as 2010. While I am not suggesting a rapid return to the liquidity of 2006, in the bank finance market we have already seen new growth in the syndicated loan market. Lloyds Banking Group is one of a few banks in the sector willing to lead major transactions.

The broker consolidator sector specifically is an area where we have a number of large and important relationships. It is also one to which we are committed to provide financing in the medium term.

If this availability of bank finance is backed up by renewed interest from investors, most likely private equity houses, then we could see significant developments in the sector by mid-2010. With an investment thesis based on continuing rate rises and a potential upturn in the UK economy, the sector could be very attractive to equity investors familiar with financial services.

The attractiveness of the sector in 2010, from an investment perspective, could of course extend beyond private equity houses. AXA, following various acquisitions under the Bluefin brand, has already built a distribution capability in the UK small and medium enterprise (SME) market.

This leads us to the possibility of AXA making further acquisitions, and to considering if other composite insurers will follow this path. We can only assume that other composite insurers, with significant UK businesses, are following Bluefin’s progress closely.

There is also the (little talked of) possibility of a global broker trying to build a presence in UK personal and SME broking. It is unlikely that a global broker would pursue its own roll-up strategy from scratch, but the acquisition of an established consolidator should not be ruled out.

Taking management ambition, the potential for bank financing, and the influence of existing and potential investors, it is apparent that there are a number of factors that could drive development in the sector.

However, positive thinking about the financing of potential developments in the sector should not detract from the immediate importance of successfully managing existing businesses in a challenging economic environment. Strong trading cashflows are vital to servicing the aforementioned debt facilities, and beyond that delivering value to existing shareholders. IT

James Smyth is a relationship manager at Lloyds TSB Corporate Markets