The senior managers and executives I’ve met who aspire to be involved in an M&A deal at some point in their careers have one thing in common: They are all fans of Gordon Gekko, the investment banker character played by Michael Douglas. They romanticize about the 1987 movie, Wall Street, with visions of glory flashing before their eyes as they remember Gekko pacing around his large Manhattan office, barking orders, and ripping the competition’s face off. “Greed is good” is a line most people remember from the movie.
Proceed with Caution!
The real world of M&A is a tad bit less exotic than the great Michael Douglas leads us to believe, especially in an insurance context where it can be as fun as watching paint dry!
Experts estimate that a significant number of acquisitions fail to meet shareholders’ expectations. Deloitte puts the number at 83 percent and McKinsey at 61 percent. Accenture’s survey of more than 400 U.S. and European corporate executives revealed that 55 percent of deals did not achieve expected cost-savings synergies. (See reference here)
So, now that you have been warned, if you are not discouraged and want to forge ahead with your M&A ambitions, remember to proceed with caution.
M&A Reality Check
In The Insurance Management Playbook I delve into the below fundamental questions in considerable detail, draw on real-life experiences, and provide case studies:
What are your M&A drivers?
Vertical or horizontal product or segment play?
Ego, Gekko-wanna be play?
Do your immediate and extended teams have the expertise and bandwidth?
Do you have the stomach for long and protracted due diligence and bidding rounds?
Do you have the head-office’s full support?
Are your business cases (base-, best-, and worst-case scenarios) as well as valuations and financial models robust?
Did you conduct proper due-diligence and line-up the right internal as well as external resources?
Did you protect the downside?
Robust Business Casing
The main components of a robust base-, -best, and –worst case scenario insurance M&A business case are addressed in the M&A chapter of The Insurance Management Playbook, which can be downloaded here. I also delve into the tough, tedious, and supremely important task of performing due diligence and provide a step-by-step approach to help you avoid common pitfalls and achieve the highest probability of success:
Determining if they fit;
Protecting the downside;
Valuing properly; and
Key components of your purchase agreement and price adjustment contract provisions.
Below is a high-level guidance on what to include as the main elements in your business case:
Start with an executive summary on the target company and explain why you believe it qualifies as a good fit for your firm.
When it comes to numbers, present base-, best-, and worst-case scenarios. Here are some factors you ought to consider:
What is your projected growth plan?
Where will this position you from a market-share point of view?
Are the numbers realistic?
Did you take into account profitable growth and not just piling more premiums on the books to just grow for the sake of growing.
Loss ratios, severity as well as frequency, given your projected portfolio mix.
Expense ratios—integration as well as business as usual.
Discount ratios and your cost of capital.
Compatibility between your underwriting approaches and philosophies and the target’s.
Actuarial pricing models.
Overall projected portfolio retention rates. You may realize that a lot of the business you acquired does not fit your underwriting appetite.
Claims: Opening, closing, and reserving philosophies, releases, strengthening, and so on.
Deal financing structures that are ideal from your balance sheet and P&L points of view. Options include cash, stock, cash and stock, bond or share issuance, loans, private equity investments, and other mechanisms.
Investment strategy and projected returns.
The cost of capital if future cash injections may be required to shore up solvency and its effect on your ROE projections.
Accounts receivable and claims recovery assumptions.
What can your firm bring to the table to create value? People, operational synergies, IT systems, better controls, and more?
Real estate valuations if you are keeping the bricks.
Customer profiles, density, and potential for up- and cross-selling.
Product and customer retention rates.
Existing and potential distribution channels.
Open compliance and litigation issues.
I want to conclude with some tips I noted during an e-mail exchange with Ian Smith, the CEO of The Portfolio Partnership:
Successful acquisitions are about buying what you want to buy not necessarily what's up for sale.
Acquisitions are merely another tool to successfully execute your strategy.
Preparation is key. Most acquisitions fail because of a lack of post-acquisition planning.
When you are buying you are actually selling at the same time. You are selling the fact that you are a great fit for the target owners. You are selling the fact that the deal is a great thing for both the acquirer's staff and the target's staff.
The key to executing the process: Go for no as early as possible. That's why the process continually asks: Do you really want to move to the next stage? Aborting acquisitions 5 minutes before legal completion is very expensive.
Finally remember on price: Sellers aspire to price, buyers perceive value. Only the buyer can put a personal value on the target business. The seller is really aspiring to a price they hope to achieve.