After a couple of years of private broker valuations at 18x – or at times above – heavily adjusted earnings, Hub has come in at 15.7x based off a more soberly adjusted Ebitda figure.
That’s a meaningful drawback and will send a chill through the segment.
Moreover, the softer factors around the Morgan Stanley process also point to a much tougher market. This was a challenging deal to get to the line, with Blackstone Tac Opps dropping and leaving Hub essentially at the mercy of Leonard Green on the deal valuation.
This is also not a one-and-done deal that allows Hub to now move on and refocus. There is still more work to do to secure all the liquidity that selling shareholders wants.
According to sources, a stake of between 15% and 20% has been sold to Leonard Green, which will act as an anchor. Now controlling shareholder Hellman & Friedman will look for Limited Partners to syndicate the deal on these terms.
So not only was the valuation relatively low, but competition on the deal was muted, and the transaction moved slowly.
This is a 180-degree change from what we saw with the Barclays-run Foundation Risk Partners process last year. And this is even without the need for the debt to be refinanced (I think).
The negative read-across
When one of the A-grade assets in the sector segments at a retro 2019/20 multiple, the read-across to other assets is highly negative.
For assets looking to monetize (or partially monetize) like World or Inszone, this is particularly painful. But it is also potentially painful even for broking businesses that are not passing through that process because assets need to be marked to market quarterly, and this is a deal that is hard to ignore (although perhaps in some degree it can be explained away if you really want to explain it away).
As you would expect, there are private broking businesses that were watching Hub to see how it went before pulling the trigger on their own H2 strategic processes. At minimum, this will give them pause.
As much as this should unsettle the private broker sector, it is unsurprising, and in essence confirms my earlier assessment that this would not be a slam-dunk deal.
The argument in that March piece was broadly that the multiple would be restrained by a) the size of the deal; b) the limited governance protections available (the passenger problem); and c) the number of major PE firms that know and like the sector with a competing investment.
Just to illustrate the first of these, based off an assumed ~7x debt, Leonard Green would have had to cut an equity check of just shy of $2bn for a 15% stake – a mammoth investment for a deal where the investor picks up no control around strategy or exit.
In addition, Hub is to a degree a victim of its own success. This is true both from a growth perspective – where it is harder to double when you are $4bn of revenue than $2bn – and from a margin perspective, where Hub at 34% operates near the top of the sector.
Hub does have growth options from here, but they are arguably harder and mostly lower margin than its heartlands in the mid-market US and Canada. Large account business has been very hard for others to crack, and going international would put Hub in smaller markets with more execution risk.
On top of this, there are a series of macro/sector tailwinds.
First, debt markets are much tighter, with a transition to 10%-11% interest expense underway. Debt ceilings are also coming down for most players to just over 6x Ebitda – squeezing returns.
Second, the growth outlook is worse due to a slowing economy and an anticipated waning of the commercial lines pricing cycle. (It will eventually happen.)
Third, US mid-market M&A is heavily competed with 30+ PE-backed platforms and another four public players involved, and we have reached a middle innings of consolidation.
Though some of the reasons for the valuation were Hub-specific, the outcome remains a real blow to the private equity-owned brokers, and it underscores the reversal of what has been a period of historic tailwinds.
It is important, though, not to get carried away with the extent of the challenge.
The days of automatic home runs with every deal for PE are over. We will find out now which management teams are good, and which were coasting the wave of the market.
But the sector is highly resilient, with revenues holding up even in downturns, margins manageable and cashflows predictable. Brokers will remain a core private equity investment, with their defensiveness attractive in a weak economy.
Falling equity values, refinancing issues or liquidity challenges are still likely to remain the preserve of mismanaged businesses.
But as suggested in February, the Boom Times are over. Welcome to The Squeeze.
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