Deal activity “cooled off” into 2022, against a backdrop of geopolitical instability, rising interest rates, and inflation.
This is according to PwC’s half-yearly deal report. The news is not all bad – the PwC experts predicted that deal activity will “rebound” into the second half of this year, propelled by private equity (PE) backed buyers.
There were 343 announced transactions for the six-month period from mid-November 2021 to mid-May 2022, including two mega-deals. Total deal value was $15.4 billion, down from $31.4 billion for the previous six-month period when there were 476 announced transactions.
The Federal Reserve hiked the US interest rate by 0.75% in June, the biggest increase in nearly three decades. The impact of this will be felt across insurance dealmaking, according to Mark Friedman, partner in PwC’s financial services deals practice.
The rate environment change could lead to a shift in the “buyer profile”, according to Friedman, particularly where it comes to brokerage M&A. The PwC expert predicted the market will see “some temporary dislocation”, with M&A up but valuations shrinking somewhat after five years on an upward trajectory.
“With historically low interest rates and debt relatively cheap, private equity saw opportunity to use leverage to enhance their returns, thereby driving valuations up,” Friedman said
“If the debt markets continue the way they are, I think it will impact valuations and if you look back in the first half of the year, one of the reasons you saw a bit of a dip was [that] it takes time for sellers’ expectations to reset.”
“What we’re hearing from a lot of PE-backed platforms is that they’ve got a lot of debt on their books, and the interest rate on that debt just got much more expensive,” Friedman said.
“What we’ll likely see from PE-backed platforms is a shift from all of the proceeds [being] paid out in cash upfront to pushing more towards earnouts or some share of equity roll of those businesses from the sellers, into the existing company to the buyer, because it’s hard to pay 15x EBITDA.”
This could spell opportunity for some of the “corporate strategics”, according to Friedman.
“[Corporates] don’t rely as heavily on leverage, but they tend to use cash on their balance sheet,” Friedman said.
“They will have a more competitive model going forward, with PE- backed platforms, somewhat impaired by their ability to use leverage to make the economics work.”
While there will be “winners and losers”, according to Friedman, a rising interest rate environment is likely to be a “net positive” for insurance carriers.
“The industry as a whole is definitely welcoming the higher rate environment, primarily for the long term,” Friedman said.
“While there may be some short-term disruption as a result, it’s a net positive and a tailwind, so valuations will go up.”
There has been an “unprecedented” amount of PE interest in acquiring annuity and life blocks, and Friedman said he expects that to continue.
“Valuations will likely go up in that space, because the underwriting profit is just a part of the equation – and that will likely remain relatively flat – but you will see enhanced returns as a result of better than expected investment income or reinvestment opportunities that [could] drive those values up,” Friedman said.
As for insurtechs, PWC said they could see a renewed interest from carriers looking to invest after six to 12 months of publicly listed valuation shrinkage.
The “overwhelming majority” of insurtechs that have gone through an initial public offering are now trading at a significant discount, Friedman said.
While in some instances this is “probably justified”, this could also be as a result of “collateral damage”, according to the deals expert.
“There’s opportunity there,” Friedman said. “There’s a lot of corporates, as well as some private equities, that are looking and trying to identify if there are some companies that have the valuations that have been hit significantly as a result of the collateral damage and their fundamentals may actually be better than others, in which case there may be opportunity to invest or buy some of these assets at relatively low valuations.”
Insurtechs may face a choice between raising equity at a valuation that could be 20% to 25% of what it was several months ago, or merging, or being acquired by an insurer.
“[This could afford] some insurance companies the opportunity to upscale their technology quite aggressively, and leverage some of the distribution and other technologies these insurtechs have across their existing business to justify their valuation,” Friedman said.