BRO - Monetizing The Insurance Business Gives Truist Options But Also Brings Risk

Summary

• Truist has chosen to sell a 20% stake in its insurance brokerage business to Stone Capital Partners for $1.95B.
• The transaction values the insurance brokerage business at $14.75B, or about 17x trailing EBITDA and 27.4x trailing P/E, a good price relative to the business's status and relative performance.
• Management must execute well on capital redeployment, as diluting ownership in an attractive, growing business sets a higher bar for reinvestment.
• Truist shares continue to look undervalued.

Where there’s smoke, there’s usually fire, and while rumors of proposed transactions can be just that (rumors), Truist ( TFC ) has in fact chosen to monetize a minority stake in its large insurance brokerage operations (Truist Insurance Holdings, or TIH) by selling 20% and warrants for another 3.75% to Stone Point Capital for $1.95B in a transaction that values the entire operation at $14.75B.

Truist got a good price, particularly for a minority stake, and management deserves credit for that. The question, though, is what Truist will do this fresh pile of capital. While parking the money in securities makes sense for now, a failure to deploy the capital effectively will ultimately mean this deal is dilutive, and the market’s initial response to the deal does reflect some of that concern and skepticism.

The Deal

Truist announced on February 16 that it reached an agreement to sell 20% of TIH to Stone Point Capital, a private equity group, for $1.95B in cash. The deal also includes warrants for another 3.75% of TIH at identical terms. The deal includes a 6.5-year lock-up with an interesting twist at the end – at the end of the lock-up SPC has the right to request the sale or IPO of TIH and if Truist declines, they’re obliged to buy back the stake at market prices.

This transaction values TIH at $14.75B, which is a healthy if not generous valuation. This enterprise value works out to a trailing EV/EBITD of 17.2x against a group valuation of 17.7x and a trailing P/E of 27.4x versus a group multiple around 25.3x. More on this in a moment.

The Business

TIH is the sixth-largest insurance brokerage and the seventh-largest in the world, with the company just behind Brown & Brown ( BRO ). Insurance brokers work as valuable go-betweens for the insurance industry, working with companies to assess their insurance needs and then going to insurance companies to get the needed coverage. Brokerages are paid for their expertise in assessing the necessary coverage (and in many cases effectively designing complex programs) and insurance companies are generally willing to give better quotes to brokerages, as it is more cost-effective to serve these large, sophisticated customers.

TIH has unusually large exposure to wholesale brokerage, a category of the market that covers various specialty lines including excess and surplus. Customer needs within wholesale tend to be more idiosyncratic and this has been a faster-growing part of the brokerage world. Close to 60% of TIH’s business is categorized as wholesale, with only Brown & Brown coming even close to such a high weighting (35%), while Aon ( AON ) and Marsh & McClennan ( MMC ) do very little here.

Truist has built this business through serial M&A over the years, and that’s not at all uncommon within the brokerage space.

Relative to its peers, TIH has usually kept up with growth, but lagged a bit in margin terms. For 2022, TIH grew revenue at an organic rate in excess of 7%, in line with Brown & Brown and Marsh & McClennan, below Arthur J. Gallagher ( AJG ) (at close to 10%), and above AON (6%), and Willis Towers Watson ( WTW ). This past year was actually one of the weaker ones on a relative basis, as TIH had consistently been outgrowing all of its peers, helped in part I believe by the growth in demand for specialty insurance.

On the margin side, TIH isn’t as much of a standout. EBITDA margin of about 28% in 2022 was well below the 30%-plus margins of AON, AJG, and BRO, though above MMC and WTW. This has actually been a stable pattern for years, with AON, AJG, and BRO consistently earning higher margins, which I attribute in part to business mix.

Given the moving parts of differing growth, margins, and market exposure, I think Truist got a good deal for TIH, particularly given that it’s a minority stake. I’m sure the buyback provision played some role in the price that SPC was willing to pay, but I do think that Truist did relatively well by its shareholders with a deal multiple that is above typical deal multiples in the space.

Why Do This Deal?

This deal will initially be EPS-neutral for Truist and accretive to tangible book value and capital ratios. Truist was not pressured on capital before this deal, so there was no need to the deal.

Management said that they will initially be parking the cash in securities yielding 4% or higher, and that will drive the EPS neutrality in the near term. Over time, though, such investments will lag the growth that TIH produces and will result in dilution unless management redeploys the cash elsewhere.

I don’t see Truist using this capital to simply offset higher-cost deposits in the core banking business. That would be an option in the short term, but would very likely be dilutive over time. I do believe that Truist could look to use this capital to fund more M&A in fee-generating businesses, including insurance brokerage. Truist will now have the option to work with SPC, and SPC has stakes (including outright ownership) in many other insurance brokerages that could be combined with TIH. It also seems likely that SPC will become a partner in future brokerage consolidation, if for no other reason than to not dilute its stake.

Partnering with SPC could ultimately be a path toward accelerating more M&A-driven growth at TIH, and it is likewise possible that they could work together for other deals. In any case, I expect M&A to be a likely use for at least some of the proceeds.

Truist does of course also have the option to use this case for buybacks – at current prices Truist could buy back about 3% of its shares with these funds, a move that would boost my ’23 EPS estimate by about $0.16/share.

Last and not least, I believe Truist may have pursued this deal at least in part to unequivocally demonstrate the value of this business to the Street. As I’ve said in past articles, Truist has never really gotten full credit in its valuation for owning TIH. That’s not so unusual when standout businesses are buried within a large organization, but perhaps investors will look at this name with new eyes.

For my part, I’d been giving a somewhat conservative bonus to Truist for TIH. My forward P/E multiple has been 11x instead of the 10.5x I use for many peers. Given the price SCP paid, a weighted average forward P/E closer to 11.5x would seem more fair now, boosting my fair value by that metric from $54 to $56.50.

The Bottom Line

I don’t have strong feelings on this deal at this point. Truist got a good price, but now management has to show that they can redeploy that capital effectively for the benefit of shareholders. I’d describe my feelings on that as “cautiously optimistic”, but I think how management uses this capital over the next year or two could have a disproportionate impact on sentiment for some time to come. In any event, I still believe Truist is a stock worth owning today.

For further details see: