Monetizing the insurance business offers real opportunities, but also risks (NYSE:TFC).

Where there’s smoke, there’s often fire, and rumors of proposed transactions can be just that, Trust (NYSE:TFC) chose to monetize a small stake in a large insurance brokerage (Truist Insurance Holdings, or TIH). It will sell 20% and guarantee another 3.75% to Stonepoint Capital for $1.95B, bringing the total business to $14.75B.

The trust got good value, especially for the minority stake, and management deserves credit for that. The question is what the Trust will do with this new pile of capital. While keeping the money in securities makes sense for now, not deploying the capital effectively means this deal is a mess in the long run, and the market’s initial reaction to the deal shows some concern and skepticism.

The agreement

Truist announced in February 16 announced an agreement to sell 20% of TIH to Stonepoint Capital Private Equity for $1.95B in cash. The deal similarly includes guarantees for another 3.75% TIH. The agreement includes a 6.5-year lock-up at the end of which is interesting – at the end of the lock-up, SPC has the right to request a TH sale or an IPO, and if Truist refuses, they will be forced to buy it back. Share on market prices.

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

The business

TIH is the sixth-largest insurance broker and the seventh-largest in the world, the company behind Brown & Brown ( BRO ). Insurance brokers are a valuable adjunct to the insurance industry by working with companies to assess their insurance needs and then approach insurance companies to obtain the necessary coverage. Brokers are paid for their expertise in evaluating the necessary coverage (and in many cases designing complex programs) and insurance companies are generally willing to give better quotes to brokers because it is more cost-effective to serve these large and sophisticated clients.

TIH has exceptional exposure to wholesale, a market category that covers a variety of specialty lines, including profit and loss. The needs of clients in wholesale become more idiosyncratic and this is part of the rapidly evolving world of brokerage. About 60% of TIH’s business is wholesale, and only Brown & Brown comes close to such a high weighting (35%), while Aon ( AON ) and Marsh & McClennan ( MMC ) do much less here.

Trust has built this business through a series of M&A over the years, and this is not at all unusual in the brokerage space.

Relative to its peers, TIH has maintained growth for the most part, but has lagged slightly in terms of margins. For 2022, TIH will grow at an organic rate of over 7%, along with Coffee & Brown and Marsh & McLennan, with Arthur J. Gallagher (AJG) rose below (about 10%) and above AON (6%). , and Willis Towers Watson (WTW). This past year was relatively one of the weakest, as TIH consistently outperformed all of its peers, I believe helped in part by growth in specialty insurance demand.

On the margin side, TIH isn’t that outstanding. In the year EBITDA margin of around 28% in 2022 was below the 30%-plus margins of AON, AJG and BRO, though higher than MMC and WW. This has actually been a stable pattern over the years, with AON, AJG and BRO consistently achieving higher margins, which I attribute in part to business mix.

Considering the moving parts of different growth, margins and market exposure, I think the Trust got a good deal for TIH, especially given its minority stake. I’m sure the buyback offer played some role in the price SPC was willing to pay, but I think the Trust did relatively well for shareholders with a deal multiple that was above the normal deal multiples in the space.

Why are you making this deal?

This agreement will initially be independent of Truist’s EPS-neutral and accretive to actual book value and capital ratios. The Trust was not capital-stressed prior to this agreement, so the agreement was not required.

The management said that they will initially park the money in securities that yield 4% or more and this will lead to EPS neutrality in the near term. Over time, however, such investments slow down the growth TIH generates and dilute it unless management reallocates the funds elsewhere.

I don’t see the Trust using this capital simply to offset high-cost deposits in core banking. That will be an option in the short term, but it may dissolve over time. I believe the Trust can use this capital to fund additional M&A in fee-generating businesses, including insurance brokerage. The Trust will now have the option of working with SPC, and SPC has shares in a number of other insurance brokerages (including direct ownership) that can be combined with TIH. It also looks like SPC could be a future brokerage consolidation partner, if not to ruin its own stake for no reason.

Collaborating with SPC could ultimately be a way to accelerate M&A-led development on THA, and they could work together on other deals as well. Anyway, I expect M&A can be leveraged for at least some revenue.

The Trust of course has the option to use this issue for buybacks – at current prices the Trust could repurchase 3% of the stock with these funds, a move that would increase my ’23 EPS estimate by $0.16/share.

Last and not least, I believe that the Trust may have pursued this agreement at least in part to clearly demonstrate the street value of this business. As I have said in previous posts, the Trust did not receive full credit in the assessment of THIN ownership. It’s not unusual for outstanding businesses to be buried within a larger corporation, but perhaps investors will look at this name with fresh eyes.

For my part, I would give a somewhat conservative bonus to Truist for TIH. My forward P/E multiple is 11x instead of the 10.5x I use for many peers. Given SCP’s paid price, a weighted average P/E of nearly 11.5x now looks more fair, raising my fair value on that measure from $54 to $56.50.

Bottom line

I don’t have strong feelings about this deal at this point. The trust has achieved good value, but now management must demonstrate that they can effectively redeploy that capital for the benefit of shareholders. I’d describe my sentiment on this 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. In any event, I still believe Trust is the stock to own today.