AUB Group Limited (AUB) Earnings Call Transcript & Summary

Thank you for standing by. Welcome to the AUB Group acquisition of Pacific Indemnity and Equity Raising Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Mike Emmett, CEO and Managing Director. Please go ahead.

Thank you very much. Good morning, and thank you for joining us today. We're pleased to announce that AUB has entered into an agreement to acquire a 70% equity stake in Pacific Indemnity Underwriting Solutions. Before we dive into the details, let me highlight 3 key points. Firstly, the acquisition is firmly in line with our strategy to build scale in agencies and in financial lines product in particular. We know the team at Pacific Indemnity very well. They're based in Australia, and we've had aspirations to invest in Pacific Indemnity for some time. Secondly, we're buying a high-quality business on good financial terms. Pacific Indemnity has solid revenue growth rates and margins at or above our own agency target margin. It is well supported by carriers. And with today's placement, the purchase is EPS neutral before synergies and before we deploy the remaining capital from today's $200 million equity capital raise. And finally, AUB continues to trade well. We expect financial year '24 results to be at the top end of the guidance range previously communicated. We have a clear strategy and are executing well. All divisions are performing strongly, and we have multiple growth drivers with organic momentum and a very attractive pipeline of further acquisition opportunities. Now let me give you more detail. I refer you to Slide 9 of the presentation pack released earlier today. Pacific Indemnity is a leading Australian-based underwriting agency, specializing in Professional Indemnity, Directors and Officers Liability, and General Liability insurance products. The business has achieved strong historic growth and operates with the margin at or above our own agency model. Pacific indemnity is led by an experienced management and underwriting team that are highly regarded in the industry and well connected with the [ Austbrokers ] membership. In financial year '23, Pacific Indemnity delivered gross written premium of AUD 177 million and earnings before interest and tax of AUD 15 million. The acquisition is highly complementary for AUB, continuing AUB strategy to invest in underwriting agencies and to build out a portfolio of agencies offering risk products relevant to AUB's clients and their insurance needs. The build-out of our agency division has been very successful. However, as we have highlighted previously, we lack sufficient scale in financial lines, specifically in areas such as Professional Indemnity, and Directors and Officers, both of which are strengthened by this investment in Pacific Indemnity. The acquisition values Pacific Indemnity at an enterprise value of AUD 192 million, representing a 13x FY '23 EBIT multiple. The upfront consideration for AUB Group's 70% stake is for AUD 105 million to be paid on completion with the balance payable 18-months after completion on a sliding scale, subject to financial year '25 performance. AUB has estimated the deferred contingent consideration likely to be in the order of AUD 35 million. This structure aligns the interest of AUB and the Pacific Indemnity management team who will remain with the business and continue to own a 30% stake. The acquisition is expected to complete on the 1st of July 2024. AUB is delivering against its strategy, with continuing strong performance across all divisions. As announced on the 7th of May 2024, AUB is forecasting our financial year '24 underlying net profit after tax to be towards the top end of the outlook range of $161 million to $171 million previously announced to the market on the 20th of February 2024. AUB has a track record of executing on strategically aligned acquisitions and a robust acquisition pipeline for financial year '25 and beyond. We continue to assess opportunities to add scale and capabilities to the group on an ongoing basis. AUB is undertaking a $200 million equity raising to fund the upfront consideration for the acquisition of Pacific Indemnity that is payable on completion of the acquisition and to provide balance sheet flexibility to support AUB's ability to capitalize on its continued attractive and value-accretive M&A pipeline. Following the equity raising and completion of the acquisition of Pacific Indemnity, AUB expects its net leverage ratio to be under 1.75x with cash and undrawn debt of AUD 400 million. The acquisition and equity raising are expected to be EPS neutral pre-synergies. We do see synergy opportunities, both with our retail brokers and [ advertisers ]. AUB expect EPS accretion once the balance of the equity raising is deployed on its FY '25 M&A pipeline. Now moving to Slide 11. This slide summarizes the progress in building out our agency portfolio and particularly the early achievement by the end of calendar year '23 of our stated target to exceed $1 billion in GWP through our agencies. A key pillar of this growth has been the acquisition of agencies such as 360 Underwriting, Strata Unit Underwriters and now Pacific Indemnity to form the cornerstone of our growth in the areas of General Commercial, Strata and Specialty, respectively. On Slide 12, we provide an overview about Pacific Indemnity. Pacific Indemnity was established in 2015, and operates broad Professional Indemnity binders with Lloyd's syndicates as well as with local insurance carriers. It also offers Directors and Officers and General Liability products. As shown on the doughnut chart, they offer these products to a diversified client base across multiple industries. As shown on the right-hand side of the slide, Pacific Indemnity will form part of the specialty agencies portfolio, and will continue to operate under the Pacific Indemnity brand, led by the same very experienced senior management team who have a strong track record in writing quality risks in the Australian market. We anticipate additional revenue growth for Pacific Indemnity as a result of mutual benefits between AUB and Pacific Indemnity and the opportunity to expand Pacific Indemnity's offering to Austbrokers and to leverage AUBs distribution and operating scale. Slide 14 shows the pleasing historic growth of AUB Group underlying net profit after tax and underlying EPS. In addition, on the right-hand side of the graph, we highlight the steady strengthening of the outlook for financial year '24 underlying NPAT, including most recently that we now expect the underlying impact towards the top end of the previously communicated range of $161 million to $171 million. Moving now to Slide 16. The left-hand chart on this slide indicates the annual contribution to growth and underlying impact since FY '20 split between organic growth and the contribution from acquisitions. We are proud of the strong underlying organic growth AUB Group continues to deliver. However, it is also important to emphasize the contribution from acquisitions over this period. The right-hand chart sets out the annual investment in acquisitions, excluding Tysers and shows the investment in Pacific Indemnity. As the Pacific Indemnity investment will be made on 1 July, this will more accurately be shown in future periods as part to financial year '25. However, we chose to keep it simple for today's purposes. Slide 17 shows the key use of proceeds from the equity raising announced today. $105 million of the raise will be used to fund the upfront consideration for Pacific Indemnity while the balance of $95 million will support the continued execution of AUB's accretive and strategic M&A pipeline and fund the cost of the equity raising. By the end of June 2024, pro forma for the equity raise and Pacific Indemnity investment, AUB Group will have access to circa $400 million in cash and undrawn debt and the leverage ratio will be below 1.75x. On Slide 18, we provide an overview of the equity raise. I'd like to reinforce several key points. The raise is for $200 million, the offer price of $27.50 is at a 6.7% discount to last close and a 9.3% discount to the 5-day [ volume ]. 7.3 million shares are to be issued, representing roughly 6.7% of AUB's existing placement capacity. New shares will rank equally with existing AUB shares from the date of issue. AUB will consider making an offer to eligible shareholders under a share purchase plan. Further details will be provided to the market, should AUB decide to make such an offer. However, the share purchase plan, if made, would be for no more than $25 million worth of new AUB shares. I'd like to now hand over to the moderator for questions.

[Operator Instructions] Your first question comes from Kieren Chidgey with Jarden.

A couple of questions, if I can. Mike, maybe just starting with sort of the multiple you paid here towards the high end of what we've seen you pay historically for acquisitions? And also I note financial lines are at a point in the cycle where globally, we're seeing rates start to soften. And the EBIT margins in this business, look, as you've stated, pretty solid or already above your own agency business on average. So it's not clear, I guess, in terms of why sort of pay such a full multiple at this point in the cycle? So just keen to get your views on sort of what the growth drivers here, have been more recently and how you see them playing forward?

Yes. So 3 things here. One is, I think if we bought it 2 years ago, I think your question about rates would have been a very valid one. The fact is that the rates in financial lines have softened significantly over the last 12 months. And we now believe that they represent a stable -- if you like, almost the normalized view of what the run rate will be. Secondly, it's a multiple on FY '23, I'd emphasize that some of the acquisitions that have happened in the market for agencies over the last year or 2 have been multiples where some of the growth has been paid for as well. So a significant portion of this is based on the FY '23 growth, or sorry, profit. And the third one is a comment I made previously, which is effectively, we value agencies based on 3 things, and then we value M&A generally on a key extra piece. The first is the nature of the binder terms, particularly 2 things commission rates and the capacity. And so -- and the third one is really around the length of commitment around the binder. And so that fundamentally drives the future profitability and growth potential of an agency. And so we're obviously comfortable paying near the top or above our normal range if we believe that there is long-term growth prospects and a significant opportunity premised on the quality and tenure of the binder arrangement. So that's the first key point. Second is, we obviously anticipate a number of synergy opportunities. I think there are 3 obvious ones. The first is our Australian broking group place these types of products across a number of agencies and insurers. And so we obviously anticipate as we have seen with the rest of our agencies that our brokers place an increasing amount of business into agencies that become part of the family. And so we've seen disproportionate growth of our agency placement into agencies versus business they place elsewhere. So that's one. The second is, while the lion's share of the capacity that Pacific indemnity has access to is an Australian domestic binder, they have a number of London binders as well, which are not placed through Tysers. And so obviously, over time, as those arrangements -- there as an opportunity to migrate those. We'd be looking at the appropriate action to take, but nonetheless, that's a synergy opportunity. And the third one is I've spoken many times about the key components of scale in agencies. So the fact is larger agencies make higher margins to smaller agencies, partly because of the income leverage that they have, but also just structurally, the fixed cost element is quite significant in an agency. And so what this gives us is the opportunity to leverage their scale together with our existing specialty agencies, which, in many cases, are subscale be able to improve the margin across the full portfolio. And so if you take all of that into account and the fact that largely, we anticipate strong growth that we're not -- that we will benefit 70% from, we're not really paying away for that synergy growth. We believe that the multiple is a fair reflection and that we are comfortable that in the short to medium-term, the effective multiple will normalize back to our roughly 7.5 to 9x.

And sort of a related second question, which you partly touched on, but you did mention sort of the rates you believe has stabilized now over the last 12 months. But just wondering if you can give us an indication for how different the '24 earnings for this business is likely to look given we're very late in the year. And you've talked about obviously EPS neutrality on a '24 pro forma basis. How should we be thinking about Pacific Indemnity's '24 earnings relative to the '23 numbers you provided?

Well, I think it would probably be no surprise to you that we would have looked at post FY '23 performance to assess whether we're paying a fair price or not. And so I think it's safe to say that performance will be stronger rather than weaker in FY '24 base than the FY '23 numbers we've used for valuation.

Okay. And double-digit growth like or we're talking pretty moderate growth over the last 12 months?

Kieren, no comments. It's not appropriate. We'll only own the business from 1 July and tell you about the FY '25 growth rate.

Your next question comes from Julian Braganza with Goldman Sachs.

Just following on from Kieren's question there. In terms of just the completion, just a deferred consideration payment and the EPS neutrality comment, that seems to imply, I think its sort of to be clear that I've got the numbers correct, if it's AUB share or the group, but it seems to imply $19 million of EBIT into FY '25. So I just want to be clear, if that's correct? And then just any comments on the growth into '24 and '25, given that data point?

I won't comment specifically on the number, Julian. What I will say is that the EPS neutrality comment is around -- it really opens the question around if we were raising purely for the $105 million then it would be accretive, however, we sized the raise around EPS neutrality. So it's really around the question of what will the $95 million be used for. The assumption for our EPS neutral comment is that it will simply be used. It will remain in the form of cash flow debt -- debt reduction piece. Clearly, if that's deployed into other M&A, that is accretive. And so if you look at it in isolation, it's accretive. However, we've sized the raise based on EPS neutral piece. So rather than, I think, trying to presuppose what that looks like for an FY '25 EBIT number, I think you should just work off those premises.

Okay, sure. But if I use that $35 million deferred consideration and the formula you provided. Is that $19 million that you backsolved of FY '25 EBIT? Is that the group number? Or is that AUB share?

So the [ $15 million ] that we provided is the 100% number.

Right. Okay. I understand. And then just in terms of -- just a couple of other follow-up questions. Just in terms of M&A spend going forward, obviously, that's increased a fair bit. Just wanted to understand how we should be thinking about that into years going ahead, just underlying in the M&A front.

Well, you say it's increased, I mean, I think, for 2 years, so for FY '23 and '24, it's pretty much been -- I'll call it, a new normal. So if you left out BizCover, then if you look you'd have FY '21 and '22 at a certain run rate level, as the group is growing significantly we've established a new run rate level for '23 and '24. What looks like a spike, I referenced it earlier is because we're showing Pacific Indemnity as part of '24, it really is actually part of '25. It is the rest of the number for '25 we don't know. So you can't take '23 to '24, including Pacific Indemnity and then draw conclusions from that. It really depends on how much we spend in '25 that's additive to the Pacific Indemnity.

Okay. Great. And just one last question. Is there any debt in this business as well, just to be fair?

No. As a general principle, we acquire all of our -- we make all of our investments debt-free.

Your next question comes from Andrei Stadnik with Morgan Stanley.

So I want to ask my first question just around the -- your makeup of your agency division going forward. Do you see any large gaps remaining in your agency business going forward? Or are you broadly happy now in terms of having all the right components in the mix there?

Well, I'll answer -- I mean I think in terms of strategic capability gaps, then I would say little, I think they're more complemented by bolt-ons. We're still don't have enough scale in cyber, et cetera. But having said that, our strategy has been to make, let's call it, a key acquisition for each of the agency subunits or subdivisions, right? So we bought 360 to become our primary agency around general commercial. When we bought 360, they had 10 agencies. It's now 20 and so some of those have been bolt-on acquisitions and most of them have been new agencies that we've seeded and grown. In Strata, we acquired SUU and that's become, if you like, our scale component of our strata piece. And our Pacific indemnity gives us scale around the financial lines, particularly D&O and Professional Indemnity. And so in a way, I guess, while we've had bolt-on acquisitions and the others, I think you could think of it the same way, which is we make one, let's call it, an iconic acquisition. And then we build around it to complement and leverage that acquisition. But it doesn't mean that there won't be any future acquisitions in Australian agencies either, nor does it mean the job is done in terms of margin expansion, et cetera. But this is an important acquisition for us in terms of that specialty area.

And my second question. Can I ask around what are you seeing in terms of pricing in financial lines because it has been soft. But we have been getting feedback that some of the brokers, insurers are thinking it could be turning. But what are you seeing in terms of pricing in financial lines in Australia and also maybe globally?

Yes. So well, that links to the answer I gave earlier -- to Kieren, which is around I think a year ago, people were talking about rates coming off. I think the fact is we didn't invest in this business or a similar business 2-years ago. We invested in it now. And that's precisely because we believe that the rates have largely normalized, and we believe that the downside risk is much smaller than the upside opportunity we have. So in a way, the timing is precisely to cater for. And that's why we didn't buy something 3-years ago to get a sort of a sugar hit.

A very quick third one. You've actually done a sell-in here. So like is it management itself that is selling 70% stake to you?

Yes, it's predominantly management. There are some external -- or there are some non-management that's involved in the industry shareholders. But by far, the largest shareholding group is management and everyone has sold down the portion there.

Our next question comes from Jason Palmer with Taylor Collison.