By Jack Bailey, Managing Director and Co-Founder of Bailey Southwell & Co.
After one of the most challenging years for business in memory, we headed into Q4 with business activity beginning to normalize amid the pandemic and real gross domestic product increasing 33.1% in Q3 over the prior quarter. Nonetheless, COVID-19 continues to spur uncertainty across the U.S. economy. In workers’ compensation services, many business owners have real questions about the state of M&A in the sector.
As business activity rebounded in Q3, we saw companies again turn to acquisitions as a key growth initiative. This interest was driven by traditional goals – geographic expansion, adding new services lines, etc. – as well as some new areas of focus.
Factors Driving Interest in Acquisitions
- The Difficulty of Winning New Customers
In-person conferences – traditionally a key avenue for fostering relationships that drive sales – are on hold for the foreseeable future. Opportunities to visit client offices – important for both desk-level and C-suite marketing – are drastically reduced. As such, sales teams are left with few proven avenues for winning new customers. This significantly hampers organic growth and makes buying an attractive book of customers through acquisition an efficient and cost-effective way to drive growth. - Opportunity for Simplified, Integrated Workflows
Like so many others in the pandemic, claims professionals increasingly work remotely, creating a new set of challenges for managing claims. Innovative technology solutions that enhance best practice and expedite claim closure are very much in demand. Businesses delivering predictive analytics, payment solutions, and other tools that streamline claims management are well-positioned to simplify the claims process and reduce administrative costs. In the present environment, these businesses are especially attractive acquisition targets. - Desire for National Coverage
As vendor panel consolidation continues at major workers’ compensation insurers (and TPAs), workers’ compensation services firms are increasingly feeling the pressure to scale operations to service these larger accounts or risk losing business. The desire to scale and fill gaps in geographic coverage makes strong regional players particularly compelling acquisition targets. - Continuing Trend Towards a One-Stop Shop
While some firms are successful focusing on a single service line, many vendors continue to move towards a one-stop shop. The benefits are clear: (a) cross-selling opportunities, (b) referring between service lines (e.g. case managers sending referrals to other service lines within their own firm), and (c) simplifying vendor management for customers. Established monoline vendors will command a premium valuation given that they offer a turnkey solution suite expansion opportunity for larger industry firms.
Critically, as the market has come back to life, we are seeing valuations for attractive businesses return to their pre-COVID levels. We believe the valuations are driven by a combination of macroeconomic and industry-specific factors.
Factors Currently Driving Valuations
- Scarcity of Quality Companies
A long period of industry consolidation has resulted in a scarcity of quality companies. Profitable businesses with attractive growth prospects continue to command strong valuations. - Availability of Inexpensive Capital
Historically low interest rates provide low-cost capital that supports the valuations offered by buyers looking to complete acquisitions. - Return to Pre-COVID Revenue/Profitability Levels
The strongest industry players have already returned to (or are now above) pre-COVID revenue/profitability levels. Given this, buyers are willing to pay premium valuations for these firms based on a normalized level of earnings and will overlook financial performance during the height of COVID-related shutdowns. - Consistent, Reliable Cash Flows
Stable cash flows continue to make workers’ compensation services attractive for investment. This steady stream of cash supports interest payments, funds internal investment in technology and customer service, and finances strategic acquisitions. This attractive cash flow profile exhibited by industry firms continues to drive demand to invest in the space.
Where do we go from here? Next week, we will share a few thoughts regarding the future of M&A in workers’ compensation.
About Jack Bailey
Jack Bailey is a Managing Director and Co-Founder of Bailey Southwell & Co., a Nashville headquartered investment banking firm focused on the payer services, healthcare, and tech-enabled services industries.
With over 20 years of middle-market deal experience, Jack has worked on over 75 sell-side, buy-side, and capital raising transactions for both public and private companies. He has a focus on the payer services industry, with the majority of his recent experience working with founder-led companies in the workers’ comp industry.
Jack’s depth of experience and extensive network has enabled him to provide ideas, solutions, and processes that result in exemplary outcomes for Bailey Southwell clients.
Jack received his J.D. from Vanderbilt Law School and served as Corporate and Securities Counsel in a national law firm and in a Fortune 500 company. He holds his Series 24, 79, 62, and 63 securities registrations and is registered with BSC Securities, LLC, member of FINRA/SIPC.
About Bailey Southwell & Co.
Headquartered in Nashville, Tennessee, Bailey Southwell & Co. is a partner-owned investment bank focused on middle-market healthcare and tech-enabled services businesses. We provide customized M&A advisory solutions for middle-market change of control transactions and growth capital raises. Since our founding in 2005, our senior bankers have closed over 200 transactions representing more than $15B in value. We also manage BSC Capital Partners, a co-investment fund supporting high-growth healthcare and technology companies with flexible capital and strategic insights to accelerate growth. View our website for further information: www.baileysouthwell.com.