Top 25 Brokers: Analysis - Shape shifting

James Simpson reports on recent changes to the shape of the EC3 brokers bottom line including the implications of dollar movements and restructures

There have been a number of changes in the market over the last 12 to 18 months that have manifested themselves in the 2006 accounts of the EC3 brokers, and there are probably a few still to mature.

Acquisitions, buyouts and restructures have changed the shape of the table, and this has brought HL Group and Lockton into the reckoning this year, as being EC3 brokers as well as a newcomer in the form of HRH, which acquired Glencairn (number 20 in last year's league table).

Others have dropped out due to management buyouts of subsidiaries such as HWS (25 in 2005), with CJ Coleman to follow with the buyout of Corrie and Partners With Lockton and HL coming into the table.

The other major impact on the table has been the weakening US-dollar exchange rate.

The table has also been impacted by the fact that four of the EC3 brokers have changed their year-ends, and did not have their 2006 financial results available for inclusion this year.

The near-14% decline in the value of the US dollar (based on year-end rates) during 2006 has had a noticeable impact on companies, which is made more noticeable by the performance of those brokers, SBJ and Hyperion, who are not so dependent on the dollar.

One outstanding performance has been that of RK Harrison, with 28.8% revenue growth to June 2006, closely followed by Hyperion, with 24.2% and SBJ at 22.5%. RK Harrison's result is also supported by good profit and margin growth; what is more surprising is the fact that the growth has all come from North American business, a direct result of its recruitment and creation of incentives of new reinsurance and energy teams.

Rising profits

Hyperion's growth has come from its underwriting agency, Dual, operating in the UK and Europe, and generating substantial profit commissions. Management has provided SBJ's income figure, and no analysis is available, but the group has been successful in the acquisition market (albeit not London Market companies), and we would assume that much of this growth is from this.

The picture for profits is one of movement in every direction. Recovery from poor prior-year results, restructures and sales of subsidiaries or investments mean that profits do not really provide a sound basis for analysis. Looking at brokers' margins does, however, provide a better view of the market in 2006, and there are a good number of businesses that have achieved double-digit margins.

The head of the pack is Windsor, with a 25.3% margin that has been achieved with a modest 8% growth in revenue, and obviously good cost control. The chairman puts this performance down to the excellent results of their UK acquisitions over the past three years.

CJ Coleman has a profit margin of 20%, but this if for 2005, and is after a £2m profit on the sale of an investment and a pension write-back. The next best 'real' margin is RK Harrison at 19.2% - the motivation of the new recruits and the valuation of their incentive shares is profit-driven, so this would appear to be showing dividends for the group. HRH's margin at 17.2% is before any amortisation costs, a good performance but one we are unable to analyse as detailed figures are not available yet.

Employee numbers

By and large, the number of employees of the top 25 EC3 brokers has risen during the period under review. Acquisitions account for some of these and correspond to increases in income, but not to the same extent yet.

The largest increase in income per employee has been from RK Harrison at 21%, with just a 6% increase in employee numbers. Gallagher, THB Group and CJ Coleman have also turned in good performances, all achieving double figure brokerage income growth per employee.

As might be expected the average cost of each employee has risen although Bell & Clements was the exception to this with a decrease, led from the front with a decrease in directors' remuneration. All of the companies with good revenue growth saw significant increases in employee costs - a reflection of the common practice of senior brokers enjoying commission-sharing deals with their employers.

Capital employed

Last year we noted that there was a wide range of shareholders' funds-to-income ratios, and this remains the position. This year could have been worse due to the change in accounting treatment of preference shares, which the accountants are now treating as long-term liabilities rather than share capital.

Notable decreases in ratios are Benfield after its share buyback and cancellation in 2006, but it still has a healthy ratio of 46.5%; RK Harrison, where the increase in income has been on a static capital base, but the ratio is again healthy at 44.4%; and Gallagher, where a trading loss has reduced the ratio by 12% to 30% at December 2005.

Increases have been seen at HL, where the restructure has enabled a healthy ratio of 43%; Windsor, where an already healthy ratio of 64% increased to 76.5%; and PWS where, based on its 2005 balance sheet, the ratio has improved to 44.1%.

With goodwill set to become an ineligible asset for Financial Services Authority solvency purposes in January 2008, it does not appear that any EC3 brokers will be impacted, as what goodwill they have in their balance sheets is not in a regulated entity. If the FSA looked at consolidated group accounts, there could be one or two companies with a potential issue. Benfield has significant goodwill in the group balance sheet following the acquisitions it has made, and this represents almost 100% of the group's equity, although only 3.7% of this is attributed to the UK.

Lockton, THB, Besso and Windsor all have significant goodwill in their balance sheets, but again this goodwill is not in an FSA-regulated company. Obviously, having a holding company is the way forward.

- James Simpson is principal at IMAS Corporate Advisors.

Top 25 Brokers: Analysis - Shape shifting (PDF, 209kb)
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