BSC In WorkCompWire: Workers’ Compensation Services M&A – Where Are We Now?

December 9th, 2020 | BSC News Insights

Bailey Southwell’s Co-Founder and Managing Director Jack Bailey was recently featured in WorkCompWire for his first article of a two-part series on Workers’ Compensation Services M&A. WorkCompWire is a trusted online news and information service that shares relevant news, events, and analysis affecting the workers’ compensation industry.

In this most recent installment of Leaders Speak from WorkCompWire, Jack Bailey shared his thoughts on the factors driving interest in acquisitions and the factors currently driving valuation. Read the full article below.

Workers’ Compensation Services M&A – Where Are We Now?

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.