Thoughts on Brown & Brown: Stay Away!

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Courtesy of Vitaliy Katsenelson

I looked at Brown & Brown about a year ago (May 2010), here are my thoughts which are still relevant today:

Risk of growth by acquisition

Very significant portion of Brown & Brown’s (BRO) growth in the past came from acquiring brokers.  I am naturally skeptical of sustainability of this type of growth as it comes with the following risks:

• Integration risk. Although well managed companies can reduce this risk by creating strong processes to integrate acquisitions, to achieve the same percentage growth year after year BRO has to buy larger agencies or larger number of smaller agencies.  Either way integration risk increases every year as BRO gets larger.  I’ve seen this happen with banks that grew by acquisition – they were successful at buying and integrating smaller banks until they were not.
• Overpaying for acquisition and the value of BRO’s currency (stock). I don’t know a single management team that calls themselves an “undisciplined” acquirer, BRO team is no different.  Thus instead of taking management’s word for it, I looked at the price paid / revenue acquired (the only metric I could find consistently disclosed since 2003).  It increased but not sufficiently to indicate that management was an undisciplined acquirer.Also, kudos to management for using its stock to pay for acquisitions when stock was expensive: between 2000 and 2003, when BRO’s stock was trading between P/E of 21 and 26, BRO increased share count by almost 30%).  Since 2004 as P/E contracted BRO has not issued much stock and paid for acquisitions from free cash flows.Though based on company’s history, I believe this risk is small, the longer the soft insurance market drags on the greater are the chances that management (out of frustration, it has not grown earnings for years) will overpay for an acquisition and/or use cheap stock to pay for it (if acquisition is large) and thus destroy shareholder value.
• Sellers are selling their agencies that they’ve spent decades to build, for a reason - they want to monetize their single biggest asset and retire (not because they want to work for someone else).  After earn out period is over sellers’ motivation to grow the business lessens, especially since the sale turned them into multi millionaires.  This in part explains why BRO’s return on capital has been on

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