Description

Company Overview

Ryan Specialty Holdings (RYAN) is primarily a wholesale insurance broker (~65% of revenue). The wholesale channel has consolidated over the last decade with the top 3 brokers now making up ~85% of the estimate premiums placed (#1 Amwins, #2 RYAN, and #3 CRC - part of Truist’s brokerage division). RYAN derives the other ~35% of its revenue from underwriting and binding authority programs (MGAs/MGUs). RYAN was founded in 2010 by the former CEO and Founder of AON, Pat Ryan. Over the next 13 years, RYAN has grown to approximately $625m of EBITDA through consistent double digit organic growth and a series of more than 45 acquisitions. PE firm Onex Partners provided growth capital to help scale the business, but has mostly exited their investment. Today, Pat Ryan and other employees continue to control more than 55% of the company with a multi-year focus on value creation rather than near term optimization. You can do your own research on RYAN’s reputation in the industry, but I believe they have a winning culture and motivated team. RYAN’s high employee retention is due to above industry compensation (willing to pay for talent) and the autonomy provided by a decentralized organizational structure amongst its various product lines/MGAs.

Why is RYAN attractive?

• As a wholesaler focused on helping retail brokers place specialized risks in the E&S channel, RYAN benefits from the faster growth in the E&S channel.

  • Excess & Surplus lines have grown at 2x the rate of admitted markets. This has allowed RYAN to grow organically considerably faster than its retail focused peers since it came public.

• Asset-light business

  • Similar to other fee-for service businesses, RYAN sees it’s earnings in cash. It does not take balance sheet risk like an insurer and requires minimal capex of <1% even with 30% EBITDA margins.

• The largest wholesaler brokers benefit the most from the consolidation of retail insurance brokers

  • The traditional retail insurance brokerage market has seen continual consolidation over the last decade. This is driven by both public players like AJG, BRO, and MMC buying smaller players as well as PE-backed aggregators like Acrisure, Alliant, NFP, and HUB. There are more than 600 retail broker acquisitions completed per year. RYAN is able to benefit from this M&A in 2 ways. First, PE consolidators have chosen to simplify their relationships with wholesale brokers to drive efficiency and better commercial terms. They achieve this by decreasing the number of wholesalers they work with (known as Panel consolidation). This panel consolidation has favored the largest wholesalers like Amwins and RYAN since they receive a disproportionate share of flow from this process. Panel consolidation has been going on for close to a decade and has slowed now that the Big 3 wholesalers command a dominant market share. Secondly, the larger benefit going forward is these aggregators continue to acquire hundreds of smaller brokers, and in the process require them to use the same wholesalers as the parent organization. This effectively allows RYAN to grow faster organically, piggybacking on the capital deployed on M&A by their customers without putting up any capital themselves.

• Continued M&A consolidation opportunity

  • While the wholesale space has mostly consolidated to the big 3 players (Amwins, RYAN, and CRC), there are still a number of smaller wholesale candidates who may chose to exit as their competitive position becomes less viable to the big 3. RYAN has also chosen to deploy most of its M&A firepower on the more fragmented MGA space which has plenty of whitespace.

• Low correlation asset

  • RYAN is a nice portfolio diversifier. It has a beta significantly lower than 1 and insurance pricing has its own pricing cycle which is not perfectly correlated to the broader economy.

Why the opportunity exists

• Worries around the hard insurance market ending

  • The main bear case on RYAN is that it over-indexes to E&S (Excess & Surplus is >70% of their premiums). Typically E&S grows ~2x faster than admitted markets (more plain vanilla policies). The overall insurance market has been in a multi-year hard market that has also pushed some more vanilla insurance policies into the E&S channel (allowing RYAN and other E&S-centric peers like Kinsale to grow organically very fast). There is a fear that as the pricing cycle turns some of those policies might flow back into the admitted market as regular P&C insurers like AIG, Chubb, etc. have more B/S capacity to write those policies again. My understanding is this process would be gradual if it happens and it doesn’t apply to all business lines. Furthermore, if the market softens rates could decline which would also hurt RYAN’s organic growth rate. As a result, I believe a significant portion of the buyside already expects a slowdown in growth that is more significant than what sellside is currently modeling (hence why the multiple has already de-rated to its lowest valuation since IPO).

  • Mitigant:  RYAN management has talked exhaustively about how they think they can grow organically at a double digit pace even in a soft P&C market. They generated consistent double digit organic growth in the 8-9 years (2010-2019) before this current hard market started at the end of 2019. They should be able to grow at this rate just by taking a small % of market share.

  • Mitigant:  unlike the mature brokers, RYAN drives the majority of its organic growth through volumes/taking market share/playing in the faster growing E&S market so pricing is less of a headwind as a % of their overall organic growth.

• Rapid pace of Property rate inflation in 2023, likely shifts to more hardening in Casualty lines in 2024+

  • Most of the rate inflation/out-sized premium growth the last couple years has come from the property side of P&C (big rate increases for home, auto, flood, etc). Insurers are now starting to talk about inflation kicking in on the casualty side (liability, workers comp, health, personal injury in Auto, etc). So that can help the hard market sustain a little longer. The E&S market actually over-indexes to Casualty so it benefits less from rapid property pricing last year than retail brokers, and could benefit going forward more than retail peers if casualty hardens.

• I have seen a number of insurers talk about concerns around Casualty reserves on recent earnings calls. Continued social inflation, rising medical costs, nuclear verdicts, and more complexity all favor continued pricing gains in the E&S Casualty market.

• Street underestimates the dollar amount and margin upside from contingent commission growth

  • RYAN’s upcoming contingent commission opportunity is on a much larger premium amount than what shows up in their revenues today (a large portion of contingent revenues earned today are from policies written 3-4 years ago when RYAN was much smaller). Contingents also have the potential to be bigger because the hard market = higher profitability for insurers on more recent policies (so a higher contingent success rate % x much higher absolute dollar amounts of premiums bound = big contingent revenue potential assuming adequate loss ratios). I believe RYAN pays out a lower cut to brokers on this type of commission so the margins are extremely high on this revenue stream. Any incremental revenue from contingents will have an out-sized impact of profitability.

  • Gallagher talked about this dynamic about a decade ago – suggesting 85-90% margins were possible on contingent revenues at that time.

• If short end interest rates fall, RYAN’s EPS would suffer from lower investment interest income (tied directly to SOFR)

  • RYAN is earning interest income on >$800m of client capital they hold as a fiduciary. A rapid rate decline would hit this ~100% margin earnings stream

  • I estimate a 100bp drop in short term rates would hit EPS by ~1.5% and a 200bp drop by ~3%

  • Interest Income is adding nearly 200bps to RYAN’s current margins. I wouldn’t expect 100% of this income to go away, but it could be a 100bps headwind to margins

• Lack of familiarity

  • There are no pure-play wholesale peers in the public market

  • Small free float/ADTV

  • RYAN was a recent IPO that may have been overlooked when hundreds of tech firms went public in 2021

Valuation

RYAN trades near its lowest valuation since it’s summer 2021 IPO at ~15x 2025 EBITDA and 20x 2025 P/E. I believe an asset-light growth asset in an oligopolistic market with an under-optimized capital structure should command at least a 25x Fwd P/E multiple. A 25x exit multiple would lead to 25% upside over the next 11 months in my base case (equivalent to 18.5x Fwd EBITDA). From there, RYAN should continue to compound it's intrinsic value by 15% over a multi-year period. Note that I have only modeled 8.5% base case organic growth for 2025-2026 which provides some room for management to miss their double digit target (they may not hit every year, but should acheive this over an entire insurance cycle).

It is important to recognize RYAN is operating well below its target 3-4x ND/EBITDA leverage target. If RYAN were able to deploy 100% of it’s FCF and B/S capacity on M&A at historical multiples paid, there would be even more upside from the typical multiple arbitrage. If M&A targets are unavailable, RYAN management have indicated they would be willing to consider dividends, special dividends, or buybacks. While this is unlikely in the near term because there are still ample growth opportunities to deploy capital rather than return it to shareholders, RYAN could retire more than 11% of shares in 2024 without exceeding their leverage target.

Margin upside at Maturity

• RYAN’s closest peer (Amwins) is privately held, but discloses financials due to their rated debt. They have generated close to 35% EBITDA margins which is where I believe RYAN can trend over time if organic growth slows. RYAN has consistently shown margin expansion the last few years, with margins rising from 25% pre-COVID to ~31% in 2023. Using a mature trading multiple (such as AON at 15x EBITDA), shows there is a margin of safety embedded at the current share price. Precedent transactions for smaller brokers in the wholesale or MGA space have also taken place at mid-teens EBITDA multiples. RYAN should command a premium multiple to these transactions.

Risks

1. Organic growth slowdown due to a rapid softening in P&C pricing or shifts out of the E&S channel to admitted markets

2. Operating leverage does not materialize

3. Valuation

Catalyst

• Q1'24 and FY'24 Guide on 2/27
• Moderate short interest (~5% of free float) can act as latent buying demand if results exceed expectations
• Continued double digit organic growth
• Greater liquidity as insiders control less of the float leading to greater active/passive flows
• Capital deployment via M&A or special dividends