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Tax reform could slow PE-backed deals for insurance brokers, Gallagher says

A proposed change to the tax deduction for interest on debt could lessen the intensity of private equity M&A in the insurance broker space, which could in turn lower valuations for target companies in Arthur J. Gallagher & Co.'s sights, executives said during an earnings call.

Private equity firms have driven up valuations in the M&A market for insurance intermediaries, which has put heat on acquisitive companies like Gallagher. A proposal from President Donald Trump's administration would remove a tax deduction that can be taken on interest on debt, which would hamper private equity firms because they often use leverage to buy out firms, company management said.

"I think the competition would become less fierce when it comes to using leverage to borrow and buy brokers, so I think that would be helpful for us," CFO Douglas Howell said during the call.

Chairman, President and CEO J. Patrick Gallagher Jr. said deal multiples for prospective brokers have risen due to the growing influence of private equity.

The CEO reiterated the company's preference for "small, tuck-in size" deals and maintained that it will steer clear of large transactions unless deal multiples fall.

The company has already snatched up five smaller brokers, representing combined revenues of $32 million, in January. The pipeline of potential deals remains strong, the CEO said.

The company is unconcerned over the prospect of a change in the ownership of USI Insurance Services LLC, Gallagher added. He described USI as "a solid franchise," but he does not see any threat from the Onex Corp.-backed insurance brokerage.

"As for [USI] becoming a greater threat ... we have about 32 areas [where] we have vertical strength," he said. "We believe in every single one of those we are stronger than anybody in the marketplace and we don't fear anyone."