"Insurance policies... are the most complex contract that you'll ever enter into without the help of a lawyer."
- Hyatt Brown, Chairman at Brown & Brown
Brown & Brown (BRO) is an insurance broker for businesses. Because the insurance needs for a business can be complex and bespoke, the insurance brokers play an important consultative role with their customers. Relationships are important and customers are sticky. And since every business needs insurance, the brokerage business is resilient even in times of economic distress.
The more and more I learn about Brown & Brown, the more and more I like it and the industry it is in. John Wepler, Chairman of MarshBerry (a leading investment bank for the insurance brokerage industry), recently said the following:
“The good news is that irrespective of value, we believe there will continue to be a healthy demand for insurance agencies given high recurring revenue, low capital expenditure requirements, strong EBITDA margins and fairly high barriers to entry. In my opinion, even with a correction, the insurance distribution system will remain the greatest industry in the history of mankind.”
Wepler may be overstating his case, but I sympathize with his enthusiasm.
We have owned the stock of Brown & Brown since the inception of our fund and the stock has doubled from our initial purchase. (Because we have substantially added to the position since, our average cost basis has gone up too). In fact, all of the publicly traded insurance brokers have done well — Aon, Marsh and AJ Gallagher, too. This performance is not just a recent phenomenon. They have posted market-beating returns for decades.
Of these, Brown & Brown is a good fit for our partnership with its high insider ownership (~35%), anchored by the Brown family itself. But employees are also significant owners. I recently listened to a talk delivered by Hyatt Brown, from which I drew the quote above. And he talked about how employee ownership was important to him. In the early days, he set up a plan whereby the employees — teammates, in Brown & Brown language — could buy the stock at a 10% discount.
Many employees have taken him up on the offer and they have made themselves rich over time. Here is a chart from Brown’s talk:
This is the hallmark of a good culture in my mind and reflects well on Brown’s management. The preservation of this culture is important and management talks about it quite a bit. The biggest risk to any insurance agency is that it loses its good people.
Retention of good people is especially important because all of the publicly traded insurance brokers depend, for some part of their growth, on acquiring other insurance brokers. The industry has undergone massive consolidation over the years. Here is another chart from Brown’s presentation:
Of the top 10, only Marsh exists as an independent. The others have been acquired. Little Brown & Brown is now in the top five and revenues this year will come in around $3 billion. Marsh is still the giant, with about $20 billion in revenues. And Aon weighs in at $12 billion. While Brown has plenty of room to grow, the big heavies may be hitting some limits.
Recently, the U.S. government blocked a merger between Aon and Willis Tower. The particulars don’t interest me, but I read through the legal briefs and was struck by the discussion of the competitive advantages of these firms.
To wit, the government used the CEO’s own words against him. Citing Willis Towers’ annual report in 2018 where he wrote “[h]igh barriers to entry, existing market share, brand recognition and long-term client relationships give incumbents the edge over newcomers.”
And further, the government noted “the prevalence of post-employment non-compete and non-solicit clauses in the insurance broking industry, including by Aon and WTW, serve as barriers to attracting clients away from the Big Three [Aon, Marsh and Willis Tower].”
Finally, and my favorite part, the government cited the failure of competitors to break through those barriers:
“Past attempts have shown that successful entry is difficult. For example, several years ago a number of employees from one of the Big Three attempted to start their own commercial risk broking firm with a focus on serving large customers.
“Despite having deep experience in the industry and existing relationships with many potential customers, this new venture failed to take much business from Aon, WTW, and Marsh.
“Similarly, at least one major direct-to-consumer provider spent several years attempting to expand into the private multicarrier retiree exchange market, but has since abandoned that effort due to a lack of success. This direct-to-consumer provider’s foray into private multicarrier retiree exchanges was hampered by, among other things, its lack of reputation and experience with large employers that Aon and WTW have handled for years.”
Indeed. There is more; the circuit court filing runs over 300 pages. But you get the gist. And it affirms the competitive strengths of the established brokers. Now Brown is one-seventh the size of Marsh. Plus, Brown’s acquisitions are small — but numerous. Brown did 25 last year. The point is: We are well below the government’s radar and have plenty of room to grow.
Still, it’s interesting when the government makes the case for the competitive strengths of your business. Insurance brokerage may not be the greatest industry in the history of mankind, but it’s pretty good.
Two Big Ideas from Sosnoff
"If you have caretaker management, you get caretaker results."
- Martin Sosnoff, Silent Investor, Silent Loser
I was on a podcast today with my long-time friend and fellow globe-trotter Joel Bowman. (The podcast will be out Friday). We talked about one of my favorite investing books: Martin Sosnoff's Silent Investor, Silent Loser.
Published in 1986 and long out of print, my own copy is well-worn and full of highlights. While I enjoy Sosnoff's writing style, I must say he is different sort of investor than I am. So, this is not an endorsement of everything he says or of his approach. But I did take away two big ideas from this book when I read many years ago. I thought I'd share them here.
The first is the idea of investing with management teams that have skin in the game. With chapter titles such as "The Case Against Custodial Management" and "The Enduring Rape of Shareholders," Sosnoff makes his intense dislike of kept boards and consultants and other parasites clear. As he puts it:
"Would you rather own a company whose management owns the business and minds the store 24 hours a day, or would you rather invest in a New York City Bank or a Fortune 100 company with a board of directors of two dozen insiders and passive outsiders, none of whom will ever own more than a token percentage of the equity?"
He gives several colorful examples of what managers with skin in the game tend to do. One of them is the story of John Kluge:
“The capacity of energize management to surprise you consecutively never ends ... while the old generation of network broadcasters slept, John Kluge had traded himself up to a billion dollar fortune. Contrasting his behavior and actions with the typical custodial managers - most of the Fortune 500 - the marginal difference is boiled down to guts, brains, and a single-minded determination to advance the price of the stock based on improving the fundamental[s]..."
In stark contrast to owner-operators such as Kluge, Sosnoff blasts the typical uninvested boards of most companies. Here, his target is International Paper:
“The International Paper company has revenues of 5 billion dollars and earning power of just a hundred million dollars. It ranks as one of the Fortune 100. Twelve directors owned collectively 74740 shares of the approximately 50 million outstanding. No nominee owns as much as one tenth of 1%. Why should they? The return on stockholders equity has flowed downhill for the past ten years, averaging less than 7% in the past five years, and just 3% in 1985. This deadly combination of management's negligible equity stake... and the poor returns to shareholders is a paradigm for many of the 100 largest corporations. Stay away.”
And one of my favorite lines from the book:
"My experience as a money manager suggests that entrepreneurial instinct equates with sizable equity ownership."
The second big idea is to think of investing as an abstract art, one of full of ambiguity. He writes about the artist Shūsaku Arakawa and his painting, titled "Marx's Desire:"
Sosnoff writes:
"Note the interconnecting lines. Each image radiates and is connected to the other images in a spider's web interrelationships. If I were to draw a picture of the stock market, it would not be the stock tables, but the symbolism of the distorting transmogrification of a simple lemon into a pattern of ambiguous concepts and facts – some false, some real - that coexist and pull each other with magnetic force... As Arakawa suggests, the lemon adumbrates ideas forms and relationships, but none of us ever sees the true essence of lemon perfectly.”
That is excellent. And something to ponder. The market, stocks, etc., all part of an interconnecting web of abstract ideas.
Money management, in Sosnoff's conception, is more of a minimalist art. It's about trying to get as close to what really matters as possible. "Conceptual power is everything," he writes. This means, in part, embracing the idea that investing is an art full of ambiguities where awareness of interrelationships is more important than the precision conveyed by numbers.
I've built both of these ideas into the foundation of Woodlock House. For more about Martin Sosnoff, see his website here.
I hope you enjoyed today's post and thanks for reading!
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Published: October 6, 2021
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