Industry spotlight – F&I Agencies & Payment Plans

Welcome to the Middle Market Mergers and Acquisitions podcast by Colonate Advisors. Colonate is a middle-market investment bank and we have completed over $9 billion in transactions. We are here to dissect the M&A process, discussing the technical aspects and tactics used in middle-market mergers and acquisitions. Today we're going to continue our industry spotlight series and cover two sub-sectors within the broader Auto-FNI products industry. We've got a couple of podcasts that we've already talked about other industries. We've got a previous podcast on administrators in this sector, which is a great one. We promised to do a deep dive on a couple of the other industry segments that we cover. Today we're going to cover FNI agencies and payment plans that support the purchase of FNI products. Jeeta, we're going to kick off with the FNI agency market. Let's just start with a background about what this subsector contains and who the big players are and, importantly, where they fit in the value chain. Well, let's start with the last part of that question first. Where do FNI agents sit in the FNI ecosystem? So you have automotive dealerships and in the auto dealership, there's the FNI office. Sometimes you're referred to the FNI box and you have the FNI product administrators, which we discussed in a previous podcast, between the FNI administrators and the FNI office and the dealership. There are FNI agents, independent agents. They are like insurance agents. So they bring together the product administrators and the dealers. They have deep knowledge about the products they represent. They can train the FNI office on those products. They can train the FNI office on how to use the menu systems. They can train the FNI office on how to sell the products. That's a big component. So they also act as the middleman, the interface with the administrators. So if a dealership is having a problem with a vehicle service contract, getting a payout for a customer, the bought a car, has a VSC claim. It's not going anywhere. They will talk to their FNI agent. The FNI agent will call the administrator. So the agents sit between the dealerships and the administrators. They are the distribution arm for the administrators, which makes them critical in the ecosystem. They are a very valuable component of the overall FNI ecosystem. These agents are usually representing multiple administrators and there are multiple dealerships. So they may represent one administrator that is really strong in vehicle service contracts. They'll represent another administrator with some VSCs, but is really known for their ANSLAIR products. They'll represent perhaps another administrator that is strong and gap on his little bit of VSCs and some ANSLAIR products. They'll represent multiple administrators. Rarely do I see agents that are exclusive to a single administrator. And I rarely see dealerships that are exclusive to a single agent. So the agents hold a lot of power in this value chain. And they get paid on every product sold. Their commission is often packed into the turn in the industry. That's often packed into the payment that goes back to the administrator, or kind of the payment that the consumer is making. The agent's getting commission on everything sold. The FNI agent is a particular point in the value chain. It's a differentiator. Some administrators sell to dealers through direct sales force. Others use FNI agents, which is a big piece of it. And importantly, these are all going to dealerships. So this is outside of the aftermarket segment. This is strictly to dealerships. That is correct. And one other thing I'd point out is there are administrators who go direct to dealer, but administrators, except for those that are selling into independent dealers, universally, are also using independent agents. They may have a direct sales force, but they have direct independent agents also. The only sector where that seems to not always be the case is selling into independent dealerships. You tend to see more direct agents that are employed by the administrators are selling into the independent dealerships. So the agents are ever present in this industry. And you made an important parallel there to the P&C industry, to the retail insurance agents there. And I always think of FNI agents is very comparable to retail insurance distribution folks. But the FNI agents really provide a much broader service. Yes, they're the interface between the products. In this case, the administrators or the carriers in the P&C world and the users, the consumers. Obviously, the FNI offices in between there as well. But expand a little bit more on the services that these guys offer. An important component of what the agents do is help the dealership with reinsurance. Reinsurance is an important component of a dealership owners profits. Every contract, every FNI product that is sold, there is a reserve set aside for future claims. That's in this industry that's called reinsurance. And there's money in that reinsurance. I mean, there's underwriting profits that's in that reinsurance. A lot of money is tied up in there and it's complicated. It's usually offshore in the Turks and K-Cos, their tax structures involved. And FNI agents are usually very fluid and very educated in talking about reinsurance and making sure that the dealership has the right reinsurance programs. So they deal with reinsurance. They do training on products. They do training on how to sell products. They sometimes help with staffing in the FNI office. And they'll help with some of the technology that is between the FNI office and the administrator. Yeah, the staffing is the most interesting that I've heard of. anecdotally, that the FNI agent might get a phone call one day and bring a big dealership and say, "Gosh, my FNI product guy is out today and I need an extra set of hands." The FNI agent will drive on over and show up and work the floor, which you'd never see a retail insurance agent do that obviously. But that's an interesting sort of really tightening relationship there where they're almost like part of the staff. That's right. They're considered part of the staff, almost part of the family. And the reason is FNI represents a third of a dealership's profits. So everybody within the organization and affiliated with the organization is going to make sure that FNI runs smoothly. So how is the FNI agency world set up? It sounds like you've got to be really close with boots on the ground. Is it local, regional, national? How do you scale a business like this? There are well over a hundred independent agencies. And I would say 75% 80% of FNI agencies are less than 10 employees. And that includes back office employees. And that is where W2 employees. Oftentimes, you'll see independent agents like me. So I could be an independent agent. And I may be a 1099 employee for an agency. It doesn't really mean I'm an employee. I'm an independent contractor. But a lot of these independent agencies are set up like that. There are very few large agencies. There are a few that are scaling, but there really aren't many. Now, because they're not large agencies, you don't have agencies that are national. There's one that comes to mind is owned by Spectrum Automotive. And it's called Vanguard. Vanguard has been very inquisitive and building out their agent workforce. And I think we could comfortably say that they have a national footprint. And they continue to grow through acquisitions successfully. They're probably the biggest. We also see Brown and Brown, which is a P&C brokerage publicly traded. They've been acquiring FNI agencies over the last few years. I don't know if they have a national footprint yet, but they're probably getting pretty close. So those are the two biggest that are close to a national footprint. And then you have a lot of small agencies. So really local in some cases, but more likely regional. The Brown and Brown example is an interesting one. And we've watched that over the last five, six years or so where they've entered the industry. And we've always thought that that makes a lot of sense, given the parallels to the P&C distribution market. But they've really been quite inquisitive over the last several years and are seemingly trying to build up a meaningful, basically, ancillary business to their core business by adding on FNI products. Again, for many of the reasons we've talked about, it's very similar in distribution. And they can expand nationally, given their infrastructure, that they can buy up these smaller players using the playbook that they have for small P&C players. They can go go bubble up all these small independence and really build the national franchise. So we see all these agencies that are trading. And we think that the M&A market for FNI agencies will continue to be hot in 2022. Agent value is driven by a couple of different factors. One is diversification. One of the challenges for these small agencies, just like any small company, is having all of their eggs in one basket. For an FNI agency, they may have one dealership group that represents 40% of sales or 30% of sales. That is a dating factor to trading typically or to trading and getting the highest possible value because if an agent loses that dealership, they lose a third of their profits and that's hard to recover from. And so agencies that have significant concentration, which I call greater than 15%, trade at a lower value than agencies that have little concentration. We also see another value driver as the number of W2 employees. Sometimes I'll talk to agents and they're like, "Yeah, I have plenty agents." And then we start looking in and they're like, "Well, you have 20 agents, but actually only three are on your payroll. The rest are independent agents." They're like, "No, you understand. They are really close to me." And I'm like, "Do they only work for you?" And they'll say, "Yes. Do you tell them which dealerships to go to?" And they'll be like, "Yes, those are my relationships too." Yeah, they're not really independent. You really shouldn't call them 10.99. You need to get them on your payroll. And then the 10.99 agent, probably pretty smart, will say, "I'm going to have to pay a lot to be a W2 employee and lose that flexibility." And so right there, money's walking off the door. And so we always have to be careful when we're talking to agents who are 10.99 employees, can they become W2 employees and how risky is that? And further to your comment about concentration, the mirror image of that is who owns a relationship. And to your point about the employees being 10.99 or W2, that's more of a seemingly a technical matter. But importantly, when you go to sell these companies, where's the relationship held? Who owns the dealer relationship and what's the risk of attrition in a transaction? Does the administrator really own the relationship? You oftentimes will see administrators that will be very close to the dealership. You know, they will come in whenever an agent goes in to see a dealership, somebody from the administrator might be showing up at those meetings too. So who really owns that relationship? Therefore, what is the true value of that agent? So if an administrator buys that agency and there's another administrator that's in there with that dealership, are they going to lose that dealership? So a lot of diligence needs to be done in these transactions to really understand the nitty gritty of who, not just on paper, but in practice, who owns the relationship. That's interesting. This sounds like an industry that could be rolled up further. Again, following the playbook of the PNC Insurance Distribution Market, you get a lot of mom and pops out there, small businesses and a few large players. What's the consolidation activity that you've seen over the recent years? And where do we expect that to go? So let's start with the two names that we had already talked about. Brown and Brown and Vanguard dealer services, which is part of Spectrum Automotive, are both rolling up agencies and you could consider them to be independent. And the rest of the M&A activity we see is not a roll up, but administrators buying agencies. So national auto care has been very inquisitive. Portfolio group has been very inquisitive. There are many other administrators who bought one, two, three agencies and they're trying to lock in their distribution channel. They don't want to be in a position where one of their main producing independent agents is acquired by another administrator. So they're acquiring agents to lock in the distribution channel. In terms of roll ups, those are really the only two that come to my mind that are actually doing a roll up of agencies that will continue to be independent, which by the way, shocks me. There should be another roll up of agencies. There should be a private equity firm that's coming in here saying, I'm going to put $150 million to work. And we're going to leverage it. We're going to buy up 20 FNI agencies. We're going to make a super agency with national coverage. And that could be over-successful for everybody involved. Just hasn't happened yet. It is surprising, given the industry dynamics. But you're right, it is a pretty liquid market at this point, the folks that are acquiring are paying pretty high multiples as I understand it. And it's a challenge. And so any new entrant would have to go in and go big pretty quickly. You find a platform that they can scale and put a lot of capital to work and kind of hold their nose while they pay big prices up front. One of the things that has baffled me about M&A in the agency industries, I think of FNI agents as the true entrepreneurs. These are people who, when they start an agency, they are working for themselves. They're not working for the man. They're entrepreneurs. And then they sell out to a big corporate. And they have to work through their earn-out for a couple of years. There's a trade-off, right? How much is the money worth versus kind of giving up your ideal of not working for the man? And I would have to imagine that for some of these agents, they put those concerns aside, but it's not an easy road. And do you see similar dynamics to the insurance distribution market where a small independent gets gobbled up by a larger player, they work through the earn-out, and then three years later, the principals walk out the back door and start a new agency? Not the principals, but I think the junior people. So I think a lot of the M&A activity we have are with an older generation that this is kind of their last transaction before retirement. But I do think there's some leakage happening where the younger, talented, hungrier, FNI agents are like, "I get it. I can do this." And they leave, go start their own agency. And I think we'll see that next generation starting to trade in about a year or two. That's interesting. And I'm always surprised, again, in the PNC distribution world, there are 30 to 40,000 independent agents across the US. And there are 250 or 300 M&A transactions a year. And yet, there are always still 30 to 40,000 agencies across country. And so many of these folks drop out the back door in a similar dynamic where you got an aging demographic is selling out. And then, most likely, the next tier, the folks that are starting to control the relationships and actually running the businesses don't like working for the man and pop out the back door. So. I have one last point I want to cover about FNI agency M&A. What's driving the activity? First of all, there's a lot of money, private equity firms, backing administrators that need to grow inorganically. So we've talked about that ad nauseam. But we also see a lot of M&A activity at the dealership level. The bigger getting bigger, big dealership groups are buying up other dealers, independent shops and dealership groups, and they're getting bigger. Well, every time one of those transactions happens, the agent that represents the target dealership is at risk of losing that client and that client base. You know, the buyer, which agency group are they going to keep in. And I really think that that is the issue that keeps a lot of agents up at night. And that is motivating some of the sellers because they may have an incredible relationship with their clients. And maybe long term, they may be well diversified. But you know, there are three M&A transactions away from losing half of their livelihood. So I think that is a big factor here in this industry here in 2022. You still see a lot of M&A activity happening here in the beginning of 2022. I don't know how that's going to play out by the end of 2020 to beginning of 23 with further challenges in sourcing new cars and oil prices being high and interest rates going up. Not sure it's going to happen with dealership M&A, but dealership M&A is driving agency M&A. Let's talk about another area in the FNI ecosystem. That is the payment plan sector for financing the purchase of vehicle service contracts. Jeff, why don't you start by explaining what is a payment plan versus a loan in the sector and where does it come into play? Sure. So payment plan companies sort of came out of the ground maybe 20 years or so ago. They started as an offshoot, the cousin of the insurance premium finance market, which we talked about in previous podcasts, very similar collateral structure. Number of players in the industry and the premium finance industry said this looks very similar to what we're doing in premium finance. We can just attack a different market segment that has no financing source. And so fundamentally, this market is designed to help consumers purchase FNI products cost effectively. So whether you're in a dealership and the FNI person says, you know, this warranty or sorry, this VSC is going to cost you $3,000 or whether you get a piece of mail about an extended auto warranty and you make a call to a direct marketer and they want to sell you a $3,000 product. Once you get sold on buying the coverage, the question is always, do you want to write a check for a free grand or do you want to finance it over two or three years? And in most cases, it gets financed. And so at the dealership, it typically gets rolled into the auto loan. It's just one of the line items gets rolled in the auto loan and you pay it off as you go. In the after market, which is really where we see these payment plans flourish, it's a different dynamic. So if you're on the phone with a direct marketer and you agree to buy the coverage, say you're buying five year VSC and it's $3,000 product, you can stroke check for three grand or put 10% down and pay over 18 or 36 months depending on the payment plan. they're interest-free and cancelable at any time. And so on a five-year product, if you've got a three-year payment plan, it might be a hundred bucks or so, plus or minus a month depending on the structure. And as you continue to drive your car and assess the usefulness of the product, you can cancel it at any time. And if you cancel it, all you do is you call up the seller or the administrator and you say, "I want to cancel my payment plan," and you get your money back. The unearned premium, very similar to the insurance premium finance market. The contract is earned over the life of it, so if it's a five-year product and you're one year into it, you might get 80% of the money back. And the payment plan company, which we'll talk about, sort of how they get inserted here, the payment plan company is indifferent, because they'll just get their pro-radar share back from the administrator. So let's talk about how these are set up. The seller will sell the product to the consumer. And if they attach financing to it, the seller will collect the 10 or 15% down payment. And the payment plan company will insert themselves and front the rest of the money to the administrator and to the seller. And the administrator, just like any VSE product, has to front some money back to the clip provider, but the profit here to the seller and the admin fee get fronted by the finance company. And so there's a pie chart. We've got a white paper on this on our website, but you know, a big portion of it is the seller profit. And what we found over the years is that by fronting the seller profit, that the seller would otherwise have to earn over the life of the contract, is really fuel on the fire for the industry. So this is the gas that drives the industry. All of a sudden, these marketers can focus on marketing and not having to play catch up with accounting or cash. And again, these are payment plans. They're generally not loans. No credit pull. Yeah. So there's no credit. The finance companies don't care who's on the other end of it. They just want to make sure that it's a real vehicle. And there's a real contract being put in place. But there's no consumer credit pull and really no consumer credit risk to the payment plan company. So the payment plan companies are taking credit risk of the sellers and the administrators because in the event of nonpayment or cancellation or defaults by the end consumer. Again, the finance company doesn't go after the consumer. There's no recourse. And instead, they just collect the owner premium back from the other parties. And this is all contractual. So different than the insurance premium finance market, which is driven by state statutes and regulations. Very well defined. And there's real underlying insurance. And so it's generally governed by the insurance groups, the state regulators, the insurance or the finance institutions. This is all contractual. And there are different mechanisms that the payment plan companies use to mitigate risk because sellers do, in some cases, go out of business. And so there's a real credit risk there. There's little but manageable credit risk on the admin side. So it's a really good finance product. So you've got from the finance companies perspective, five years generally worth of unearned premium. And you've got a two or three year contract. And so the gap on the collateral curve that we show is very favorable to these payment plan providers. How big is this industry? We estimate this is probably about a five billion dollar a year originations market plus or minus. There's not good data. We've done a number of studies over the years and think that's the size of the market. It grows with auto sales and adoption of products like these is grown considerably over the last several years for all the reasons we've talked about before. Typical contract here is probably $3,000 just like the VSC products. And again, we capture a down payment and finance the rest of it. There are probably 10 independent players in the market, which being kind of generous. There are just a small handful of large players. Who are those? The biggest players are Paling, which is owned by Fortress and Milestone and has announced a transaction with SPAC last summer. Walco is the next biggest. And they're growing nicely. This is the Walder team that previously ran Mapco and Omnichur. And they've started up a new finance company that's growing quite rapidly. There are other smaller players like Budco, Line 5, Mapco is a large player. They're top three for sure. That's owned by Seabury. The service payment plan is a big company in the dealer space. Again, different dynamics, but similar product offering. And then there are a couple others. Universal Lenders and others that are smaller players on the industry. So 10 players being generous, less than a handful of significant players in the market. Paling, Omnichur, and Mapco really dominate the aftermarket space. And folks like service payment plan really dominate the dealer channel. And so just as an aside, the dealer space, as I said, typically these VSCs and other FNI products get rolled into the auto loan. But sometimes they don't fit. The car buyer has too much other stuff in there. And a payment plan can be an extra piece of credit that can be extended to the consumer. So the market for payment plans in the dealer space is considerably smaller than the aftermarket world. But it's still quite a valuable product. And we find it's quite integrated into the FNI agent world and the DMS systems over there. I love the payment plan business because it is so low risk. What the payment plan companies do is they hold the cash reserve on each funding in case the underlying consumer cancels. And that happens. There are a lot of cancellations in the direct consumer market of vehicle service contracts. As we've discussed before, it's not because the contracts are bad contracts. But it's because consumers actually have transparency. Unlike the vehicle service contracts rolled into an auto loan, consumers don't get a breakout every month of the components of their auto loan that they're paying. They don't see 80% of your auto loan payment is for the car, 10% is for the vehicle service contract, et cetera, et cetera. But when a consumer is financing or using a payment plan for a vehicle service contract in the aftermarket, they have complete transparency as to what that cost is for. And so if they decide as a household, they no longer need that product. They need to redeploy that payment to something else like their mortgage. They can. And they can cancel. But the payment plan businesses, they have a cash reserve for this. So it is a very low risk business and has great returns. Two points on that. One is when the FNI products are rolled into the auto loan, you're really paying for those products over the life of the auto loan, which is typically five years or more. And these payment plan companies, the monthly payment might be a little bit more, but you're buying the entire coverage over two to three years. It's a very different structure. And I agree the transparency here is much in the favor of the consumer. So these guys are really providing a valuable service. And the risk here is really low. We see charge offs less than 25 basis points across the industry considerably less in 25s, probably high point. In terms of the collateral structure here, again, you've got contractual rights to unearned premium coming back to the finance company in the event of cancellation. You've got seller reserves, which are the funds that the finance companies hold and reserve and actually don't forward to the sellers at the time of sale. That combination provides for really low losses. As you said, this is a very transaction processing intensive business. So you've got some of these companies have several hundred billion dollars of portfolio. And each contract starts out of $3,000 and burns down. These are very granular portfolios. You're not going to take a big loss on any particular contract. Unlike the insurance premium finance industry, the incidence or likelihood of fraud is negligible. And the risk here is quite low given the granularity. So we like the short duration of these assets. We like the low loss rates. Generally, these transactions are priced. It's 15 to 20% unlevered return. So they're very high yield. And as you said earlier, there's no credit risk. We're not pulling or doing anything with consumer credit risk. We're just managing our relationships with sellers and administrators. So all those dynamics, we think are very favorable to this lending universe. And I love this business too. I think it's great. It's a niche industry. It's $5 billion is not the $50 billion commercial PNC market. But it's meaningful and it's growing. And the yields here are significantly higher in general than the PNC market. And there's no fraud risk. So for all those reasons, we really like this business and think it's going to continue to grow. Let's talk about some of the M&A activity that we've seen in this sector over the last few years. There really hasn't been much. There's a limited universe of players. And I didn't mention that some of the admins are vertically integrating. So that's another important component. They're probably half a dozen or so admins that have decided that they can do this business too and be vertically integrated. I think we've talked recently about vertical integration and pros and cons. of that. But in the payment plan industry because of the small universe, there really haven't been that many transactions. So the earliest that we worked on was in the initial sale of Mapco to independent bank that was almost 20 years ago now at this point. Pay link started up, you used to call warranty finance company that started up with the e-shaw that was sold a couple of times. It's now owned by Milestone Fortresses. We talked about Omnistur and Paul Walder. Start up that business from scratch and grew it to a couple hundred million dollars of receivables, sold at Fortress, pay link and Omnistur merged several years ago back in 2017. That put together the two leading players in the industry really created the behemoth. That was probably the big transaction in this industry. And the other important one to mention was C-Berry's acquisition of Mapco out of independent bank back in 2017 as well. Mapco has really grown considerably from them. We don't have size stats on those, but they're being very aggressive, they're funding with some sort of nontraditional capital sources and have really grown the market considerably. And most recently, Walco has come out of the ground. So Walco started in early 2020 as Ed and Paul Walder again, starting up another competitor in the sector and they've grown considerably in recent years and are doing a great job building out that business. So we don't see a ton of M&A activity per se, but it's a really interesting market. Part of the challenge from an M&A perspective that I'll mention is there has not traditionally been a deep bank buyer universe of this product. And that confounds me a bit. You know, for all the reasons we mentioned, this is a really interesting dynamic asset class. Again, very similar to insurance premium finance, which has a number of large banks in the sector and a number that want to get into it. This collateral structure looks very similar to me, except that it has higher yields, higher return on asset ultimately and even lower losses. And the challenge that we've heard repeatedly over the years is even though this is a B2B sale and this is commercial finance by all definitions, there is indeed a consumer at the end of the transaction. And so some people have worried about CFPB risk and others getting in the way here. And the way that these contracts are structured, the payment plan companies are actually buying the paper from the sellers at a discount. That's how they earn their return. So they're not actually extending credit to any consumers. There's a very bright line in my view that this is a commercial finance segment. And even though there's a consumer way down the value chain, this is a B2B sale and falls squarely in the commercial finance segment. So despite that and despite my thinking, a lot of banks have shied away from the sector. I think there's a real opportunity for a forward thinking bank to embrace this asset class and do quite well with very little risk. I agree. It's a great asset class. I think banks that are actually in emanating should actively be looking at this sector. They're doing their shareholders no favors by ignoring this sector. In today's episode, we continued with our industry spotlight series and focused on two industries in which Colonyde plays a dominant role in M&A transactions, FNI agencies and payment plan providers. For each of these sectors, we discussed market dynamics, industry players, and M&A activity. Colonyde has studied the FNI agencies and payment plan provider markets for the last 20 plus years. We have worked on nearly 30 M&A transactions on both the buy side and the sell side. We have gotten to know the industry players, buyers and investors. We believe that there's some high opportunity M&A plays that could help to drive even more value and scale in both industries. If you are contemplating next steps on a transaction, either buying or selling, or are looking to raise capital, please don't hesitate to reach out to us. Thank you for joining us. For more information on Colonyde Advisors, the deals we've done and our thoughts on other M&A-related topics, please go to our website at coladv.com or contact me or Gina directly.