Prior to the scheduled shareholder vote on 11/18/15, ISS and Glass Lewis advised TW owners to oppose
the deal. They noted the attractiveness of the merger, but insisted that TW shareholders should hold
out for a bigger split of the value. In response to these demands, TW and WSH management postponed
the vote and came to an agreement on an increased special dividend of $10 per share, and a
commitment for more aggressive capital deployment going forward. Both ISS and the dissident holder
have continued to demand a marginally higher dividend. Both seem to be ignoring the significance of
the capital allocation commitment, and both are arguing for relatively tiny changes from here: it appears
to be a classic example of “penny-wise, pound-foolish” behavior. The vote on the revised terms is now
scheduled for 12/11/15.
The underlying businesses
TW
The legacy Towers Watson business offers a variety of actuarial and human resource consulting services. The largest
of these focuses on pension benefits, but it also encompasses consulting on risks specific to the insurance
industry, “talent and rewards” (compensation), investment consulting, and healthcare benefits
including the aforementioned private exchange product.
Investors new to the story might be wary of the pension benefits consulting, given that defined benefit
pensions are gradually dying off. This is a legitimate concern, but it tends to get overblown. First, TW’s
revenue in this area is hourly or project based – not per capita, so there isn’t a direct link between a
shrinking plan participant count and TW revenue. Given the actuarial nature of the product, TW also has
good visibility into activity levels. Further, TW has an exceptional market position. After the merger of
Watson Wyatt and Towers Perrin in 2009, TW has been larger than the rest of the pension benefits
consulting industry combined. Not surprisingly, margins have steadily increased since then: clients have
essentially nowhere else to go, and the same is true for the actuarial consultants that TW employs. With
pricing power and moderate cost pressure due to lack of competition for talent, the bottom line has
expanded. Despite the growth worries, revenue in this segment has grown at an organic CAGR of 3.7%
since 2006.
Risk and Financial Services encompasses specialized actuarial work primarily for life insurance firms, as
well as investment consulting. While not exciting, growth has been moderate and margins have
expanded. Talent and Rewards has grown revenue and margins nicely, though it is the most cyclical of
TW’s businesses. The most exciting area is the Exchange segment, as previously mentioned. In this
business, TW earns a recurring per capita fee to provide a healthcare benefits management portal for
clients’ employees. TW also coordinates buying of services from the major healthcare providers,
hopefully increasing competition and containing costs. The broader concept is that exchanges give
corporate clients a vehicle to gradually transition towards healthcare benefit programs that are more
“defined contribution” than “defined benefit.” In other words, employers provide employees with a
fixed dollar amount to use as they see fit, rather than providing an open ended obligation. This business
is early stage, but it is growing at 30+% and should see high incremental margins as it matures.
WSH
Willis is the third largest global insurance broker after Marsh and Aon. Insurance brokerage is a business
with an unusually stable growth profile. Revenue generally comes in the form of a commission or fee on
premiums purchased by the corporate client. Global P&C premiums have risen in 48 out of the past 50
years. Over the past few years, commissions/fees as a percent of premiums have been stable or
increasing. There has been little change in the competitive environment for years: the market for large
corporate clients has been dominated by Marsh, Aon, and Willis. In the midst of the Spitzer investigation
into contingent commissions and other improprieties, there was speculation that Marsh would be
unseated and upstart competitors would gain traction. Nothing of the sort happened. The big three
have continued to get larger and more dominant than ever.
Relative to Aon and Marsh, Wills has been the laggard of the group in certain respects, especially
margins. The roots of this lie in the acquisition of HRH in 2008, an ill-timed effort to gain share in the US
market. HRH was itself a messy roll-up, and WSH struggled to integrate it, especially in the midst of the
financial crisis. More recently, WSH has been going through an extensive restructuring aimed at
rationalizing back office and IT expenses. While some skepticism is warranted here, we have learned
nothing to suggest that WSH shouldn’t be able to reach a margin profile similar to its peers.