Description

It goes without saying that a lot has been going on at Willis Towers Watson (WLTW) over the past 12-18 months with the AON deal announcement in March 2020, subsequent regulatory pushback and negotiation, and ultimately the deal breaking in late July. But the future is looking bright for WLTW and patience should be rewarded as the result of a new 3-year plan that is being put into action with the aided oversight of Elliott and its new board appointees.

Willis Towers Watson was in a 17-month long merger process with AON when the deal finally fell through in late July this year. Since then, arbs have sold, a new management was put in place, and a plan was outlined with how the company was going to become a more focused version of its prior self. Before the upside of the plan can come to fruition, WLTW has to complete its reinsurance sale to AJ Gallagher ($3.25b) in early 2022, WLTW has to rehire the personnel lost during the merger (some of which AON poached themselves), and costs have to be incurred for things like real estate footprint optimization and tech initiatives. In other words, it’s not a clean “up and to the right” trajectory but ultimate upside is material.

To reiterate, patience is required in that near term earnings will be compressed from front-loading of expense items to achieve margin goals going forward, but earnings growth rates should be industry leading starting in 2023 and continuing into 2024. Revenue growth and margins should converge with best-in-class peers at the same time. We think it will be tough to argue for a significant multiple discount to peers if this happens. Adjusting for the net proceeds to come in from the reinsurance sale to AJG, we have WLTW trading at 9.8x 2024 EBITDA (on current cap structure and 7.9x forward cap structure) and a 7.2% unlevered FCF yield (8.9% on forward cap structure). Peers are trading at 15x 2024 EBITDA and 5.5% unlevered FCF yield.

Based on historical WLTW multiples of 12x 2-year forward EBITDA and 16x 2-year forward P/E, WLTW would be $300/sh by YE22, or in roughly a year from now. 30% upside sounds pretty good for a sticky, growing, oligopoly-like business, but we think there’s potential for more. The sector has rerated vs historical ranges and using comp multiples of 15.4x 2023 EBITDA (where the group trades today), the implied year ahead value for WLTW would be more like $380/sh or 60% upside in a year. The reason we think that this is more of a probability than not is that WLTW was historically dinged for sub-peer growth and margins, but with growing topline, ramping margins and an underleveraged balance sheet being put to work, we project 2023 and 2024 EPS growth to average 25%, over 2x that of peers and a 60% higher growth rate from 2022-2024.

Even if the 3-year plan is an absolute flop and no expense savings and operational leverage are produced – something we deem unlikely given “adults” overseeing the implementation and a playbook basically handed to them by AON – we arrive at $17.50/sh in 2024 EPS from capital allocation alone. Using WLTW’s own historical 16x vs the group that has had multiple expansion, we get a $280/sh stock in a year or 20% upside.

Bottom line, Willis Towers Watson is a steady growth compounder in a consolidated insurance brokerage industry that has had a lot of distraction and volatility the last couple years. That distraction and volatility is in the process of returning to focus and discipline. Going forward, which is what the market should care about, there’s structural cost being taken out and tech optimization being implemented. At the same time, talent is returning after a period of attrition during the merger process with AON. What should take place is a front-loaded investment in 4Q21 and early 2022, followed by growth from new hires and margin expansion from cost takeout / tech initiatives starting in the middle of 2022 and continuing thereafter. When will people notice or care after accepting that 2022 is a reinvestment year? It’s unclear, but it feels like the multi-year risk/reward is too good not to enter now.

Summary earnings progression through 2024 and comps:

3-year plan:

Capital allocation should drive ~half of the $7/sh+ EPS expansion through 2024

WLTW is currently underleveraged. Adjusting for the proceeds to come from the reinsurance sale of $2.5b after-tax, WLTW has roughly no net debt vs peers at ~1.7x net debt/EBITDA. WLTW intends to buy back stock aggressively with the reinsurance proceeds and at today’s prices, should buy back >10% of market cap in 2022. As part of the 3-year plan, $5b-$6b of FCF is expected from 2022-2024, including expenses to achieve margin expansion. This $10-$11b of capital to deploy over the next few years compares to a $29b and $31.5b market cap and EV, respectively, today. $4b+ buyback through YE22 and $1.3b of dividend through 2024 leaves a lot of capital left for growth M&A and/or incremental buybacks.

Expense savings and operational leverage should drive ~half of the $7/sh+ EPS expansion through 2024

 $300m of expense savings in the three-year plan (or ~300bps margin expansion) compares with a perceived conservative $800m synergy with the AON deal. To achieve the $300m, $750m expense will be frontloaded to achieve, with 2/3 coming from opex and 1/3 from capex. At least some of this is likely taking the AON blueprint, leaving it relatively low risk in our opinion, especially with the new board appointees / Elliott.

·         Real estate footprint rationalization of ~$175m or $1.20/sh

·         Fully integrating past acquisitions through removing redundant systems, implementing common technology, moving to cloud of $125m or $0.85/sh

·         Another 100-200 bps or $1/sh+ comes from growth and leveraging existing assets.

As part of the overall streamlining and simplification initiatives, WLTW is consolidating from 4 segments to 2 – Risk and Broking and Health, Wealth and Career.

Company Overview

Willis Towers Watson is a leading global advisory broking and solutions firm with over 45,000 employees in 140-plus countries serving 91% of the Fortune Global 500, 93% of the FTSE 100, 91% of the Fortune 1000, and thousands of other companies. WLTW operates in a market that is highly recurring, highly concentrated with high barriers to entry, and with low capital intensity. Health and wellness has 2 broad buckets – retirement and health and benefits, with retirement steady with extremely high retention and health and benefits also with high retention but growing quickly in HSD% range. And then benefits, delivery and administration is growing strongly at >MSD% as is benefiting from the growth in Medicare/Medicaid population and comes with low-to-mid 20% operating margins. Corporate risk broking is more like traditional insurance broking and the industry should, over time, grow MSD%. Management’s 5% topline growth algorithm through 2024 makes a lot of sense in this regard given the above breakdown of business mix. Nothing in our work suggests that WLTW is structurally disadvantaged vs comps.

New management

Carl Hess is the new CEO and was head of investment, risk and reinsurance and improved operating margins 540bps from 2017-2020 with strong growth. While he’s not dynamic and doesn’t show all that well in our opinion (he’s not “slick”), he’s a producer and is viewed very favorably internally. Alexis Faber, the new COO overseeing the 3-year optimization program, has been described to us as “super impressive” from a top producing, 40-year veteran of Willis / Marsh. And that “if anyone can get synergy going at Willis, it’s her.” We also have heard that the prior COO was rather invisible to the organization. There’s low hanging fruit as there was a lot of complacency with the prior leadership team.

Typical growth algorithm in insurance brokerage:

·         Average loss ratio is around 93% so losing 7% of business annually

·         Some clients increase in size to make up for this, but also lose from M&A

·         Then bring in net new business to get to net 0

·         With avg price growth of 5-6% per year, that’s what gets you to total company growth in MSD% range

·         People business and growth should come back as rehiring bears fruit in form of revenue production    

Margin realization to come from:

·         Real estate footprint rationalization

·         Moving certain functions to lower cost countries

·         Technology modernization, including moving more to the cloud

·         Simplifying the number of platforms – commonality

·         Growth and incremental margins

More detailed business overview:

·         Health, wellness, and career (55% of revenue) – on balance, should be a mid-single digit growth business with very high retention rates and 25%+ existing operating margins - “provides an array of advice, broking, solutions and software for employee benefit plans, the human resources (‘HR’) organizations and management teams of our clients.”

o   Human capital and benefits ($3.3b rev) – 40% retirement, 38% health & benefits, 17% technology and admin solutions, 5% talent and rewards

o   Benefits delivery and administration ($1.4b rev) – 70% individual marketplace, 30% benefits outsourcing and group marketplace

·         Risk & broking (45% of revenue) – should return to mid-single digit type peer growth rates by mid-2022 with margins of low 20% expanding to mid-20% in next few years -  “provides a broad range of risk advice, insurance brokerage and consulting services to clients worldwide ranging from small businesses to multinational corporations, and places more than $20 billion of premiums into the insurance markets on an annual basis. The segment delivers integrated global solutions tailored to client needs and underpinned by data and analytics through a balanced matrix of global lines of business across all of the Company’s regions.”

o   Corporate risk and broking - $3b of revenue with 41% NA, 23% W Eur, 21% UK, 15% Int’l

o   Insurance consulting and technology - Investment, risk and reinsurance – $650m rev after sale of Willis Re closes in early 2022

Catalyst

• Time is the primary catalyst and the closer we get to mid-2022, the more excitement there will be