Towers Watson Merger Continues To Pay Dividends
Human resources consultant Towers Perrin Forster & Crosby merged with rival Watson Wyatt Worldwide back in January 2010. Economic uncertainty prompted the two firms to come together in an effort to reduce costs and compete more effectively with the likes of Mercer, a subsidiary of Aon Corporation (NYSE:AON), and Hewitt Associates, itself part of Marsh & McLennan (NYSE:MMC). Two years later, business looks great and so does its stock. (For more, see Earning Forecasts: A Primer.)
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Terms of the merger gave Watson Wyatt shareholders 50% of Class A and Class B shares outstanding with Towers Perrin shareholders, and some designated employees getting the remaining 50% on a restricted basis, generally vesting over a three-year period. If my math is correct, two-thirds of those shares have vested with the remaining third vesting in January 2013. For instance, James Foreman, Managing Director of North, Central and South America, received 74,120 shares of Restricted Class A common shares. Half of which is already vested with the rest will be vested on Jan. 1, 2013. Sitting on unrealized gains of $1.1 million with more to come in 2013, shareholders and certain employees appear to have done very well. In a little more than 25 months, Foreman's achieved a 29.5% total return compared to 19.3% for the S&P 500. In my opinion, the best is yet to come.
Towers Watson (NYSE:TW) announced strong second quarter earnings February 6. The highlight being the net operating income (NOI) margins of all three business segments. The benefits division, its largest, achieved net operating income of $162.3 million on $475.5 million revenue. That's a NOI margin of 34.1%, 360 basis points (BPS) higher year over year. Even more impressive is the 850 BPS improvement to 33% by its Talent and Rewards segment, nearly matching the NOI margins of its largest division. Sandwiched in between was the Risk and Financial Services segment, which delivered an NOI margin of 26.3%, 510 BPS higher than in the second quarter of 2010. The trio of improvements led to an overall NOI margin of 32%, a 480 BPS improvement. The merger was about reducing costs and improving its ability to compete. Bottom- and top-line improvements, in both its three-month and six-month numbers, is a clear indication the merger is working and the integration is not yet complete.
At a time when companies like Caterpillar (NYSE:CAT) are making record profits and still managing to toss workers out on the street for not accepting 50% pay cuts, it's gratifying to know that Towers Watson takes a far more egalitarian view of employee compensation. Happy employees make better employees. If you take a look deep in the 10-Q, you'll see that it increased base salaries in the first six months of fiscal 2012 by 4%. How many people can say they got a 4% pay increase in 2011? I doubt very many. On top of that, it paid out $185 million in bonuses, which is about 19% of its total spending for salaries and benefits. Having made these points, I'm not suggesting life is perfect at the benefit consultant. According to its 10-K, its employee savings plan has a 100% match on the first 2% of pay and a 50% match on the next 4% of pay. That's decent, but the company's contributions don't vest for two years. Caterpillar, on the other hand, matches 100% of the first 6% of pay and their contributions vest immediately. So, not all is bad at Big Yellow. However, given Towers Perrin pays out 19% of salaries and benefits for year-end bonuses, I can let the savings deficiency slide. On a 50,000 annual salary, a Towers Watson employee would receive a $3,000 annual matching contribution under the Caterpillar plan. Under the Towers Watson bonus plan, that same employee could conceivably receive as much as $9,000 and then another $2,000 for the savings plan. In the end, the Towers Watson employee is better off financially than most, and while money isn't everything, it certainly helps.
The Bottom Line
Although I haven't spent any time discussing Towers Watson's stock price or valuation metrics, it doesn't mean I haven't thought about those things. It's just that I don't think they'll matter if the company continues to execute on its post-merger plan for winning business. Furthermore, if it continues to look after its employees, its stock price will be higher in six months' time, six months after that and so on for some time to come. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)