When the rumors of a Willis sale first emerged two years ago, I speculated that Aon might not be the only option. Since it’s been so long since that first post, I thought I’d re-share that post below with a little bit of additional commentary.
First, when I suggested Gallagher could find a way in, even as a much smaller company at the time, I pointed out they would likely need to divest certain pieces (mainly the consulting) to make the price tag digestible.
One thing has noticeably changed since then. Gallagher’s market cap has doubled and is now the same (actually a little higher) as Willis! (Given the lack of alternatives Willis has, Gallagher can probably buy it at a discount to Aon’s offer). If there are going to be divestitures, they will be to satisfy the FTC, not because Gallagher can’t digest Willis.
The logic for Gallagher buying Willis hasn’t changed. This is their last real opportunity to become a player in large account. Now, maybe that isn’t a business that excites them, and it would be a culture change, but most companies in this situation tend to take the plunge and go for it.
Would the FTC object? It doesn’t appear like it. Maybe I’ve overlooked something, but let’s look at those five markets they defined in the Aon case – large account P&C, large account healthcare, large account defined benefit, private exchanges, and reinsurance.
Gallagher is small in all five and was teed up to buy Willis’s reinsurance without any objection. Feels like a green light to me and, my guess is, the company would feel out the FTC ahead of time and make sure they’re considered an acceptable buyer.
While the FTC is pretty anti-merger in general now, they can probably claim a victory with a Gallagher purchase. “See, we’re not against every merger, just ones that are ‘anti-consumer’ “. Gallagher is their ideal white knight.
With that, here is the original piece. The ball is now in Pat’s court. We will see if he decides to play or take it and go home…
DISCLAIMER: This is not investment advice. Don’t take it as such!
Also, I have not spoken to any of the companies mentioned below. All that follows is pure speculation on my part.
1) Willis Towers is now in play, whether they want to be or not.
2) Aon pulled a master stroke by going “stealth hostile”.
3) Gallagher can buy just the brokerage and create a true Big Three alternative to Aon & Marsh.
Is Willis Towers Watson For Sale?
Last week brought one of the more interesting merger stories I can ever remember. First, Aon was buying Willis and then it wasn’t. The only thing that apparently changed in the middle was Aon’s stock price, down 8% on Tuesday.
Was the strong reaction enough to make Aon realize they would have to issue equity lower than they thought thus changing the M&A math? Or did investors overreact to a mandatory disclosure (due to different rules in Ireland) and erroneously assumed the deal was much further down the road to completion than it actually was? I’m not sure we’ll ever know.
Regardless, I think the conclusion is the same. Willis is likely to be sold. The market seems to have come to the opposite conclusion. Willis didn’t just reverse the 5% gain from Tuesday. It actually ended up down 2% from Monday’s undisturbed price. This is an unusual reaction for a company who was not perceived to be for sale and now may be.
What gives? My guess is the market is saying Aon was the only potential buyer and since they have said they’re no longer interested, then Willis is stuck, especially with the language that Aon “can’t” buy Willis for a year under Irish takeover law.
My take is Willis wouldn’t have engaged in serious conversations if they’re not open to a sale. This sounds fairly obvious, but sometimes the most obvious story is the right one. Furthermore, there is now blood in the water. Other potential buyers will knock on John Haley’s door now.
Aon’s Stealth Hostile
What Aon has effectively done is go hostile without having to actually engage in a hostile battle. I’m not sure if it was intentional or an accident of the Irish takeover law, but it is a brilliant move if planned and a fortuitous break if by chance!
Part of the aim of a traditional hostile offer is to put a company in play. It is rare that the opening bid is going to get the deal done. What the hostile maneuver does is force the seller to look for other bidders and then position the hostile buyer to top it with a final bid.
If you are of the belief that Aon is the only obvious buyer for Willis, especially post the MMC-JLT deal, then a hostile play by Aon makes a lot of sense. They would be awfully confident they can top anyone else who comes along.
But hostile deals come with animosity. If there is a way to avoid one, you would wish to, especially if Willis is holding out for too high a price. One way to avoid an outright hostile battle might be to have the media find out you made an offer and force you to disclose under Irish law and then walk away over price, apparently handcuffed for a year. You also get the side benefit of not having your stock dragged down by M&A arb traders.
But note the last sentence in the Aon press release. “Aon reserves the right within the next 12 months to set aside this announcement where so permitted under Rule 2.8“. You don’t have to be Houdini to escape those handcuffs! If another bidder emerges, you take the handcuffs off. If Willis says they’ll agree if you raise the price $5, the handcuffs come off. Basically, Aon has Willis’s queen in check without an obvious escape strategy.
So this is a strategic gem by Aon then, right? They just have to wait Willis out and they eventually capture the prize? Not so fast…
Can We Identify Another Buyer?
One risk of putting a company in play rather than overpaying upfront for certainty is you may not win! Surprise bidders tend to emerge that don’t make any banker’s initial list.
As mentioned earlier, one reason for the reaction of the WLTW stock is the perception that Aon is the only realistic buyer. Let’s explore that a little.
MMC – they are sidelined by the JLT deal.
BBT – maybe they want to create a global broker? But they’re tied up with their SunTrust deal.
AJG – see below 😉
BRO – too much of a size difference to overcome.
PE-owned brokers (Hub, USI, etc.) – similar to BRO, the size difference seems too significant.
Large Private Equity – could a KKR or BX come in for a mega deal? It’s certainly possible but it’s a big check. I wouldn’t dismiss it and it’s more likely than much of the above list, but it’s going to be tough especially when Aon can pay up for synergies.
Could Gallagher Form a Big Three?
I conspicuously punted on Gallagher above. Let’s address them in more detail. At first glance, it looks like a stretch financially. Put a deal premium on WLTW’s $22B market cap and you get a takeout nearly twice AJG’s almost $15B cap. Set that concern aside for a moment and let’s explore whether there is even a business reason for Gallagher to want Willis. If so, we can look for a solution to the financing.
If you asked me ten years ago, could I foresee Gallagher becoming a true global broker on par with Aon and Marsh, I would have looked at you a little funny. Pat had done a wonderful job creating a powerhouse agency brand (and claims organization) with impressive financial results but it would be too risky to go chase the big guys in large account land.
However, over the last five years, Gallagher has made several successful international acquisitions and clearly has more global aspirations. They can compete with anyone in wholesale, programs, and other specialty areas. They have gotten back into reinsurance broking. The only thing really missing is large account. That’s not a small thing by any means, but it’s not hard to envision a future where Gallagher decides they think they can make a run at it.
Now, let’s examine the timing. There were really only two companies Gallagher could have bought to try to make a third global broker on par with Marsh and Aon. One, JLT wouldn’t have got you all the way there and was just acquired by Marsh. The other – and frankly the more obvious one – is Willis. If Pat has dreams of making a Big Three, Willis is his last chance to buy a seat at the table.
So we’ve established motive. Let me address a few other issues before getting to financing. First, would a Willis-Gallagher combo really be on par with Marsh or Aon in large account? No, not initially. However, one could see how they could get there as Gallagher has already successfully added capabilities to move from small account to mid market and because they have two things Aon doesn’t and where they arguably are better at than Marsh – agency operations and claims management.
While Marsh has been successful building MMA, their agency operation, I don’t think anyone would say it is on the level of Gallagher yet and Aon doesn’t have much here. Willis has struggled in agency and arguably Gallagher would have the best chance of anyone to fix those US operations. In claims, Marsh is formidable with Sedgwick but Aon doesn’t have a comparable offering. There are likely synergies where certain Willis clients would be interested in using Bassett’s services. One could also envision a lot of opportunity in the UK where both Willis and Gallagher have large retail franchises.
The one major challenge would be what would Gallagher do with the legacy consulting businesses from Towers Watson? These are at least half the market cap and not a place where Gallagher has expertise. These fit much better with Aon. But here’s the swerve…turn that weakness into a strength and don’t buy the consulting.
Gallagher Can Acquire Brokerage and Find a Partner For Consulting
What if Gallagher just bought what WLTW calls the CRB and IRR segments? These essentially represent the brokerage business. They would then find a partner to buy the consulting businesses. Now, you’ve brought the size down to where a larger group of PE firms can get involved and potentially some trade buyers on the consulting side.
Let’s look at the numbers and see what it might look like. The CRB & IRR segments combined have $4.4B of revenue and around $1B of EBITDA. Wouldn’t you know Gallagher’s brokerage segment is $4.2B of revenue and a bit north of $1B of EBITDA. So there is certainly reason to think you could get in the neighborhood of a merger of equals (MOE).
Recall the earlier commentary that a deal with a control premium would be in the upper $20B range. But that was for everything. A sum of the parts valuation would suggest brokerage is a bit < 1/2 the value at WLTW so now we’re at a $12-15B valuation which is in line with Gallagher. Again, a MOE is feasible. If Pat wants the healthcare exchanges, he may even be to stretch to get that depending on what the other buyer is willing to (over)pay for the consulting. An additional lever is the energy tax credits which could be used a lot faster with twice the income.
If Gallagher could find a partner for the consulting businesses, it can acquire the brokerage businesses and form a legitimate third global player in insurance brokerage. This would be quite a crowning achievement for Pat Gallagher’s career.
But don’t forget the analysis of Aon’s strategy. By putting Willis in play, Aon creates a last look for themselves and if they saw Gallagher emerge as a serious bidder, they might be willing to raise their offer to ensure global brokerage remains a duopoly.
Either way, it is hard to see how Willis retains its independence given its scarcity value and two logical strategic buyers.