June 25th, 2015

140.43

Edgewood

Towers Watson (TW)

Management LLC
Gavin Durham

Buy

Market Cap.
Hist. Rev. Growth Rate

9.55B
15.75%

FY15 FCF
Debt/EBITDA

355,590
355.59M

EPS Growth Rate for FY15

6%

Dividend Yield

4.3%

LT Future EPS Growth

ROE
Shares Outstanding

7.5%
12.56%
69.32M

2015 EPS
2016 P/E
Avg. Daily Volume

5.47
23.06
240,725

Required Return Category

10.5%

Sector

Management
Services

Company Overview
Towers Watson is a leading global professional services company that provides consulting,
technology, and solutions. The company was founded in 2010 with the merger between Towers
Perrin and Watson Wyatt Worldwide. Towers Watson provides services in the areas of benefits, risk
and financial services, talent and rewards, and exchange solutions. TW focuses primarily in the
Americas generating the rest of its revenue from EMEA (primarily Germany) and Asia Pacific.
Over the last two years, Towers Watson has had to
restructure its business strategy to accommodate the
rapidly growing private exchange business. This has
required a significant amount of investment and
restructuring. The company is transforming its
business strategy so that it can focus on the private
exchanges, but they do not want to take away from
their solid existing business.
Towers Watson boasts an impressive management team.
John Haley is the CEO of Towers Watson and has worked
for the company for 35 years. He was named CEO in 1998
and under his direction the company went public in 2000
and completed two historic mergers in 2005 and 2010.
UVA alum Roger Millay was appointed CFO of Watson
Wyatt in 2008 and, in 2014, was named CFO of the year in
2014 by the Washington Business Journal. Impressively,
most of the executive management team has been with
wither Towers Perrin or Watson Wyatt for over 20 years.

Industry Overview
Towers Watson has broad exposure to industries with businesses in several sectors. There are a
number of competitors within the Management Services industry. The size of these companies varies
greatly and M&A is the primary tool for growth. Towers Watsons major competitors in the private
exchange market are Aon (AON) and Marsh & McLennan (MMC). The three companies were the first
in the market and have a substantial advantage over any newcomers. Of the three, Towers Watson is
easily the smallest (Market Cap: 9.5B), this gave Watson an advantage as they have been better able
to adjust their business model to maximize the exchange market. As a result, Towers Watson is
projected to emerge as the industry leader in 2015 over Aon (29.2B) and Marsh & McLennan (31.8B)
As Private exchanges have become more popular, many companies have tried to enter the market.
Outside of the big three, competitors within the industry have a negligible impact.

Sturdy Foundation
Towers Watson has historically been a very solid, but undeniably unexciting, company. Towers
Watson is extremely proud of its status as the leading provider of actuaries and also provides services
in benefits, talent and rewards, and risk and financial services. The company has been able to
establish itself as an industry leader in several categories through by simply providing superior
services and following a strict business strategy of providing services and products they know they
can excel in. The foundation of Towers Watson has traditionally been the companys benefits services
which they have used to penetrate businesses and expand the services they provide.
Benefits comprise 53% of revenue, with
retirement benefits comprising 69% of the
category. Towers Watson enjoys a 98%
annual retention rate of Fortune 1000
retirement clients due the companys
superior product. The company is looking
to expand this part of their business into
markets like Asia and Europe. The
company is also very excited about the
potential room for growth their health and
group benefits services as companies are
increasingly concerned with rising health
care costs. Benefits are the companys
bread and butter almost every other
category has been an outgrowth of the
benefits business.
Talent and Rewards is a promising
category with mid-to-high-single digit
constant currency revenue growth. This
growth is primarily driven by growing
demand internationally, specifically in Asia

Pacific. Risk and Financial services has suffered lately with low-single-digit constant currency decline.
However, the company maintains the importance of the category as, though it is not growing, risk
and financial services is still a profitable business CFO Roger Millay recently described it as a great
cash cow.

Health Care Exchange Boom

Corporate health care costs are rising ~7%-10% annually in the United States. Traditionally,
companies have cut health care costs by lowering the amount of premiums they are willing to pay for
employees health care, forcing employees to pay the rest out of pocket. This is not a long-term
solution and employers are usually reluctant to reduce health care for employees. Furthermore, in
2018 the Cadillac Tax is set to take effect. Part of the Affordable Care Act, the tax would force
companies to pay a 40% rate for benefits paid to individuals over $10,200 and families over $27,500.
The Obama administration has maintained the tax will effect a very small group of employers, but
many expect the number of companies effected to be much higher.
In the last three years, private exchange markets have emerged as a solution for rising corporate
health care costs. Towers Watson was one of the first to the market and the companys private
exchange service, OneExchange, has become an industry leader. Private exchanges provide an
online marketplace where employees can select personal health care plans based on their needs.
Employers can set a defined contribution for employees, select which plans are available on the
exchange, and create a tiered benefits program for employees. OneExchange is able to reduce costs
by maximizing Towers Watsons the significant purchasing power to negotiate better prices and by
increasing the competition between health care providers to lower prices on the online marketplace.
OneExchange promises to save employers between 5%-15% on health care costs for active
employees and 15%-25% for Medicare-eligible retirees. The service averages $1,400 in savings per
employee in their first year. Most impressively, OneExchange can reduce the annual increase in
health care costs to ~1.8%.
The private exchange industry is still developing, however, the growth potential is significant. In 2014,
2.5 million employees were enrolled in private exchanges, Watson projects that number will rise to
~300 million by 2018. 1.2 million are currently
enrolled in OneExchange and the company projects
that, by 2018, 30 million employees will participate in
the service. Companies have been slow to switch to
private exchanges, though a few companies have
moved such as Walgreens. Companies want to see
proof of concept before they commit to the switch.
As companies continue to make the switch, others
will follow.
Towers Watson is better positioned than anyone
else to capitalize on the growing private exchange
market. The company has committed to establishing
itself as an industry leader with large investments in
the business. In May, it was announced that Towers

Watson had agreed to acquire Acclaris, a provider of software-as-service technology, for $140m. The
acquisition will enable Towers Watson to accommodate for the rapid growth. As the managing
director for Towers Watsons Exchange Solutions segment, Jim Foreman, put it this combination will
allow us to offer the end-to-end process for both traditional benefits administration and private
benefits exchange solutions, and to deliver a seamless experience for our employer-clients, an
exceptional experience for consumers and high-quality customer support for both. Towers Watson
has also reinvented their business strategy to focus on the exchange business. They remain
committed to their existing businesses, but have admitted to reallocating assets from the benefits
segment to enhance the exchange business.

Conclusion
The management team at Towers Watson has proven they can run a stable and profitable business.
The company has managed to grow steadily, despite the lack of an obvious growing business
segment. The excitement within Towers Watson over their rapidly growing business is clear in
everything the company does. In a recent interview John Haley said he wished he could restart his 35
year career at the firm right now, as its the most existing time in his time at the company. Where as
Aon and Mash & McLennan gave a slide or two to their exchange business in investor presentations,
exchange solutions dominated the most recent Towers Watson investor presentation and
represented nearly all of the questions following last quarters earning calls. This may not be an
indicator of future success, but it is encouraging to see a management team so committed to their
fastest growing business.
Consensus opinion that private exchanges are the future of corporate health care is overwhelming.
The rapid growth of private exchange services is a forgone conclusion in the industry, the only
question that remains is when companies will flood to exchange services. I ran two cases in my
model, one multiple valuation and one perpetuity valuation. My model produced prices per share of
$159 and $157 respectively. I rate Towers Watson as a buy.