Willis Towers Watson Public Limited Company (WTW) Earnings Call Transcript

Good morning, and welcome to Arthur J. Gallagher & Company's call to discuss the acquisition of certain Willis Towers Watson Pick operations. [Operator Instructions] Today's call is being recorded. [Operator Instructions] Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to cautionary statements and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements and related risks and uncertainties. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to our most recent SEC filings and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce your host, J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you, and thank you all for joining us this morning on such short notice. On the call with me today is Doug Howell, our Chief Financial Officer. We will also be referencing the presentation that is posted on our IR website during today's call. Let me start the call by saying we are really, really excited about the announced transaction. To me, it's another seminal moment for our company. And like we have throughout our history, we seize upon the opportunities to drive our long-term strategy forward in what we think are really attractive valuations for great operations. So let me give you some background on what we are buying on Slide 7. It's the vast majority of Willis Re's Treaty and Facultative Reinsurance brokerage operations as well as certain U.K. specialty European and North American brokerage operations. It's part of the remedy package that was submitted by Aon plc to regulators around the globe. All told, we will add more than 6,000 new colleagues, $1.3 billion of estimated pro forma revenue, $357 million of estimated pro forma EBITDAC, and we're doing that at a really compelling price and valuation. And the 6,000 brains we are adding, the expertise will make Gallagher even stronger. Our carrier relationships will be enhanced. And our increased scale, the data and analytics capabilities that will follow, is incredible. And these benefits ultimately accrue to our clients. So let me talk a little bit more about the strategic rationale for this acquisition on Slides 9 and 10 before I turn it over to Doug, who will hit on the key transaction features and walk you through the pro forma financials. So overall, this is a compelling transaction for us. Number one, it expands our global reinsurance brokerage value proposition. Number two, it broadens our global retail brokerage footprint. Number three, it increases the depth in key specialty operations like cyber, financial lines, space, aerospace and niches like construction and energy. And we're adding a great management team that leads an organization with a strong sales-based culture similar to Gallagher. And the team is excited, very energized about joining the Gallagher family. And last but not least, this is financially attractive. We are paying 10x 2020 estimated pro forma EBITDAC. It's 9.2x if you include net assets acquired and working capital. Moving into more detail by business, starting with reinsurance brokerage on Slide 11. We're combining the vast majority of Willis Re's Treaty and Facultative Brokerage Operations with the best start-up I've seen in my career, Gallagher Re. We think we should drive tremendous value for our clients, carrier partners and shareholders. We will increase our scale, add products and services in new niches and new geographies. We will become the world's third largest reinsurance broker with a presence in more than 25 countries, and we get expertise with more than 2,300 colleagues putting on a Gallagher jersey and joining our team. We also get top-notch, I mean, really world-class data and analytic capabilities. From catastrophe and capital modeling to dynamic financial analysis, tools that we can further leverage with our current Gallagher Re relationships and potential prospects. And with our increased scale and commitment to providing our teams with the tools, resources and products to win, I see us investing in and broadening out the services we provide over time. Moving to the next slide in the European retail and U.K. specialty businesses. We are equally excited about the European businesses included in the transaction. They're at scale, well-regarded brokerage operations, including the leading broker in France Gras Savoye. Operations in other key countries, representing 4 of the largest EU economies and approximately 50% of the EU's annual GDP. And most of these tend to be focused on middle market and large multinational clients weighted towards property casualty and sell across a number of niche verticals, so they align nicely with our strategy. These operations accelerate our expansion into Western Europe, the expansion that we have been undertaking thoughtfully over the past 5 years, and we can leverage our London specialty operations to better serve our retail clients. These new European platforms will allow us to continue our successful tuck-in merger and acquisition strategy. And lastly, the U.K. specialty operations. These are some attractive niches, including cyber, financial lines, space and aerospace fit nicely. This should strengthen our leading London specialty operations and complement the opportunistic aerospace aviation transaction that we announced about 2 years ago that has already been a smashing success. Moving to North American brokerage on Slide 13. We're adding $50 million of profitable business and around 100 new colleagues. These operations are focused in Houston, San Francisco and Bermuda. This should further strengthen our large account capabilities and deepen our expertise in key niches like construction and energy. We also see the potential to leverage our U.S. wholesale and our London Specialty Operations to help solve clients' needs. So overall, a compelling transaction and an exciting day for Gallagher. I'll stop there and turn it over to Doug to discuss the terms and the financials in more details. Doug?

Thanks, Pat, and thanks for joining, everyone. I'll echo Pat's comments. This acquisition is an exciting opportunity for us. Not only does it expand our global value proposition and global footprint, but it also increases our depth and expertise in many other areas of our operations. Today, I'll discuss the financial metrics of the transaction over the next few minutes, and then we can move to Q&A. So turn to page -- to Slide 6 in the investor materials. As Pat mentioned earlier, the acquired operations pro forma revenues are approximately $1.3 billion with pro forma EBITDAC of approximately $357 million. The gross consideration is 10x EBITDAC or $3.57 billion. The net consideration is about 9.2x EBITDAC or right around $3.3 billion after net assets and working capital. Of the total consideration, we're expecting to finance this using a combination of long-term debt, short-term borrowings, free cash and common equity. The split we've assumed between debt and equity allows us to maintain a prudent and conservative leverage ratio. That's very important to us. We do not want this transaction to slow our ongoing tuck-in M&A strategy. Tuck-in acquisitions are an integral part of our growth story. With this balance of free cash, debt and equity, we estimate these pro forma acquired operations are 9% to 11% accretive to our 2020 adjusted GAAP earnings per share, excluding clean energy. If we also exclude the noncash amortization expense from the calculation, it improves it to 10% to 13% accretive. This is really terrific. As for integration, we are expecting to spend approximately $350 million in total over 3 years to integrate these operations. This consists primarily of migrating the reinsurance business onto our Gallagher Re platform as well as porting over and standing up operations in France, Spain, Germany and the Netherlands. That integration number also includes purchase-related incremental retention amounts. While there will likely be wins in expense savings as we consolidate offices and bring the employees onto our systems over the next couple of years, our plan is to further strengthen our reinsurance and global footprint by reinvesting those savings in the business. Given the operations already run at a healthy EBITDAC margin of about 27% to 28%, we don't need expense synergies to make the business look attractive. And given our focus on operational excellence across the organization, longer term, we do see the potential for EBITDAC margins to slightly improve. The closing of this transaction is dependent on the European Commission, U.S. Department of Justice and other regulatory approvals as part of the pending Aon and Willis combination. While the timing of these approvals is unknown and inherently hard to predict, we anticipate closing during the second half of 2021, perhaps as early as July 1. Before we open for Q&A, let me recap. This acquisition is an exciting opportunity for us. It accelerates our long-term strategy. It adds scale and capabilities, and most importantly, talent. All the while keeping our conservative financial profile, our commitment to an investment-grade rating and delivering really attractive earnings accretion. With that, I'll turn it over to the operator for questions. Rob?

[Operator Instructions] Our first question comes from Elyse Greenspan with Wells Fargo.

My first question on, as you guys think about integrating, I'm assuming each business will be thought of kind of separately. And then I guess, I just want to confirm the integration amount you called out that will be pulled out of adjusted earnings?

Yes. To answer that question. Yes. I think if you look at this as a series of tuck-in acquisitions, like, for instance, in the U.S., we have San Francisco, Houston, and then we also -- I shouldn't say North America, we have Bermuda. We have -- we do 40 acquisitions a year in those -- in North America. So those will be nice tuck-in integration strategies there. Then when you look to Europe, really -- and Gras Savoye stood on its own for many, many years. So that should be a stand up. Germany has its own system. Spain does, the Netherlands do. So it's really standing them up on their own selves. And then the reinsurance business, we're already using the reinsurance system that was the target system in the -- that we're using that right now in Gallagher Re. So moving that business on to our system, we know where it needs to go, and we have experience doing that with our own operations. So you're right to look at it as a series of tuck-in and stand up type integrations. So it's not 2 sets of hands on everything. We've got hundreds and hundreds of hands that can do that. And the total cost, we think will be about $350 million over 3 years. And we'll adjust that out going forward.

And then are you guys willing to disclose the margins, I know we have the revenue for each of the kind of separate I guess, acquisitions, if you want to call it, North America, Europe and reinsurance? Are you willing to disclose on the margins on each of those businesses? And then, Doug, to your point that, I guess, you guys will reinvest some of the savings. I mean the EBITDAC margin here, obviously, is below the high level you guys got up to with a good amount of expense saves during the pandemic. So when you say longer term, it could go higher, I guess, can you just kind of shed more light on that a little bit, too.

Sure. Here's the thing is -- I think it's probably better that we wait until our Investor Day, maybe in June, to give you hint of margins by group. But we would say that reinsurance and certain parts of North America performed slightly higher than what we're seeing in Europe, so you could look at it that way. In terms of coming in somewhere in the 27% to 28% range. Actually, we took out our COVID savings, would be -- we're running on that. It'd be pretty close to what we're running. So it could be initially a little margin-dilutive. It's also seasonal. One thing to make sure you look at in the investor materials is that it's highly seasonal to the quarters, first and second quarter. So make sure you dig that out of the presentation. I think it's some place back on Pages 20 -- it's on Page 17, I believe, in the presentation.

And then Willis Re generates some earnings in the U.S.? The reason I ask is, I would think there would be a component of this transaction that would enable you to use the cash tax credits you have on your balance sheet, potentially quicker than if you did have the earnings coming on?

Yes. Let me -- that's a great point. We do -- there is a significant amount of the Re business that's in the U.S., let's call it, maybe half and half, half in the U.S. and half the rest around the world. We're doing that for the part of the transaction as an asset purchase. So we will get the step-up in basis for amortization, so it's a tax-deductible deal. It will -- so we get the deduction of the amortization. And you will know this, that if you get the deduction of amortization, it really enhances -- it brings the multiple down by as much as a full point, maybe 1.5 points. So that will help us on that piece of the business in the U.S., and we will use our tax credits a little faster. Is it a substantial amount each year that will be used faster? No. But between the deductible amount of amortization, between using our tax credits, it brings our multiple down, let's call it, a full turn in terms of if you're looking on a cash basis versus an EBITDAC basis.

Okay. That's helpful. One last one. You guys had $400 million, I think, of cash on your balance sheet as of your last earnings call. With the financials here, how much cash versus debt are you expecting in that component of the financing?

We're still working through that mix. There's no question we'll be raising debt and equity as a result of this. So I think that will come apparent here in the next few days.

Our next question comes from C. Gregory Peters with Raymond James.

Congratulations on what is going to really be a transformative acquisition for your company. I know I'm not supposed to say things like that on conference calls, but I know you're a company for a long time, and this is a pretty important step for you guys. Pat, every management meeting you host with investors, you always go back to the cultural aspect of Arthur J. Gallagher. And when I see this big transaction being announced and knowing some of the assets like Gras Savoye, which has been traditionally fiercely independent, it begs the question, how are you going to ensure cultural continuity going forward as you integrate these large assets?

Well, first of all, I would give a lot of credit to our counterparts at Aon, because, Greg, to your point, and I don't mind starting there. So thank you for the question. We started in discussing this with the people at Aon saying that the most important thing to us was the cultural aspect. And they granted us the opportunity to talk to the people both at Willis Re, as well as Gras Savoye, as well as Spain, et cetera. And it was those discussions that led myself, Tom Gallagher and others on the management team to say, this is a really good dynamic fit. The -- let's start with reinsurance, which is the jewel of transaction is reinsurance. We're very, very excited to be bigger at that. The complementary aspect of that with Gallagher Re right now, which you know is our best start-up is really exciting. It puts us in a position now to clearly be in the top 3 in virtually every part of the business that we touch. And it was a hole that we filled in what you're correct in calling a transformational deal. But what I'm really is excited about is, I believe that we'll be standing in front of you at our investor days, over the next few years, saying that this was not even close to a problem. This was an incredible fit. These people are professionals. They're putting -- and kudos to the folks on all these teams, keeping their teams together and certainly, talking about joining Aon, had a lot of excitement to it as well. They were able to balance that with their folks. But really, the message was let's stick together and see how this all works out. And they are very excited about joining Gallagher. And that's not a knock-on the others. It's not a knock-on our competitors. You know I have great respect for them and a lot of time for them, but it does speak to the culture. And these people know our culture in the marketplace. They know our people all over London. They know the transactions we've done in France and in Germany, Netherlands and around the world. And they know that at Gallagher, our customers come first. And quite honestly, they realize that Gallagher is a broker run by brokers. And they really, really like that, because they know that if they call Tom Gallagher, if they call Pat Gallagher and say, "Can you help me on this account? Can you go on this meeting? We are one phone call away from that, and nobody enjoys being involved in a sales process or a customer engagement more than me. So I will tell you, I think this deal is compelling financially, which is wonderful. But to me, the people we're getting are even more exciting.

Greg, I think you have been around a long time -- this is Doug. And I think you asked the same question 7 years ago when we bought Wesfarmers, Crombie Lockwood, OAMPS, OVAL, Giles and Noraxis, kind of all in a year period. And when you look at those operations now that are selling insurance, embodying the Gallagher way, feeling part of a team I think that the track record that we've had there should be repeated here on this acquisition. So we did it 7 years ago on those 5 different pieces of business coming together all in about a 12-month period. And I think as we look at these being a series of combinations of, call it, 6, 7, 8 different operations, they'll really like being a part of Gallagher.

So -- and one of the comments in the reinsurance piece, I think you talked about getting the data analytics business. And I know that is a crown jewel of Willis. In the Aon Willis Towers Watson merger announcement and some of the marketing material, they talked about the enhanced power of data analytics from the combined entities. So I'm trying to understand what part of the data analytics that you're getting that Aon Willis Towers Watson is not getting. But they -- I'm trying to understand where the line of separation is. Does that make sense?

Yes, Greg, it does, and there's no real line of separation. This is not a have versus have not. And that's an important part of the transition agreement that we're doing with them. Part of the remedy here is that they can't sell us an operation and then have that operation not be able to compete. So when you think about the data and analytics, both parties will have the systems necessary to do that analysis. And they'll have the capability of culling that data. So it's really, to us, moving to another level. It's an area where we were behind. And I think that will take us to another level that's very exciting. And truthfully, data analytics across all of our businesses now is probably becoming one of our absolute top 3 key focuses because that's where the world is going.

Greg, do you mind if we can take another call. We've got a sunset on this in 5 minutes. I appreciate your comments. Do you mind if we jump to another one?