Willis Towers Watson

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Willis Towers Watson (WTW) is a leading global advisory, broking, and solutions company providing data-driven, insights-led solutions in the areas of people, risk, and capital. The company operates as an intermediary between insurance companies and businesses and individuals.

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The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

WTW’s operations are spread across three main segments: * Health, Wealth & Career (HWC): Provides health, retirement, benefits, and human capital consulting services to clients. * Risk & Broking (R&B): Offers insurance brokerage, risk management, and actuarial services. * Corporate: Focuses on developing new technology solutions and global strategies, including the TRANZACT subsidiary. Each of these segments contributes to WTW’s diversified revenue streams. HWC revenue is mainly driven by changes in medical and retirement plan design; R&B revenue is driven by the demand for risk consulting, and risk transfer activities; and Corporate revenue is linked to software utilization and general corporate spending. All of these, therefore, are subject to macroeconomic and cyclical volatility.

Revenue has been largely stable, albeit with some growth. The company has experienced relatively predictable revenues, but has not been immune to external factors like COVID-19 and inflation. Revenue growth was affected in 2021 by increased retirements and benefit contributions during the pandemic. It’s important to emphasize here, that, a lot of WTW services are tied to recurring revenues, allowing some resilience in economic downturns. The revenue mix has a large focus on consulting and broking services (94% in 2023) which can have volatility due to their project-based nature. The majority of revenue is sourced from the USA, followed by the United Kingdom, Europe, and other countries.

  • Moat: I would give WTW a moat rating of 3 out of 5. Here’s the justification:
    • Switching costs: WTW benefits from moderate switching costs in some of its areas, particularly the retirement and healthcare business, where moving to a new advisor can be time-consuming and costly for clients. However, the company’s large portfolio and complex products make it hard to pinpoint these switching costs. Some specific products like reinsurance can have strong lock-in, as the new provider would need to understand the complex risks.
    • Intangible Assets: WTW operates a client data moat (databases of information). But these are generally for sale and shared among the industry, thus, not giving an edge. In terms of brand, a general perception of a leading, reliable provider is there, but whether the company has a meaningful premium is not clear.
    • Economies of scale: WTW operates with a high economies of scale and has a lot of leverage due to its large business, this helps keep prices competitive.
    • Network Effects: Although many companies are using software to solve similar problems, many people still have the knowledge of legacy software. This means that if WTW has a big existing network of engineers using their software, they have an edge due to network effects, as this would lower their client’s costs of adoption.

    It is important to note that, although the business has elements of economic moats, these are not overwhelmingly strong, hence the rating of 3/5.

  • Risks to the Moat and Resilience:
    • Technological disruption: New tech may render their specific services obsolete, such as the rise of new AI based models.
    • Competition: The increasing number of consulting firms and risk-management providers has put pressure on WTW to innovate and provide cost-competitive services.
    • Economic downturn: As many services of WTW are tied to the business cycle, a recession could result in lower revenues.
    • Regulation: As a company providing insurance services, regulation changes and government policies may impose significant challenges to WTW’s profitability and operations. For instance, new government tax laws could affect the tax benefits offered by their services.

    Overall the business has good resilience, as it has diversified its sources of income and operations, thus can withstand individual shocks that a specific business segment might face. It is also well-positioned to adapt to changing situations, and has the expertise and skill to manage many market conditions. However, their exposure to a highly competitive market and the reliance on technology makes the business vulnerable.

  • Business Explanation:

WTW acts as an intermediary between its clients and insurance providers. So, it’s important that they stay up to date with the latest changes in both fields. WTW also has to handle many different and new risks, such as climate change, which might influence its margins and pricing.

  • Revenue Distribution: Revenue is largely driven by consulting (HWC) and insurance brokerage (R&B) services which provide a diversified stream of revenue. TRANZACT provides further diversification through software and technology solutions. The revenue comes from the geographical spread of the company, with the U.S. market being the largest revenue driver. In 2023, about 43% of its revenue came from the U.S., and 57% came from international markets. The company also has a significant percentage of revenues from large clients (about 78% of revenues from large clients in 2022). A lot of clients also have recurring yearly contracts with WTW. This indicates a robust revenue stream, which has some resilience.

  • Trends in the Industry: The insurance industry is undergoing changes due to tech and regulation. As technology becomes more important, insurance companies must seek help from firms like WTW to help integrate these new solutions. Regulation is also putting more pressure on insurance companies to keep track of everything. These changes pose both a threat and an opportunity for WTW.

  • Margins: Gross margins are excellent, at an average of around 50% in the past 5 years. But operating margins were only around 15%, showing that there is a lot of expense associated with running this company. The company also had a negative net income of 2021 (due to a big impairment of goodwill and acquired intangibles), but recovered by 2022 and onwards. This shows some resilience of their operations, and their ability to adjust. However, the company’s margin is still vulnerable to large scale changes in their expenses, and their cost of revenue has been increasing year after year.

  • Competitive Landscape: The market is highly competitive, with other large consulting firms like Aon and Marsh & McLennan, as well as niche players in individual sectors. To maintain its competitive advantage, WTW relies on brand recognition, client relationships, and proprietary data. In each particular sector, WTW faces different competition. For instance, in the retirement benefits space, the company has tough competition, but the situation is different for their insurance products.

  • What Makes WTW Different? WTW has a broad expertise in many different consulting, actuarial, and brokerage services, and this large product portfolio makes them unique. They also have a strong technological expertise and use data analytics for insights, this makes them more competitive in the market. They also have a global scale with multiple offices in the world, allowing them to serve clients in many different markets with ease.

  • Financials: The revenue has been mostly stable for the past few years, but the expenses have been rising. Net income is generally stable, with a high profit margin. The company has a large pile of assets (primarily intangible), but also has a good amount of short-term and long-term debt to pay out. The free cash flows are volatile, though, and the company sometimes has a negative free cash flow. This is mostly because the company acquires other companies with cash. Also the company has a negative shareholder’s equity, which is not a good sign.

  • Understandability Rating:: I would give WTW an understandability rating of 4 out of 5. The company is in the consulting and financial industry, which is highly complex and specialized. The company operates as an intermediary in insurance sales and services, providing advice on many different topics such as risk management, benefits administration, and technological solutions, which, can be difficult to understand. However, the basic ideas of the business model are easy to comprehend, hence 4.
  • Balance Sheet Health Rating: I would give the company a balance sheet health rating of 4 out of 5. The large intangible assets (goodwill and customer relationships from M&A) coupled with the high debt make the company somewhat vulnerable. It is good that they have recurring revenues to meet their liabilities and operating expenses, and it is also commendable that the company is trying to lower its debt and expenses. However, there are a lot of liabilities and not enough assets.
  • Recent Concerns and Controversies: The most recurring criticism, which management has tried to address, was regarding the high leverage of the company. The company has been working hard on deleveraging itself and trying to improve its free cash flows. They have cut costs and have put in various initiatives to increase income (like focus on higher growth businesses), and increase the number of recurring contracts, which is a good sign. They are also focusing on streamlining operations to improve performance. They also mentioned that revenue is tied to their business strategy (for their long-term benefits) and the sales cycles might vary.
  • Another concern mentioned repeatedly is the effect of currency fluctuations on their revenue and profit projections. As a multinational company, the fluctuation in foreign currencies may cause volatility to their profits, or their profits may shrink, if foreign economies do poorly. While they acknowledge this effect, they say they do not do any active adjustments to it, rather letting the market dictate the correct prices.
*   The company is also facing increased competition and some challenges in their health and benefits space because of the new focus on Medicare Advantage and the shift in healthcare in US. This poses a risk to the company's performance in the coming years. However, they are looking into offering more services and having larger contracts with clients to maintain and improve their position.
*   They are also focused on expanding in new geographical markets, especially emerging markets.
*   Management has also admitted to underinvestment in R&D and marketing in the past. And, that to improve their long term prospects, these investments have become necessary. These initiatives might hurt short term earnings, but have the potential to improve them in the long run.
* Management believes the transformation program, though affecting the costs of operation, are necessary, and they will deliver value and revenue increases in the long run.