Willis Buys HRH for $2.1 Billion

By | July 7, 2008

Combined Firm Doubles Employee Benefits Business

Willis Group Holdings Chairman and CEO Joe Plumeri holds a reputation for taking on challenges. On June 8 his company gave him one. Willis announced it has agreed to buy Virginia-based rival Hilb Rogal & Hobbs for around $2.1 billion.

Willis said the deal would double its “North American revenues and strengthen its leadership in attractive growth markets.” Specifically it will more than double its “high-growth employee benefits business in North America,” as well as adding “breadth and depth to other key practice areas.”

Under its terms, a new organization will emerge in North America, renamed Willis HRH. It will be led by an Office of the Chairman, including Don Bailey, currently CEO of Willis North America, as chairman and CEO, F. Michael Crowley, currently HRH president and COO, as president, and HRH Chairman and CEO Martin L. Vaughan III, as vice chairman of Willis Group Holdings.

Willis will acquire all of the outstanding shares of common stock of HRH for $46.00 per share, 50 percent cash and 50 percent stock. The stock component is subject to a collar, which sets the value “based on the average trading price of Willis common stock during the 10-day period ending two days prior to the closing date. The deal has an equity value of approximately $1.7 billion and an enterprise value of approximately $2.1 billion. The transaction is expected to close in the fourth quarter, and is subject to customary closing conditions, such as regulatory and HRH shareholder approval.

Willis is roughly three times the size of HRH with a market capitalization of $4.77 billion, compared to HRH’s $1.61 billion. The share price represents a substantial premium. As recently as the end of April, during the negotiations, HRH shares traded at a 52-week low of $26.21. Willis has been more profitable than HRH with an EBITDA (earnings before interest expense, income taxes, depreciation and amortization) of $680 million in 2007, compared to HRH EBITDA of $186.78 million.

Willis said that the total purchase price of $2.1 billion represents a multiple of 2.4 times estimated 2008 HRH revenues and less than 10 times estimated 2008 EBITDA, including the assumption of an estimated $400 million of HRH debt. Annualized synergies are expected to amount to about $140 million by 2012.

Contingent Commissions

The deal raised comments about contingent commissions. Willis was the first global broker to say that it would no longer accept them, and Plumeri has repeatedly stressed the point. However, just two days before the acquisition announcement, Aon reached a widely publicized agreement with the five government agencies that supervise its 2005 regulatory settlement agreement (see “Extension,” N2).

Through an amendment, companies that Aon acquires that still accept contingent commissions will be permitted to continue doing so for a period of three years after the acquisition. Willis had reached a similar accord.

Queried on the subject, executives in Willis’ London office responded in a written statement to Insurance Journal: “While we knew that there was a possibility that Andrew Cuomo, the New York attorney general, might amend the 2005 settlement terms, it was a fortunate coincidence that the two developments occurred simultaneously.”

However, Willis confirmed the move did not change its view on contingents. “We still think that the insurance brokerage industry should not take contingent compensation because it is not in the best interests of clients,” Willis responded to IJ. “Consistent with the agreement that Willis reached [in mid-June] with the New York State Attorney General and New York State Department of Insurance — and in keeping with the Willis commitment not to accept contingent compensation — Willis will phase out HRH’s contingent commissions in three years.”

Willis also noted that accepting the interim payment of contingent commissions would “create a level playing field and a fair competitive environment because it allows us to make competitive bids for companies by retaining some of the earnings.”

Rating Agencies Comment

Nothing is perfect, however. Two rating agencies indicated the acquisition might strain Willis’ finances. Standard & Poor’s lowered its counterparty credit rating on Willis to “BBB-” from “BBB,” and assigned a negative outlook. Fitch Ratings put Willis on its rating watch negative list. A.M. Best has adopted a wait-and-see attitude.

Credit analyst Tracy Dolin explained S&P’s stance: “We believe that the transaction will further solidify Willis’ competitive market position and local presence in U.S. insurance brokerage; however, Willis intends to increase its usage of debt, thus further leveraging the company.”

The Willis executives affirmed: “We are committed to maintaining Willis’ investment grade rating which we have done with all three major rating agencies,” adding that despite borrowing additional funds, the company “is producing strong financial results.”

As Willis stated, the acquisition of HRH’s employee benefits business will “more than double” its revenues in the sector, which is expanding rapidly. Willis executives noted: “It has huge growth potential. Benefits are an issue for virtually all companies and we are seeing more firms seeking out advice in this area, especially in the emerging markets.”

In addition it’s a “stable, non-cyclical business and as such is an excellent hedge to the vagaries of the pricing market — this is particularly true when compared to the volatile reinsurance market.” Willis expects to see revenues from its reinsurance businesses, “which accounted for 15 percent of its revenues in 2007,” decline to “around 12 percent of the revenue of the combined company,” while the “employee benefit business will increase from 10 percent of Willis’ current revenues to 13 percent.”

Plumeri has experience integrating companies. He did after all lead Citibank’s integration with Travelers (even if they later divorced).

Willis would appear to have enough on its U.S. plate but additional acquisitions are not entirely out of the question. “We are not planning more acquisitions of this size in the immediate future, particularly in North America where we will be devoting our energies to integrating HRH,” the Willis executives told IJ.

“However, we won’t rule out the possibility of small-scale acquisitions where opportunities arise that could benefit Willis and support our Shaping our Future strategy [a specific set of initiatives to drive profitable growth], particularly outside of North America.”

Three-Year Extension

Back in 2005, three major brokers agreed to cease taking contingent commissions as the result of a multi-state investigation and settlement. Now, each has inked a deal with the states involved which will allow the brokers — Aon, Willis and Marsh — a three-year window to phase-out contingent commission payments at any new broker-company they acquire.

The agreements, which were signed in May, create similar guidelines for each company, which regulators say are aimed at increasing transparency in commission payments.

First, contingent commission payments on existing clients’ accounts must be phased out within three years at any company, brokerage or agency acquired by one of Aon, Willis or Marsh. The acquired firms are prohibited from collecting contingent commission on any business they weren’t already, and on any new business produced after the acquisition. In addition, the commission structure must be disclosed to the clients of an acquired company.

Aon spokesman David Prosperi said the changes to the original settlements will help level the playing field in the market to buy broker-firms, since companies that were uninvolved in the settlements could get more revenue — contingent commissions — from acquired brokers.

The agreements were signed by all states that were party of the original settlements: New York, Connecticut and Illinois.

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