|Shares Out. (in M):||74||P/E||0.0x||0.0x|
|Market Cap (in $M):||3,700||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-120||EBIT||0||0|
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Towers Watson (TW) is a high quality business that generates substantial free cash flow, has a net cash balance sheet and trades for less than 12x current year EPS. Using conservative assumptions, we believe EPS will increase nearly 50% over the next several years while additional cash accumulates on the balance sheet. A variety of factors that collectively put TW in the "special situation" bucket seem to be obscuring value here, a situation that we suspect will not persist for long.
TW is the product of the January 2010 merger between Watson Wyatt (formerly publicly traded under the ticker "WW") and Towers Perrin (formerly private). TW provides consulting and outsourced services for major corporations worldwide. The company's primary businesses include:
We believe that TW possesses an industry-leading consulting franchise with significant BTEs, good pricing power and stable revenues (overall, roughly two-thirds are recurring). The core business, providing actuarial work to pension and health plans and complex actuarial/reporting services to insurers, is highly defensive (even exhibiting some counter-cyclicality), yet TW offers upside in the form of unrealized merger cost synergies, a net cash balance sheet and discretionary businesses (about one-third of revenues) operating at trough levels. Mgmt also has a good reputation for execution, capital deployment and conservatism (no surprise given their actuarial backgrounds). Overall, we think the WW-TP merger created a superior franchise, and that TW's current price offers a very attractive risk-reward proposition.
In terms of valuation, TW is cheap relative Watson Wyatt's historical trading range (10-20x P/E ratio range, ~16x average forward P/E ratio over the last five years) and to the broader opportunity set. Deal-related inefficiencies are likely contributors to this depressed price level. We believe that a 14x P/E ratio more appropriately reflects TW's earnings power and growth profile. Applying this multiple to our FY-13 (June 2012) EPS estimate of about $5.30 yields a stock price of $74. This excludes nearly $7 per share in net cash that accumulates in the interim (note that we assume moderate stock buyback activity). Meanwhile, we struggle to see a scenario in which TW earns less than $4.00. Even if business conditions deteriorate, the company has at least 50c of EPS coming from incremental (i.e. post-FY-11) cost synergies in addition to copious free cash flow available for stock buybacks.
FY-10 FY-11 FY-12 FY-13 FY-14
Revenue 3,181 3,209 3,320 3,466 3,620
Adjusted EBITDA 503 556 585 627 654
Adjusted EBIT n/a 476 505 547 574
Adjusted EPS 3.52 4.20 4.60 5.28 5.91
Consensus EPS n/a 3.98 4.55 4.50 n/a
Adjusted EBITDA Margin n/a 17.3% 17.6% 18.1% 18.1%
Adjusted EBIT Margin n/a 14.8% 15.2% 15.8% 15.9%
FCF / Share n/a 4.57 5.18 5.89 6.53
Net Cash / Share 1.62 3.16 5.39 6.83 8.54
P/E Ratio 11.9x 10.9x 9.5x 8.5x
EV/EBITDA Ratio 6.5x 6.1x 5.7x 5.5x
FCF / Share Yield 9.1% 10.4% 11.8% 13.1%
Disclaimer: we and our affiliates are long TW. We may buy or sell shares without notification. This is not a recommendation to buy or sell shares.
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