Trying to put a lid on rising costs, Starwood Hotels & Resorts Worldwide last week shifted 26,500 of its full-time employees from its in-house health plan to a private health-care exchange administered by Towers Watson.
If recent history is any guide, the owner of the Sheraton and Westin hotel chains won’t be the last big company to outsource its health plan. Time Inc. moved its active employees onto a private exchange in early February; big firms, including IBM and DuPont, have shifted Medicare-eligible retirees onto these exchanges, which allow workers to make their choices online in much the same way they now handle their 401(k) selections. Companies provide their employees with regular contributions.
Barron’s highlighted this trend a year ago (“And Now for the Real Health-Care Reform,” March 31, 2014), and it has begun to gain steam, especially at Towers Watson (ticker: TW), which has posted two straight quarters of strong revenue driven by the exchanges. By the end of this fiscal year, the benefits consultant forecasts that it will have at least 1.2 million people enrolled on exchanges it manages, up from 800,000 at year-end 2014.
INVESTORS HAVE ALREADY STARTED to appreciate the opportunity for Arlington, Va.-based Towers, with some analysts notching up the shares’ target price by roughly 20%. Corporations want to rein in health-care costs, which continue to rise at a 7% to 10% annual clip. Another inducement: the proposed threat of a government-imposed 40% “Cadillac” tax in 2018 on companies that pay more than $10,200 in health benefits to individuals and more than $27,500 to families. Towers estimates that a company can realize first-year savings of as much as $1,400 per employee.
The longtime consultant, which prides itself on having the most actuaries in the world, is now a leader in a fast-growing field. Towers puts its share of the corporate-retiree market at 65%, and management believes it can maintain at least that share as the market grows.
Much bigger and more lucrative for Towers is the market that companies such as Starwood and Time are creating by putting active employees on private exchanges. By 2020-21, Towers predicts it will garner 25% of this market, or roughly seven million to eight million participants based on a projections of 30 million enrollees in that time.
Within six years, Towers expects that its Exchange Solutions unit (OneExchange is the product), which runs programs for retired and active employees, will represent 40% of its revenue base, up from 10% of about $3.6 billion now. Exchange operating margins are forecast to expand toward 30% from about 20%.
“We think health-care exchanges are a very exciting way to provide insurance to employees,” says John Haley, 65, Towers’ chairman and chief executive. He previously led Watson Wyatt Worldwide, which merged with Towers Perrin in 2010 to become the biggest benefits consultant in the world, with a market valuation of $9 billion. “Health exchanges are a growing area for the company and a growing area for the country. A large part of health care will be delivered this way, and we aim to be one of the big players in that market,” he says.
It already is. After acquiring Extend Health three years ago, Towers became the No. 1 exchange provider for Medicare-eligible retirees and No. 2 for active employees, behind Aon Hewitt, a unit of insurance broker Aon (AON). This year, Towers is expected to edge ahead of Aon Hewitt, based on the total number of employees on its exchanges. Industry growth has a much bigger impact on Towers’ bottom line because the business represents just 2% of parent Aon’s revenue. Marsh & McLennan ’s (MMC) Mercer unit and Xerox ’s (XRX) Buck Consulting also provide private health-care exchanges.
Towers posted fiscal second-quarter results well ahead of Wall Street’s expectations, reporting record revenue of $958 million, up 8% from a year earlier, and net income from continuing operations of $110 million, or $1.73 a share. Its Exchange Solutions segment saw revenue jump 42%, and its other core consulting businesses turned in solid performances.
For the full fiscal year ending in June, the company expects to report revenue of $3.6 billion and has slightly raised its projections for adjusted earnings, to $5.90 to $6 a share, on net income of about $420 million.
WITH EXPECTATIONS RISING, some analysts and investors see Towers shares, at $130.39 last week, rising another 20% in the next year; that’s on top of 15% so far in 2015.
“As earnings growth accelerates, there will be multiple expansion and a rerating of the stock,” says George Tong, analyst at Piper Jaffray, who raised his target on the shares to $157 following the company’s strong second-quarter report. “They are reinventing the blueprint of the company with the exchange business, and there will be an inflection point of exponential growth when adoption rates pick up.”
Tong’s price target assumes that Towers’ shares will eventually command a multiple of 12.5 times his calendar-year 2016 estimate of enterprise value to earnings before interest, taxes, depreciation and amortization, up from 11.8 currently. That would put it on par with rival Aon.
Because health care is so important to attracting and retaining employees, companies have been slower to move their active employees—a market that’s 10 times the size of retirees—to an exchange model. But with annual savings in the range of 5% to 15% and the expanded employee choices available from multiple carriers and plans, the exchanges make for a compelling value proposition, says Haley.
As do the shares of Towers Watson.
Date: April 4, 2015