Like many companies these days, Aon, the $8 billion risk-management, insurance, and human-resources consulting firm, has lots of excess cash. Unlike many, however, it knows exactly how it wants to allocate it: to buy back shares.
To be sure, the company isn’t completely single-minded about buybacks. In its quest to become the biggest risk and human-capital advisory firm in the world, Aon has made two major acquisitions in recent years. In 2008, it bought Benfield, a leading reinsurance broker, for $1.4 billion. And last fall it acquired Hewitt Associates, a prominent brand in the employee- benefits administrative and consulting arena, for $5 billion.
But Aon believes it can generally get more bang for its buck via buybacks. Under a share-repurchase program that began in 2005, the firm’s board authorized the repurchase of up to $4.6 billion worth of outstanding common stock, a target it has nearly reached: as of the third quarter of 2010, the firm had bought up $4.4 billion. There are no worries about reaching the limit, however: last year the board authorized a new buyback program of up to $2 billion.
When it comes to budgeting and planning, Christa Davies, Aon’s CFO since March 2008, adheres firmly to that corporate directive. “For us to spend cash on anything else, it has to beat share buyback, which sets the bar for all other capital investments.” We asked her to explain why.
What drives your overall decision-making around cash?
We are a very cash-generative business, and require very little capital to run. When we think about optimizing our return to shareholders, return on invested capital [ROIC] is our main metric. We use cash-on-cash to measure that return. If you think in terms of mergers and acquisitions, cash-on-cash is the return that M&A generates on a cash basis over the cash we’re spending on M&A.
We think about that ROIC for each form of investment, whether that’s M&A, organic investment, or the firm overall. We’re trying to drive an improved return on capital in every investment decision, as well as holistically for the firm.
You have a strong commitment to buybacks, but what else have you invested in?
The big uses of cash for us include organic investment to drive increased content and capability for clients. We’ve invested more than $800 million over the last five years in content and client-facing capability, such as GRIP, our global risk insight platform, where we now have more tan $40 billion of premium [transactions] in one database. In terms of M&A, we’ve changed the portfolio of the firm quite a lot to optimize return on capital. Acquiring Hewitt and Benfield, and disposing of our insurance underwriting businesses for a little over $3 billion, produced quite a substantial portfolio change in terms of capital. [In April 2008, Aon sold Combined Insurance and Sterling Insurance to ACE and Munich Re, respectively.]
Two other big uses of capital have been pensions and restructuring. We’ve got an underfunded pension plan that we continue to fund along minimum regulatory requirements. In terms of restructuring, we’ve done substantial operational-efficiency improvements in the business through more than 400 acquisitions over the last 20 years. As we integrate them, it really requires a serious investment to run the firm in a globally efficient manner.
But share buyback has been our primary use of cash, because we believe that the value creation at Aon over the next five years will be substantial and that we are quite undervalued today. Essentially, you’re buying a $60 stock for $40.
How do you come to the conclusion that you are undervalued?
We recalculate on a weekly and monthly basis to figure out how to optimize the portfolio. We determine how much cash our firm is going to generate over the next 5 or 10 years, and then we discount that back to give us the value of the firm today. In that way, we can see that the firm is substantially undervalued in the market today, which means that buybacks drive the greatest return for shareholders.
Given your commitment to buybacks, can you imagine ever setting a new standard?
Anything could change, but over the last three years, share buyback has generated the highest return of any form of capital usage. Having said that, however, a large deal, like our acquisition of Benfield, can exceed that. That acquisition generated a higher return than share buyback, which was the only reason we did that deal.
What made the Benfield deal so successful?
One of the key things that has happened in the reinsurance arena is that it has become increasingly complex for clients, which are insurance companies, to manage risk. They really need data and analytics to help them analyze risk and make sure that they are managing their costs, decreasing volatility, and freeing up capital. And we were already strong in that regard.
At the time of the Hewitt acquisition, some shareholders said you paid too much. Is the logic of that deal also predicated on achieving certain synergies?
We believe that we got Hewitt at a very attractive price for shareholders: 7.5 times EBITDA. Including synergies, [it works out to] 11.5 times EBITDA.
As far as synergies, there are four big buckets. The first is the removal of public-company costs from Hewitt. The second is back-office costs, because there is an overlap in such things as IT and real estate. The third is front-office cost, mostly in the consulting space. And the last stems from the fact that Aon had a $200 million benefits-administration business that was roughly break-even, whereas Hewitt had a $1.5 billion benefits-administration business that runs at a 25% profit margin. We’re moving Aon’s subscale business onto the much-larger-scale platform of Hewitt.
Do you think the new health-care law will drive growth in the benefits-administration business?
Yes. Helping clients navigate through what is a very complex piece of legislation and remain in compliance with increasingly difficult regulatory changes is a very big growth opportunity for us, both on the consulting side and on the outsourcing side.
In fact, you might say that all the tumult of the last few years has been good for your businesses across the board.
It’s a strange industry to be in, but, unfortunately, bad things happening generally drives demand for risk-management services, whether it’s an earthquake or a hurricane or financial disruptions in the market. There are so many risks today: pandemic risk, environmental risk, and business supply-chain risk, just to name three. In the latter case, it’s often because businesses are increasingly moving their supply-chain functions offshore. There are just so many risks, other than just the standard property-and-casualty risks, that companies need to manage effectively today.
What’s been your biggest worry as CFO?
The thing I worry about most is how to effectively simplify a very complex organization so that we can be better aligned with our clients. We have acquired so many companies over the last two decades. Bringing them together into a global professional-services firm has been a huge amount of work, and I think we’ve got a long way to go.