The Making of a Mega: The New $3.5B Towers Watson & Co.

Tower Perrin's Mactas, meanwhile, will serve as Towers Watson's president. He says the fit between the two firms is "excellent, starting with a deep commitment to client service and shared values of integrity, professionalism and respect. Our service lines and geographic strengths are also highly complementary, which creates great opportunities for growth. We couldn't be more excited about this combination, which will change the landscape of our industry."

No doubt. If the merger of their respective firms goes as planned, Towers Watson stands to emerge as the world's second largest HR consulting practice (behind only Mercer HR). If the integration plan falters, it could become a tremendous opportunity for its competitors to gain clients and disenchanted consultants. Either way, the HR consulting marketplace, as Mactas indicates, will be significantly altered.

Shakeup and Shakeout
Even before this mega deal was announced on June 28, it was clear that the HR consulting market was primed for change. The economic downturn was beginning to take its toll on HR consulting firms. Watson Wyatt, Hewitt and Mercer HR (the three biggest publicly-traded HR consultancies) all reported softening demand in their most recent quarterly earnings statements.

Historically, HR consulting firms have tended to lag the rest of the consulting profession. They are generally the last ones to enter a downturn and the last ones to experience a recovery. So, the HR consulting market is just beginning to feel the pinch in demand the rest of the profession has felt all year. The revised growth expectations by leading HR firms, and the limited growth prospects for the overall HR market (as estimated by Kennedy Consulting Research & Advisory), suggested that some bold steps could be in the offing.

The most widely expected move was an IPO by Towers Perrin. "Going public was something we wanted to do. We wanted to give ourselves the option and had started investing in our underlying reporting systems. We started using GAAP financials and working at bettering our reporting and controls," Mactas tells Consulting.

From his perspective, the key advantage of going public was to have a currency with which to make acquisitions, filling out the firm's service strength across the globe.
"We've watched Watson Wyatt grow quite a bit by using its public currency. It's the big advantage of being a public company," he says. "As we were thinking about where we were going as a firm, we knew we wanted to have the ability to be involved in [merger and acquisition] opportunities that might occur. Where there are M&A opportunities, you need to act fact. It's not that private companies are shut out from bidding, but being public makes it easier."

The ability to offer stock options to retain consultants is another advantage of being a public firm. Ashwin Shirvaikar, Citi director and senior analyst in charge of the business and professional services sector, says that relative to the other large HR consulting practices (Mercer HR, Hewitt, and Watson Wyatt), Towers Perrin "has been a relative market share loser because its people were leaving to join the other HR firms to get stock compensation."

"I'm piecing this together from various pieces of information I have heard, but I think they were getting ready for an S1 filing [the SEC document that announces a company's intent for an IPO] later this year or early next year," Shirvaikar says. "It would have would have made Towers Perrin a more formidable competitor. "

Joining with Watson Wyatt, accomplishes the same goal, of course, but with additional advantages. First, it gains a partner during its transition to public life. Watson Wyatt's CEO and CFO, veterans of running a public consultancy, will retain their roles within the combined firm and provide invaluable continuity of leadership. Second, the combined firm will go to market as a better positioned company than either firm was on its own.

There are a number of areas where one firm is stronger than the other. For example, Towers Perrin brings a much bigger healthcare practice to the table than Watson Wyatt has, Mactas says. Similarly, Towers Perrin is larger in Latin American and Canada than Watson Wyatt. "Our pool of talent suddenly got a lot stronger," he says. On the flip side, Watson Wyatt has a much larger investment consulting practice and a more substantial presence in Asia than does Towers Perrin. In the insurance practice, Watson Wyatt is stronger in Europe and Asia, while Towers Perrin is bigger in North America.

Merger Raises Questions
However, combining two large practices isn't without potential pitfalls. "The challenge is going to be around executing on these synergies," says a former Watson Wyatt practice leader who spoke to Consulting on condition of anonymity.

"Watson Wyatt has just never been good at assimilating or integrating similar businesses into the core practice. The firm has successfully integrated small tuck-ins. The deal that brought the Watson and Wyatt businesses together were more about adding a UK capability to a U.S. firm and vice versa," the former practice leader says. "The firm has not successfully incorporated another business with significant overlapping practice areas."

Initial investor sentiment doesn't bode well. The firm's stock price fell almost eight percent the first trading day after the merger was announced. Citi's Shirvaikar downgraded the firm, encouraging his investor clients to hold, rather than buy, Watson Wyatt's stock because of several concerns with the merger. Over the long run, he says he agrees with the "eventual strategic intent" of the ideal. But, he thinks there will be a "difficult path to get there."

First, he worries that those office leaders that lose their role, title and responsibility to their counterpart from the other firm may seek employment elsewhere. Towers Watson management is "doing what they can to lock people up by stretching the vesting of stock options out over several years. However, it's going to be a slow, painstaking process.

There is no doubt in my mind that there will be dissatisfied people," he says. "There will be some level of attrition and some client relationships will go away." Shirvaikar says he worries most about attrition from the Watson Wyatt side of the firm. Towers Perrin partners are in line for a big payday if they remain with the firm throughout the vesting process.

A source familiar with the terms of the deal says that a typical Towers Perrin partner will have the opportunity to be vested with stock worth approximately three to four times what their share of their current firm is worth. So, a partner with a $500,000 ownership stake in Towers Perrin could end up with between $1.5 million to $2 million in Watson Wyatt shares.

However, there is less motivation for the Watson Wyatt staff to be excited about the deal. At the end of the day, they are being told that they will have to compete for their jobs and face losing client relationships in the process, Shirvaikar says.

The good news for Towers Watson is that because this integration is occurring during a downturn, the firm may be able to minimize the spike in attrition that typically follows a big M&A deal. "From a retention perspective, those that are dissatisfied might not have another place to go in every vertical and geography," Shirvaikar says. Second, the announced plan lays out a three-year horizon to fully integrate the two firms. "Three years is a much longer time frame than 98 percent of investors I talk with are comfortable with—for many of them even three quarters is a bit long," he says.

The problem with a long integration process is that it means a lot of questions will remain open for an extended period of time. "The issue is that people want an answer right now to any number of questions that can't be answered today because a lot of information on the Towers side is not available or Watson Wyatt management is unable to provide. It's like doing a jigsaw puzzle with only half the pieces," Shirvaikar says. "It's harrowing from a consultant's perspective because you can't say anything to clients because you don't know the answer."

Third, Shirvaikar worries that the stock awarded to Towers employees vests each year for four years, which can result in a severe share overhang over four years and could lead to consultants leaving once the vesting period is over. "What I've seen at Watson Wyatt's own acquisition of its UK based practice was that a large number of LLP consultants took advantage of their initial stock vesting." A similar scenario could play out with Towers Perrin people, he says.

Fourth, there will likely be a modest wave of clients that will leave due to conflicts between the two firms. When it comes to executive compensation work, a single consultancy cannot provide independent advise to the board and serve management.

"It's not the firm's choice as to which side of the business they keep. It's often the client's choice," he says. Haley and Mactas don't yet know the extent of the overlap because they are prohibited from sharing client information until the deal closes. "It's anybody's guess, but I do not think it will be a huge impact," Haley says.

Cultural Hurdles
There will also be cultural challenges to the deal. "The move from a private to public firm won't be easy. They are totally different ways of doing business, different reporting systems, new financial reporting systems changes, etc.," says Bill Kelly, president of Kelly & Co, an executive search firm that works extensively with large benefits and human resources consulting firms.

Something as basic as a sales approach is also different for the two firms. Watson Wyatt has dedicated sales people while Towers Perrin's partners do most of the selling. "Towers Perrin tried using dedicated sales folks for a while, but went back to partner selling," Kelly says. "I've got to think there will be a lot of culture shock."

In the end, the senior management of Towers Watson "will be internally focused for sometime now. They'll be distracted by the deal itself," Shirvaikar says. "For now, this deal is good news for Mercer HR and Hewitt."

This merger may also be good news for smaller HR consultancies, Kelly says. Following the merger, "there will just be three major providers instead of four. When companies look to hire an HR consulting firm, they tend to need a shortlist of at least four to five firms to choose from. So, with fewer options, this could give firms like Aon and Willis and even smaller HR firms new exposure to bigger clients."

Merger By the Numbers
Combined, the HR consulting practices of Watson Wyatt and Towers Perrin would have revenues of just over $2.5 billion, split 53 percent from legacy Watson Wyatt and 47 percent from Towers Perrin. The two also house  outsourcing and non-HR consulting practices (mostly Towers Perrin's business advisory services practice) that put the total combined revenues of Towers Watson & Co. at about $3.5 billion.