Many investors in professional services firm Towers Watson (TW) have viewed the recent merger with reinsurer Willis Group (WSH) as a raw deal for TW shareholders. The crux of their argument comes down to the fact that the value of the deal, based on share prices before the deal was announced, was a ~12% discount to where TW had been trading.

Implied Synergies Don’t Match Reality

To analyze this acquisition, we’ve created a synergy impact analysis visualizing this deal from both perspectives, either as Willis Group buying Towers Watson, or Towers Watson buying Willis Group. This analysis is possible since this an all-stock “merger of equals”.

What we find is that, if we visualize the deal from the perspective of Towers Watson buying Willis Group, they’re paying a premium of $1.86/share or $321 million above market price. This scenario assumes estimated cost savings of $100-$120 million and potential tax savings from moving the headquarters to London of up to $80 million. We still see the synergies come up short, though not by that much.

However, if we look at the deal the other way, as Willis Group buying Towers Watson, it becomes clear that Willis Group is getting, by far, the better end of the deal here. The purchase price implies negative synergies of $887 million, which seems bizarre because, as mentioned, Tower Watson’s cash flows should easily improve after the merger due to the improved tax treatment, if nothing else.

Business Strength Favors Towers Watson

The discount that Willis Group is getting on Towers Watson shares in this merger is bad enough, but what also has investors frustrated is the fact that Towers Watson has been a much stronger business over the past few years. It doesn’t make sense to many investors that Towers Watson would willingly give up so much value just to merge with what appears to be a weaker company.

Figures 1 and 2 show the relative trends in after-tax profit (NOPAT) and return on invested capital (ROIC) for the two companies since 2010, when the merger of Towers, Perrin, Forster & Crosby with Watson Wyatt created Towers Watson in its present form.