Health Care Bet Pays Off

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For Towers Watson, a $435M deal for Medicare exchange Extend Health creates value

Towers Watson (NYSE: TW) has leveraged the acquisition of a private Medicare exchange to launch a broad exchange strategy. It's a story that others looking to buy or sell in the middle market information technology space can learn from.

In May 2012, professional services firm Towers Watson acquired Extend Health Inc., which operates a large private Medicare exchange, for $435 million.

In November, the company announced the acquisition of Liazon Corp., which develops and delivers private medical exchanges, for $215 million.

On Sept. 9, news broke that IBM would no longer be managing health care coverage for its Medicare-eligible retirees. The announcement meant that Towers Watson's Extend Health acquisition would pay off-IBM was deciding to use Extend Health.

The prize catch in this M&A deal was Extend Health's private Medicare exchange.

When IBM decided to transition its retirees to the Medicare exchange, it affirmed Extend Health's value. Case in point: when Extend Health was purchased, it had about 100 employers as clients and was serving 170,000 individual retirees. Since then, the number of employers served has risen to 300 and the number of retirees to around 500,000.

Towers Watson, which offers large employers solutions in the areas of benefits, talent management, rewards, and risk and capital management, earned revenue of $3.4 billion in its fiscal year that ended July 31, 2013. Revenue reported in the quarter ended Sept. 30, 2013, was $810 million.

Adding to the tally, effective Jan. 1, IBM Corp. (NYSE: IBM) planned to move about 110,000 of its retirees to the Towers Watson private Medicare exchange from company-sponsored health plans.

It was also reported that Time Warner Inc. (NYSE: TWC) plans to move its Medicare retirees to private exchanges from company health plans in 2014.

While public exchanges aim to provide health insurance for uninsured Americans, private Medicare exchanges enable large employers to continue funding retiree health care benefits while managing costs.

Exchanges also give retirees choice and buying power for their existing health care coverage, which is delivered through group plans selected by their former employers. An exchange offers thousands of individual plans from dozens of carriers, so carriers compete for retirees' business.

Not surprisingly, the outsourcing of retiree health benefits to private exchanges by IBM and Time Warner created a firestorm of media interest.

The media coverage focused on whether large employers will deliver retiree health benefits through private Medicare exchanges in the future. The coverage also contributed to speculation that employers will eventually use private exchanges for active workers.

Before the Towers Watson acquisition, in January 2012, Extend Health filed an S-1, signaling that it was planning an initial public offering.

At the time of the S-1 filing, Extend Health reported $50.5 million in revenue for the fiscal year ended June 30, 2011, up 16 percent from the previous year. For the fiscal year ended September 30, 2011, revenue was $15.8 million.

When Towers Watson announced May 14, 2012, that it would buy Extend Health, it ended the company's journey to the public markets. Considering that the Towers Watson balance sheet at the time showed just $427 million in cash, this was a bold, highly leveraged move. At the time, some analysts said that Towers Watson might have paid too much.

Additional financial details were not disclosed, but based on expected fiscal year 2012 revenue, Extend Health was acquired at a valuation of about 6.8 times revenue. This valuation is right in line with comparable transactions at the time.

On the day of the acquisition announcement, Towers Watson stock closed at $64 per share, but had been trending downward. On May 29,, 2012, when the acquisition was completed, Towers Watson stock closed at $59.78, for an enterprise value that day of $4.22 billion.

There was no remarkable change in value either way on the news. But Towers Watson stock continued to slowly decline with the market.

After hitting a low of $49.60 on November 14, 2012, however, Towers Watson gained steadily for months. In 2013, from Friday, Sept. 6, to Monday, Sept. 9, over the weekend that the IBM and Time Warner news broke, the stock jumped $6 a share - increasing Towers Watson's enterprise value to $6.3 billion.

One month later, on October 7, 2013, the stock eclipsed $115 a share - for a gain of more than 100 percent in just 10 months - giving Towers Watson an enterprise value north of $8 billion.