Aon plc (AON) Earnings Call Transcript & Summary

Happy Friday morning, everybody. My name is Mike Zaremski. I'm excited to introduce Greg Case, CEO of Aon; and Leslie Follmer, Head of Investor Relations. So it's always great introducing a company whose stock has measurably outperformed the broader market as Aon's stock has done over the past decade. So I thought instead of quantifying what we can all see on our screens, I'll offer an example of why I believe Aon continues to increase its value proposition to its customers. So as part of my job over the past decade plus, I speak with risk managers at larger corporations, including at Crédit Suisse. These are the folks who are tasked with making sure their businesses are buying the right levels of insurance, types of insurance and also consulting services. Many of these managers expressed to me that their jobs are becoming more complex. Examples include measuring cyber risk and understanding connectivities within their supply chains. So as a result, these folks increasingly rely on their broker partners, such as Aon, to make more informed decisions. So with that example, I'm going to turn the microphone over to Greg Case and Leslie Follmer will present. And afterwards, we'll have some time for Q&A. And there also will be a breakout session in Plaza 2 right afterwards. So with that, mic is yours.

Mike, thanks very much. Really appreciate it. Appreciate the invitation to this Crédit Suisse conference. It's great to be here and looking forward to it. Leslie and I are delighted to be with you to talk about the Aon story. I see a few familiar faces, who know the story very well, but some who may not. So we'll start. Let me give you the overall overview. We're looking forward to it. This is a story, as you think about it, which has a piece, which reflects continued performance and progress, and we'll talk a little bit about that. It's also a story that is -- has great potential. And if you step back and think about where we've been, we have made progress. Net-net, if you go to think about 2019, we grew at 6%, which was the highest growth rate in 15 years. We improved our margins to 27.5%, up 250 basis points. We improved free cash flow by 10%. And as Mike said, we've been fortunate in our shareholder return, 18%, give or take, for the last 14, 15 years. So we have made progress. We would deem that progress. When you think about the Aon story, one important takeaway is to understand that as you think about the journey we're on, what I just described, what I just described in 2019, which falls on '18, '17, '16, et cetera, is on a scale of 0 to 10, if 10 is where we want to be, we're about a 4. By the way, a 4 and the progress I just described is not an indictment to our progress. It's a testament to what we believe is our potential. And what we're going to describe to you today around that potential is we have put together a series of assets that are uniquely positioned to take very specific steps forward to support clients, as Mike is describing, also to support our colleagues and we believe to be very, very strong partners with our shareholders. To start that story and that picture, you begin with the foundation. And what you see on the slide here is where we operate in the world, 3 massive, massive sort of categories in the global economy: risk, retirement and health, underpinned by data and analytics. And we got very, very set of pristine assets here in each one of these categories. In risk, $125 billion plus in premium, maybe as many companies as anybody in the world on the topic of risk, an incredibly unique platform. On the retirement investment side, $3.5 trillion of assets that we advise, no more than 10% of the pension assets in the world, an incredibly strong platform. And on the health side, circa $180 billion, $190 billion in premium we place on health and benefits. So this -- our firm is uniquely positioned to -- we've got a set of -- we've got a platform that is incredibly powerful against these 3 categories of risk, retirement and health. That's good. We'll take that. What's even better is what we're facing off against in the global economy. And this is back to Mike's point on where risk managers are now. Understand, we sit in a place right now where when you think about the aggregate level of risk in the world, it's going up. Population ages, risk goes up. Population urbanizes, risk goes up. Population moves the curves, risk goes up. Global warming, climate change, pandemic, identity theft, cyber, intellectual property, all these things mean that the risks in the world, as we understand it today, are getting more substantial. Retirement, 20% of the world is ready for retirement. 80% is not. That's incredibly, incredibly difficult challenge facing the globe because it's true in every economy in the world. On the health side, they're one of the most dysfunctional parts of the global economy. Everyone is spending more and more on health and getting less out of it. And if you think about it, all the clients we serve, all the -- for all the times we spend with our clients, their employees, on average, around the globe are overspending on health and underspending on retirement. And to be able to balance that challenge on their behalf is incredibly powerful. So what I'm trying to highlight and what Leslie is going to talk about as well is we have an incredible set of assets being brought to bear on a global economy that is facing more and more risk than ever before in the classic risk areas, the emerging risk areas, retirement and health. And we have a set of assets uniquely positioned to serve that set of demands. Also understand that set of demands is unique. These are largely demands with clients. This is nondiscretionary spend. This is nondiscretionary demands that clients have to address. By the way, this is a highly retentive business, 95% plus retention. So it's a unique demand profile if you think about the investments you make that we face off against. So pristine assets against a very unique demand profile that's getting stronger, nondiscretionary demand that's 95% plus retentive, pretty unique in the global economy. That's Aon. That's the sort of starting point. And then we've done something else. And this is really -- when you ask the question why are we confident in saying we've made progress of 4 on a scale of 0 to 10, but we're going to take steps forward to get to an 8. By way, if you look at our history and you get comfortable that we have credibility that's a 4, that's real progress, hopefully, you get even more comfort and have even more conviction as we do that we're going to get to an 8. The question is how. What are we doing differently than everyone else? And the answer is how we conduct ourselves and bring our assets together to lead the firm. And maybe let's think about it. This is a 10-year-plus journey. This is different. This is fundamentally different. What I have up here, if you want to understand the Aon story and the evolution, understand the Aon United blueprint. A bunch of words on paper, but basically, if you look at the client value creation piece of this, this is how we connect the dots and bring our capability together to serve our clients in a very specific way. Now everybody talks about that. Everybody says we serve clients better than anyone else. But we have a single brand. Who else has that? Single opco, who else has that? Single operating company, who else has that? We have basically put 3,000 colleagues through leading Aon United workshops around how we can connect the dots on our firm and in doing so, stronger in terms of service to clients. No one else has ever done that. And this has led the way -- set of interactions with clients, which has driven greater client growth, greater client retention and greater innovation on behalf of clients. And this is fundamental. And I know this may sound a little soft, but don't kid yourself. As we get this right and the global firm connects more effectively, you take the platform I described against a client profile with the demand that I described, that's a pretty unique -- it's a pretty unique step, back to going from 4 to an 8 on the journey of 0 to 10. If you go to the bottom part of this chart, you ask what is this client service delivery piece, what are you talking about, in essence, we've stepped back and said, we have 50,000 colleagues in 120 companies around the world. Are we actually operating efficiently, back office, middle office, even how we support the front office? And we didn't have very far to go to look for models around the world. Just go around this conference and virtually every company in this conference has done things to essentially think about sort of that engine. What is one group that's unique in its absence from that little story? That would be our world. No one in our world has done anything like Aon Business Services and that you're literally looking at $3 billion to $4 billion of spend around the world in a very unique way. And things like, do we really have 31 [ nano ] class call centers or contact centers in the U.S.? 31, really. Do we need 31? That's the right answer. The answer is no. There's a whole series of things we can do to become more efficient, to create more capacity to invest back into the firm, drive better client service and client delivery. And that engine not only drives efficiency for us, but it also gives us, as I said, capabilities to invest back into the firm. It's incredibly self-fulfilling. So this whole idea of the Aon United blueprint for us, it's real stuff. It's incredibly compelling. It means we're doing things with clients no one else has been able to do. And again, back to the idea of talk's cheap. When we brought to life Aon -- the Aon Client Treaty, literally, the single most unique place in the history of Lloyd's. It eliminated the tail risk beyond the placement risk on the back end of Lloyd's placement. That requires the ability to do data analytics around 6,000 clients and $5 billion in premium. Never been done before, so far not duplicated in the way we've done it. That's data and analytics on delivering Aon United. That's our commercial risk colleagues, that's our data analytics colleagues, that's our reinsurance colleagues coming together to do something that's never been done before. The fully insured health exchange, as it came online, it was very unique, fully insured, multiple carrier, never been done before. That was our health colleagues, amazing work. By the way, though, our health colleagues never get those all done without our colleagues on the reinsurance side who created a back-end, risk-sharing mechanism so that actually carriers are more comfortable coming into the exchange. What I'm trying to highlight, what Leslie and I want you to understand is this journey, the progress, the 0 to 4, which by the way has been very strong financial performance, is nothing compared to what we can do when we connect the dots on the firm. So we're Aon United, the top part of this, top part of the circle. Then that's amplified by doing something that every other industry has done but we haven't. By the way, it's not easy to do, and that's what we're putting in place with Aon Business Services. And then you inject into it innovation, and we can talk about some of the areas where we are invested in innovation unique to Aon, I can assure you, we think unique to our industry. But again, we're going to feed into that system. Because we all had good ideas, but it's hard to scale those. With what we're doing on the New Ventures Group, we can now scale innovation faster than ever before and drive it through what we're doing with Delivering Aon United. So one thing that I want you to understand is we have made progress. Team's done a wonderful job. I certainly, in my I role, have been blessed to work with this team. They're incredible. And now we see a way forward. It's not just run faster. It's run different. And make no mistake about it, after 10 years in the making, this is really starting to drive some performance and some perspective that's pretty unique. Translation of this is like, whatever. Where's this going, Leslie? Where's this going, Greg? Well, where it's going, it's going more client impact. We're client relevant. By the way, where does that show up? How about organic growth? So this is an organic growth profile going back to 2014. Again, not genius here, but you're seeing progression. And 3%, 3%, 4%, 4%, 5%, 6%, 6% was the highest in the last 15 years, organic growth. All of these are interesting perspectives. Why are we growing organically? And there's another perspective that Leslie and I want to make sure you understand. We're not only running the business. We're also managing the portfolio. So you see us winning more clients, greater retention with those clients, doing more things with those clients, true. We're also doing a series of things that sort of change the portfolio. Last 5 years, 80 acquisitions, give or take, 80 divestitures, give or take. We're doing things and making investments that actually change the growth profile of the firm. And then we're adding net new, bottom right-hand side. Net new innovation; mortgages, 10%, 15% of the mortgages in the U.S. today originate from capital connected to insurers. That's Aon and data and analytics, incredibly powerful, never been done before. Cat bond in Latin America covering earthquake risk for Mexico, Chile, Peru and Colombia, think about that. The earthquake risk for those 4 countries, how did we do that? We put together a noncorrelated risk pool, our reinsurance colleagues, our retail, virtual colleagues, $1.4 billion [ sold via ] pension plan through the World Bank, never been done before. These are net new. So why are we winning, win more with our existing clients? We're winning share around the world, retaining more, doing more with them. We're changing the portfolio, continue to evolve the portfolio into higher-growth companies, and we're bringing net new into the equation. And that's what you see in terms of an overall result. And there are countless examples when you ask the question, what can we do on behalf of clients that hasn't been done before that is not only winning the zero-sum game? Because one of the clear things we want to make sure you understand about our story is that we've made progress. We have tremendous potential. But potential is a talk's cheap mode. It's a very specific road map around the Aon United blueprint of what we're going to get done. And then the innovation piece is kind of cool because the innovation piece is all about net new. It's about not just winning in the pie, but growing the pie. Growing the pie how? Well, intellectual property, intangible assets. 85% of the S&P 500 is connected back to intangible assets. Now is that true? That's true. What are we doing about it in the risk world to protect our clients in that environment? And the answer is next to nothing. What did Aon do? We brought colleagues in who are the patent attorneys for some of the most significant technology firms in the world, I mean, all over the world. This group, incredible capability, and they want to try to value patents. One way you value a patent is you bring risk capital in and create cover against it, you value the patent. You can do that or trade secrets. You could do that. You can borrow against it. We now actually have intellectual property protection, liability protection, things that have never existed before. This is new genres of things that haven't existed. Cyber. Cyber is just in its infancy. $6 billion in premium against the $600 billion loss, come on, we haven't even tapped cyber in any way, shape or form. And the point Leslie and I want to make is the idea around innovation as a catalyst on net new, huge. Climate change right now. Everyone is talking about climate change. What are we really doing about climate change around just transition and reducing the volatility in countries, in companies, for individuals as we go through some of the changes coming about through climate change? We, Aon, by matching capital with risk, can fundamentally reduce volatility in the world. That is a much bigger pie than the pie we're playing in now, which, by the way, we're incredibly well equipped to win. Thank you very much. We'll do that, and then we're going to do this. And that's what the Aon United approach and blueprint brings to the table that is pretty unique. So I hope you get a sense in terms of sort of what we're trying to do. This is a story around evolution. This is a story around the journey, but it's also a story on a very explicit game plan that we worked over a decade on that, by the way, along the way has produced pretty unique results, but they come nowhere near to capture the potential we see going forward. And we have a very explicit game plan on how we go from a 4 to an 8 over the next few years in order to accomplish that. And we're pretty excited -- sorry about that, we're pretty excited about what that means for our clients. We're pretty excited about what that means for our colleagues, and we're very excited about what that means for our investment partners. So that's the overall sort of story. I'm really happy now to introduce my colleague, Leslie Follmer, who leads the Investor Relations for us, who's going to talk about the important outcomes that you all are interested in as part of this overall journey. Leslie, over to you.

Thanks, Greg. Thank you. Thanks, everyone, for having us here today. So why don't we move on? I'll just talk a little bit about margins, free cash flow and then kind of overall financial performance for the firm. So as we think about margins, looking back over the past 10 years, we've driven 780 basis points of margin improvement net of all of these investments and long-term growth that Greg is talking about. We do see that trend going forward, and we think it's driven by 3 things: It's accelerating revenue growth, which we've just hit on as we get more operating leverage out of our core portfolio mix shift to areas of higher growth and higher demand in the portfolio; and then, finally, increased operating leverage from Aon Business Services, which we get as we keep getting productivity and efficiency from our operations. And so one example that I'd highlight on Aon Business Services is we've taken some of our most sophisticated analytical capability in the firm of reinsurance cat modelers, and we put them in a service delivery center. This allows us to scale best practices to our front office teams around the globe. It's more efficient. And then our front office teams, with that capacity, are able to go and spend more time in front of clients, which is exactly where they need to be. And that helps to continue to drive revenue growth. In 2019, we moved 750 roles -- over 750 into service delivery centers, mostly in low-cost locations. And as we brought together people and processes, we're able to standardize and create efficiencies, and we automated over 600,000 hours of work. Continuing for margins. Next piece is talking about free cash flow. And as I think you -- those of you who know us well know, we run the firm on cash, and we've taken significant steps to maximize the translation of the dollar of revenue into the highest amount of free cash flow. Really driven by 3 things: operational improvement, which we've just talked about; working capital improvements; and then declining structural uses of cash. So on working capital, we're working on closing the gap between payables and receivables to get to working capital neutral. We feel really confident that we can do this because some of our best-run countries already run like this today. And over time, we think this is about a $500 million opportunity over, say, 10 years, so for something like $50 million a year. On the declining uses of cash, we've taken significant steps around our restructuring, pension and CapEx. So our restructuring fund is closed. There will be no more P&L charges, and the cash charges tail off over the next couple of years. Our -- within our pension, we've taken significant steps. We've closed the pension plans, frozen the benefits and then taken significant steps to derisk the assets, which will reduce volatility and liability. And then on Capex, we saw elevated CapEx in recent years because of our restructuring program and as we got ABS up to speed but now expect that to return to more normalized levels going forward. And so you just flip using kind of a weird order. What you'll see is a $455 million decline in structural uses of cash over the next 2 years, with about $290 million in 2020. And so then what that means for 2020 is a really significant opportunity. So you start with our 2019 base of $1.61 billion in free cash flow. We have about $290 million of declining uses of cash. There's $130 million tailwind from legacy litigation that we saw in 2019, and then that's before any working capital improvements or operating income growth. So that picture starts to look really positive. And then on top of that, as our EBITDA grows and the restructuring charges tail off, we do have an opportunity for incremental debt. We will maintain our investment-grade credit rating, but we'll be able to add debt. That gives us more capital to use. As I think many of you know, we value the firm on a DCF basis, and we're very disciplined around capital allocation. And so we think share buyback is our best use of capital. We do believe our shares are significantly undervalued today. And so we'll continue to allocate capital according to that -- against that benchmark, really. And then so then if I just step back again to that big-picture, overall financial results. So as Greg said, since 2005, we've seen overall returns to shareholders of 18%, outperforming the S&P over that time period or over any time period. I mean this is really driven by performance against these key metrics that we're talking about. You've seen total revenue growth of 4% CAGR accelerating in recent years, operating income growth of 10% and free cash flow growth of 17% CAGR over that time period. So then, as I look forward, what I would just say, as Greg said, we really think we're at about a 4 out of 10, where we think we can be with Aon United, not to minimize what we've done so far but really to emphasize the magnitude of the opportunity going forward. We really think that is going to come out and reflect in mid-single-digit or greater organic revenue growth, ongoing margin expansion and double-digit free cash flow growth like we talked about. So with that, I think maybe I will hand to Mike for a few questions.

Yes, great. Maybe I'll kick it off with some questions we received from audience. I have a question, too, I'll ask you in a couple of minutes. But maybe we'll touch on Aon's M&A strategy. I believe it's a little different than your competitors. And maybe you can also answer whether you'd consider transformational M&A as well.

Sort of overall, again, as Leslie described, fundamentally, this is a very simple, straightforward metric around cash flow and cash flow generation. And then everything we do on capital, everything we do on capital starts with return on invested capital and cash-on-cash return. So it goes into an entire pool. By the way, it's taken us a decade to sort of get to this place, maybe a little more than that, to get our country leaders, everyone understands this philosophy. So in essence, if you come into the cash pool, if you look at the return on invested capital, cash-on-cash return, Leslie described we believe, on a discounted cash flow basis, our shares are fully -- are very undervalued. And so that actually sets a very high hurdle. So everything's got to do buyback, which's going to sort of -- might get us to a place where it's going to be meaningful from an acquisition standpoint, or by the way, organic investment as well. So again, capital is allocated across all those pieces. And as we look at the pipeline, we've got $3 billion, $4 billion pipeline, Leslie, right now, strongest we've had in many, many years. The pipeline is really around content. And when we can scale content, it's a very, very powerful investment for us. When you think about what we did with Stroz, we brought Stroz in. Stroz wasn't about risk. Stroz was about cyber, understanding cyber in a way in which we could actually apply capital to the cyber risk in ways no one else could do. This group really understood that better than anybody else. 601West, you might not have heard of, but these are a whole set of patent lawyers, who spent their entire life working on some of the most unique, significant well-known technology companies in the world, all of them trying to understand how to value patents. And now we've invested in 601West and essentially looking at the 10.3 million patents across the U.S. and then all the patents across the world and literally, with our data and analytics capability, taking 100 million documents and doing natural language processing to be able to compare patent strength. Never been done before in the way we're doing it as well as trade secrets, hugely powerful. Point I'm getting to, Mike, is this is really around content that we can scale. And that's really what we're looking at, and that's what we've done. CoverWallet's sort of is the latest. By the way, I would highlight, we've done more of these types of investments in the first 6 weeks, 8 weeks of 2020, 6 weeks to 2020 than we did in the entire 2019. So this is a very, very contingent set of investments for us. The CoverWallet is an awesome, awesome asset. We're so pleased to have that as part of the Aon family. And we worked with CoverWallet for well over a year doing pilots in Australia and in the U.S. in the small clients arena, hugely, hugely powerful. They took the -- literally, what we have and can actually get double the response rate and double the retention. So it's hugely powerful in terms of sort of that arena. So that's really what drives what we're doing. And we're excited about it, and we'll continue to sort of make investments on -- in that with that regard.

Okay. Great. Anyone in the audience have a question before I keep going? Okay. Maybe broader question. A lot of exciting things going on at Aon. Any areas you're most excited about growth? Maybe cyber might be one of them where it feels like there's more demand and supply for both consulting services and the insurance products.

Well -- and Leslie, you can comment on this. So I make no apologies. Where am I excited at Aon? That would be yes, I'm excited at all -- a lot of areas at Aon. That isn't just one particular area. The risk arena -- listen, it is just what it is. The world is becoming more complex, more risky. You see this every day. The traditional bucket of risk, D&O, property, casualty, it's actually -- it's becoming more complex. Just as the population changes, it becomes more complex. Fundamentally, that's more demand. But the new stuff like you're highlighting, Cyber is a great one. Everyone talks about cyber. And cyber is -- really, it's important. Cyber is growing in the world that we live in at $6 billion in premium. But consider, it's $6 billion in premium against what literally is a demand profile, if you're helping clients -- back to client relevance. Maybe it's close to $600 billion, $700 billion, right? We're going to $1 trillion on the [ dial one ] side, the connected loss, and our industry has only done $6 billion. It's nothing. I can -- we've got to do much, much better in helping our -- helping capital understand client needs, and by the way, helping clients understand why it's valuable to pay for that. But cyber is just one small piece, so we think cyber is small compared to intellectual capital, intellectual property. The intellectual property piece is -- if you go back to this 85% of the S&P that's connected back to cyber or intangible assets, I mean, this is incredibly powerful. And we've done virtually nothing to sort of protect that world. And the thing about that is that's not just protect the house. So a lot of what we do is sort of play defense on behalf of clients. This is offense. This is the way to actually say, I can value assets on the balance sheet I couldn't value before. Therefore, when 2 companies come together and they're going to think about a downgrade, they actually find assets that didn't exist, and I'll use downgrade. Or this is the potential for a unicorn that's about to go up for another round of financing, that's going to give a part of their equity. If you can value the client portfolio, the patent stack, you can borrow against that. You change fundamentally literally the economics on behalf of an owner. So for us, like, we see huge opportunities on the risk side. On the retirement side, when you think about delegated, some of the areas we're making huge sets of opportunities there. Again, the fundamental demand profile in retirement is epic. 20% of the world's ready for retirement, and that train is headed to a cliff. That's going to happen solely over time, hugely powerful in terms of being able to sort of turn that dial a little bit. And it even helps, a lot of benefits, all the different pieces around that, another set of opportunities. So we see each one of these pieces, Mike, very, very powerful. The other thing is don't miss the connectivity because, I kid you not, if you're sitting with the CEO, and you can help them ask the question, I spend a lot of money on health, I spend a lot of money on my employees' retirement. Neither of them are working very well. If I could actually help that family make a little bit better choice not overinvest in health and invest more appropriately in retirement, you change that family's life over 15 or 20 years. So we see all these opportunities that are sitting there because they are important for our clients. And that's what we're trying to position Aon to be able to address. Individual excellence in each one of the areas, but also collective greatness as you think across, and that's really what Aon United's about.

And I might also add Greg talked about our blueprint, and we've got these structural changes that we're making that help us drive it. So New Ventures is all about driving innovation faster and scaling it. And so not only are we excited about and investing in these areas, but we're putting the structure in place in the company to be able to kind of protect that innovation and scale it to support the rest of the company. And then similarly, with Aon Business Services, as we continue to drive productivity and innovation and efficiency, and we're able to better scale that across the company, it helps us drive faster growth and take capabilities like cyber and make sure that they're scaled across the company.

And what Leslie's describing just for our partners here in the audience is so important to understand. This is what's the blueprint: innovation at scale in ways we've never done before. I mean literally, to Leslie's example, we would have identified intangible assets. We would have brought somebody in to do it. We never put 100-plus people to work on an asset. We've got 100, 150 colleagues now, but it's now around the globe, collected together to do this and growing, right. That's a concentrated set of insight and effort we never would have been able to amass before. Now we can do that across multiple places. And same on small clients, same on some of our regional investments. So these things are actually pretty fundamental for us. And again, back to the idea of the catalyst to continue to push forward, that's what we have in place structurally. As Leslie appropriately points out, that sort of put us in a unique position to continue to progress.