HR Consulting
Extending coverage to both
players
Paul Ginocchio, CFA
Research Analyst
(1) 415 617 4207
paul.ginocchio@db.com
Initiating on Hewitt Associates with a Hold and $30 price target
With our initiation on Hewitt, we now cover both human resources consulting
companies. We are Holders of both Hewitt and Watson Wyatt as we believe their
current valuations versus the market seem reasonable for their medium-term
growth prospects. Our fiscal 2009 estimates are largely in line with consensus and
we expect both to show top-line deceleration from here. We prefer Watson Wyatt
to Hewitt due to its lower exposure to revenue driven by corporate headcount
(11% to 66%). We maintain our Hold rating and $45 price target on Watson Wyatt.
Deutsche Bank Securities Inc.
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208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
Coverage Change
Companies featured
Watson Wyatt & Company (WW.N),USD39.76 Hold
2008A 2009E 2010E
EPS (USD) 3.49 3.39 3.72
P/E (x) 14.5 15.2 13.9
EV/EBITDA (x) 7.1 7.0 6.5
Hewitt Associates Inc (HEW.N),USD26.24 Hold
2007A 2008E 2009E
EPS (USD) 1.53 1.99 2.31
P/E (x) 18.9 25.9 22.4
EV/EBITDA (x) 7.5 10.4 8.2
Upcoming events Date
Hewitt fiscal 4Q08 results
14 Nov 2008
Global Markets Research Company
We like the long-term opportunities in Human Capital consulting
Due to the growing importance of Human Capital in today’s information economy,
we believe HR consulting has strong long-term growth prospects. Nearly every
company wants to improve the performance of its largest P&L expense item,
which puts the HR consultants in an enviable position to add more services to
their existing competencies of retirement, benefit, and compensation consulting.
Over the coming year, due to weak revenue trends at most clients and declining
payrolls, revenue growth for the HR consultants will come under pressure. We
prefer to have most of the deceleration behind us before becoming more
constructive on either of these stocks.
Hewitt has had a great two years, but client headcount headwinds growing
With CEO Russ Fradin at the helm, Hewitt had significantly reduced HR BPO
losses, improved consultant retention, and invested to re-accelerate growth in
Benefits Outsourcing. But now with Circuit City in bankruptcy, a larger HR BPO
client, and clients cutting headcount, improving BPO profitability and growing
Benefits will be more difficult. While the FCF yield is attractive at nearly 11%, we
think that is about right for the increased competition in benefits (50% of revs) due
to the lack of new contracts in HR BPO (18%).
Companies fairly valued on reasonable expectations, slightly prefer WW
We have relied on relative valuation and DCF analysis to arrive at our target prices.
WW is currently trading on a calendar 2009E P/E of 11.5x for expected EPS
growth to 2010 of 4% versus HEW at 11.7x for 7% growth. We think the higher
risk and cyclicality of HEW versus WW is offset by HEW’s higher expected growth
(due to improving BPO margins). WW’s cal09E P/FCF is 10.7x versus HEW at
approximately 9.2x also seems reasonable. Our DCF analysis using 10-year
projections and a mid-cycle margin in the terminal value suggests valuations of
$54 for WW and $34 for HEW (see page 6 for full detail). Based on their relative
PE to the S&P 500 (premium for similar growth), we weight their PE relative much
more heavily than our DCF analysis in arriving at our target prices.
Key risks for the HR consultants
These include economic weakness that cause clients to cut back on consulting
service more than expected, layoffs at clients of the HR BPO and Benefits
Outsourcing divisions as their revenue is driven by headcount, and client losses
due to merger or bankruptcy. For upside risks and company specific risks, see
pages 8-9.

Table of Contents
Executive summary ........................................................................... 3
Industry Outlook .......................................................................................................................3
Hewitt Associates: Initiation with a Hold and $30 price target .................................................3
Watson Wyatt: Reiterate Hold rating and $45 price target .......................................................3
Valuation ..................................................................................................................................4
Risks ........................................................................................................................................4
Ratings and valuation ....................................................................... 5
Initiating coverage of the Human Capital Consulting sector .....................................................5
Valuation ..................................................................................................................................5
Risks.................................................................................................... 8
Industry risks............................................................................................................................8
Watson Wyatt..........................................................................................................................8
Hewitt Associates.....................................................................................................................8
Market growth and drivers............................................................. 10
Organic growth of companies over the cycle .........................................................................10
Consulting ...............................................................................................................................13
HR BPO..................................................................................................................................16
Benefits Administration...........................................................................................................21
HR Consulting players..................................................................... 23
Key takeaways ........................................................................................................................23
Other competitors in the market.............................................................................................24
Revenue exposures ......................................................................... 25
Watson Wyatt.........................................................................................................................25
Hewitt Associates...................................................................................................................25
Mercer, a division of Marsh & McLennan...............................................................................26
Balance sheets & cash uses............................................................ 27
Key takeaways from this section ............................................................................................27
History of sources and uses of cash.......................................................................................27
Debt capacity of each company..............................................................................................27
Acquisition focus over the medium-term................................................................................28
Hewitt Associates............................................................................ 29
Our strategic view...................................................................................................................29
Company-specific issues the market is looking at ..................................................................30
Future uses of cash flow.........................................................................................................30
Most recent corporate actions................................................................................................30
Management..........................................................................................................................31
HR BPO Contracts ..................................................................................................................31
Watson Wyatt .................................................................................. 33
Our strategic view...................................................................................................................33
Company-specific issues the market is looking at ..................................................................34
Future uses of cash flow.........................................................................................................34
Most recent corporate actions................................................................................................35
Management..........................................................................................................................35