Marsh Mac- Slowly but Surely Recovery Begins

As a result of the Elliot Spitzer lawsuit of 2004, just about every business of Marsh McLennan (MMC) suffered the scandal. Little wonder, Marsh had placed its own interests ahead of those of its clients as it earned contingent fees for itself rather than sought the best deal for its clients. There remain continued investigations into its business practices as the insurance brokerage business remains under a cloud to some degree, but in my view, the worst is over. Relationships may not be what they were and accounts that were solidly 100% Marsh are sharing their insurance needs with others, but the fact of the matter is that old established relationships often have high switching costs, and it appears that a newly sanctified approach by Marsh is imrpoving win rates for new business. Retained business appears to have stabilized.

Marsh revenues for the quarter did decline, as management claims, due to resigning from unprofitable accounts. The risk and insurance services segment had revenues drop 7% in GAAP terms, but only about 2% in terms of revenues before the impact of currency and dispositions. Despite this, and perhaps partly because of the dropping of unprofitable relationships, the segment reported operating margins of 18.2% well above the 8.7% reported last year at this time. However, contrast this with one of the jewels in the business, Brown and Brown (BRO) which has operating margins of about 33%. There's plenty of room left for improvement here. It would make a huge difference as risk and insurance services represent about half of MMC revenues.

Risk Consulting and Technology  had a tough quarter up a disappointing 4%, ex-currency about +6%. This consulting business deals in corporate preparedness to global threats such as terrorism, and homeland security as well as less esoteric business investigation and background checking. Margins fell to only 8.6% from the former 15.9% levels. In the grand scheme, somewhat insignificant at 8% of revenues. But as a growth avenue, this has fizzled.

The consulting business of Mercer looked great with growth of 10% underlying and the specialty consulting biz of Oliver Wyman looking even better with 17% growth in revenues.Operating margins here were steady at about 11.3%. This represents one-third of revenues.

Finally, Putnam. Drastic cost-cutting has offset the bleed. Operating margins are now 18.6% versus last year's 12.6%. Revenues, as a result of lowering of investment management fees, and redemptions were down 13%. Net redemptions of $6.6 million for the quarter represented about 3% of assets under management. Market performance added about $7 million to assets under management which left AUM flat for both mutual and institutional segments on a sequential quarterly basis. Year over year however, mutual fund assets are down 6.7% and institutional assets are essentially flat.

Overall, the cost-cutting looks quite effective. Operating margins are recovering in the largest segments of the business. Mercer and the Specialty Consulting businesses are doing great. The outflows of Putnam appear to have been arrested or at least restrained.  The net debt position has been reduced by over $500 million year over year.

Historically, this has been a 15-18% ROIC kind of a business which has been reduced to a merely 3% earner on capital. Plenty of room for improvement here. EV/EBIT is running at 15.5 times using TTM EBIT, The good news is that EBIT on a TTM basis is running about 90% above the results achieved for years 2004 and 2005. The bad news...still only 45-50% of the levels attained in 2003 and 2002. As I stated before, plenty of room for improvement.

I am encouraged by this turnaround story which is unfolding a little slower than I had hoped. Risks remain significant...as all of us know, you are as good as your last trade....Putnam is dependent on healthy capital markets. The performance of its funds appears to be on the mend, but nevertheless, it is a captive to the overall market. The progress in the insurance brokerage businesses appears to be tangible but still subject to the vagaries of the insurance pricing cycle.

In my judgment, the downside appears limited relative to most companies I look at and the upside could be mid-$40's over two or three years.

Disclaimer: I, my family, and clients currently have a position in MMC.