- 🐝 The Investing Show
- Posts
- AON
Why AON is a High-Quality Compounding Business
In the world of investing, few businesses combine defensive characteristics with long-term growth potential as effectively as AON plc (NYSE: AON). As a leading global professional services firm specializing in risk, retirement, and health solutions, AON demonstrates many of the characteristics we look for in high-quality compounding businesses. Despite recent market volatility following their Q1 2025 earnings report, the fundamental investment thesis for AON remains compelling for long-term investors.
The Tollbooth Business Model: Stability in Uncertain Times
AON's core business model functions much like a tollbooth on a busy highway – it collects fees on transactions that must occur regardless of economic conditions. Insurance broking, risk management, and benefit administration services aren't discretionary expenses for businesses; they're essential operational requirements. This creates a remarkably stable revenue stream that weathers economic storms better than most businesses.
What makes this model particularly attractive is the limited capital requirements needed to maintain and grow the business. Unlike insurers who must hold significant capital reserves against potential claims, AON primarily provides advisory and placement services, allowing it to generate substantial free cash flow with limited financial risk exposure.
Case Study 1: AON's Resilience During the 2008-2009 Financial Crisis
The 2008-2009 financial crisis provides a compelling illustration of AON's tollbooth model in action. While many financial services companies experienced catastrophic declines in revenue and profitability, AON demonstrated remarkable stability:
During 2009, when the global economy contracted by 0.1% and many industries saw double-digit revenue declines, AON's organic revenue decreased by only 1%
By 2010, as the economic recovery was just beginning, AON had already returned to organic growth
Throughout this period, AON maintained strong operating margins above 20% and continued generating substantial free cash flow
This resilience occurred because even during severe economic contraction, businesses still needed to renew their property and casualty insurance, manage employee benefits, and address emerging risks. While companies might defer capital expenditures or reduce marketing budgets during downturns, they cannot simply stop managing critical risks – AON's tollbooth remained active even as traffic on other financial highways diminished.
Case Study 2: The Pandemic Stress Test (2020-2021)
The COVID-19 pandemic created unprecedented business disruption, yet again demonstrated the essential nature of AON's services:
Despite global lockdowns and business closures in 2020, AON achieved 1% organic revenue growth
By 2021, as businesses adapted to pandemic realities and faced new risks, AON's organic growth accelerated to 6%
Free cash flow remained robust throughout, enabling AON to continue strategic investments and return capital to shareholders
During this period, AON's services became even more critical as clients navigated novel risks like pandemic-related business interruption, remote work cybersecurity challenges, and employee health concerns. Many clients actually expanded their relationship with AON during this period, seeking guidance on these emerging risks.
What's particularly impressive is that AON maintained this stability despite disruption to its own operations – demonstrating that its tollbooth model doesn't require physical proximity to function effectively. The company's digital capabilities allowed it to continue serving clients seamlessly even as its own workforce transitioned to remote work.
These case studies illustrate why AON's business model is so valuable – it provides essential services that remain in demand regardless of economic conditions, creating the stable, predictable cash flows that are the hallmark of a high-quality compounding business.
Formidable Competitive Advantages
AON has cultivated several durable competitive advantages that protect its market position:
1. High Switching Costs
Once integrated into a client's risk management ecosystem, AON becomes extraordinarily difficult to replace. The institutional knowledge, data access, and operational integration create significant switching costs for clients. This is particularly true for large multinational clients with complex risk profiles spanning multiple jurisdictions and risk categories.
2. Network Effects and Data Advantages
With over $190 billion in premiums placed annually, AON has accumulated proprietary data on risk pricing and outcomes that provides valuable insights no individual client or smaller competitor can match. This data advantage creates a powerful feedback loop – more clients generate more data, which improves AON's advisory capabilities, which attracts more clients.
3. Global Scale with Local Expertise
Operating in 120 countries, AON combines global reach with local expertise. This unique combination is increasingly important as businesses face interconnected global risks while navigating local regulatory environments.
Client Case Studies: Creating Irreplaceable Value
To truly understand AON's competitive advantages, let's examine how the company creates value for specific clients and why these relationships become so sticky over time.
Case Study 1: Global Technology Manufacturer
A Fortune 100 technology manufacturer with operations in 45 countries faced escalating supply chain risks and rising cyber insurance costs in 2023. Their challenges included:
Premium increases of 40%+ for cyber coverage
Significant business interruption exposure from semiconductor shortages
Complex regulatory requirements across multiple jurisdictions
How AON Created Value:
Leveraged proprietary data from similar clients to negotiate cyber premiums 22% below initial market quotes
Developed a customized supply chain risk scorecard that identified previously unrecognized vulnerabilities
Implemented a centralized global risk management platform that streamlined compliance across all jurisdictions
Why They Won't Leave: The client's CFO reportedly told board members, "AON has become an extension of our risk management department. The institutional knowledge they've built about our operations would take years for a competitor to replicate." After three years with AON, the company estimates annual savings of $14.3 million in premium costs and avoided business interruption events.
Case Study 2: Regional Healthcare System
A mid-sized healthcare system with 12 hospitals and 40+ outpatient facilities struggled with rising employee benefit costs and healthcare worker retention challenges post-pandemic.
How AON Created Value:
Applied healthcare industry benchmarking data to redesign benefits packages, reducing costs while increasing employee satisfaction scores
Implemented a predictive analytics model that identified retention risk factors among clinical staff
Created a customized retirement plan strategy that improved participation rates by 27%
Why They Won't Leave: The healthcare system's HR director explained in an industry conference: "AON's solutions are deeply embedded in our HR infrastructure. Their team knows our organization's DNA and has built tools specifically calibrated to our workforce demographics and financial constraints. Switching providers would mean starting from square one, likely with less sophisticated capabilities."
During contract renewal discussions in 2024, the client declined to entertain competing bids despite aggressive pricing from rivals, citing the disruption risk and AON's superior healthcare industry expertise.
Case Study 3: Global Energy Corporation
A major energy company with $80+ billion in assets faced emerging climate-related risks and increasingly complex ESG reporting requirements.
How AON Created Value:
Deployed catastrophe modeling that quantified previously unmodeled climate risks across their global asset portfolio
Designed an innovative parametric insurance solution that provided protection against specific climate triggers
Created an integrated ESG reporting framework that aligned with emerging global standards and investor expectations
Why They Won't Leave: The relationship has grown from a transactional insurance placement to a strategic partnership. The company's Chief Risk Officer stated: "AON's risk modeling capabilities have become integral to our capital allocation decisions. Their catastrophe analytics team effectively functions as our climate risk department."
When approached by competitors offering fee reductions of 15-20%, the client declined, explaining that AON's intellectual capital and understanding of their business outweighed potential short-term savings.
These case studies illustrate how AON transcends the role of simple insurance broker to become an embedded strategic partner for clients. The company creates value not just through insurance placement but through sophisticated risk modeling, data analytics, and deep industry expertise – capabilities that competitors struggle to replicate and that create powerful client retention dynamics.
Growth Runway: Significant Expansion Opportunities
While bears point to AON's established position in mature markets as a growth limiter, several factors suggest substantial growth potential remains:
Management estimates that the top four global brokers control only about 30% of the market, leaving significant room for continued consolidation. With scale advantages becoming increasingly important in data-driven risk analytics, larger firms like AON stand to benefit from market share gains.
Cross-Selling Opportunities
AON's established corporate relationships provide a natural platform for expanding service offerings. As businesses face increasingly complex and interconnected risks – from cyber threats to climate change – AON can deepen client relationships by addressing these emerging risk categories.
Geographic Expansion
While well-established in developed markets, AON continues to expand its presence in emerging economies where insurance penetration remains relatively low but growing rapidly.
Recent Results: Short-Term Noise vs. Long-Term Trajectory
AON's Q1 2025 results sparked some market concern, but the fundamentals remain solid:
5% organic revenue growth outpaced its closest competitor, Marsh McLennan
Commercial risk and reinsurance segments showed resilient 5% and 4% organic growth, respectively
Adjusted operating margins of 38.4%, though down from 39.7% last year, remain exceptionally strong
The margin pressure was largely attributable to the integration of the NFP acquisition – a strategic move that expands AON's presence in the attractive middle-market segment. This acquisition demonstrates management's commitment to long-term growth, even if it creates short-term margin headwinds.
Strategic Capital Allocation
AON's management has demonstrated disciplined capital allocation, balancing growth investments with significant shareholder returns. While some critics view the company's aggressive share repurchases as evidence of limited reinvestment opportunities, we see it differently – as prudent capital return in a business that generates more cash than it can productively reinvest.
The NFP acquisition further demonstrates management's willingness to deploy capital when truly value-enhancing opportunities arise. This balanced approach to capital allocation has served long-term shareholders well.
Risks and Considerations
No investment is without risks, and AON faces several challenges worth monitoring:
Margin Pressure: The NFP integration and changing interest rate environment have created near-term margin headwinds.
Competitive Dynamics: While market consolidation benefits scale players like AON, competition remains intense among the top brokers.
Disintermediation Risk: Technology advances could potentially reduce the role of intermediaries in some insurance categories, though AON's investments in technology and data analytics position it well for this transition.
Conclusion: A Business Built to Compound
Despite these challenges, AON represents a rare combination of defensive characteristics and growth potential. The company's tollbooth business model generates consistent free cash flow, while significant untapped market share and cross-selling opportunities provide a long runway for growth.
At a fair valuation (around $338 per share), AON offers an attractive opportunity for investors seeking high-quality businesses capable of compounding capital for decades to come. Short-term market reactions to quarterly results may create attractive entry points, but the long-term investment thesis remains firmly intact.
In an uncertain world where businesses face increasingly complex risks, AON's role as a trusted advisor and risk management partner becomes ever more essential – a quality that should translate to durable shareholder returns over time.
Valuation: Quality at a Reasonable Price
When evaluating a high-quality compounder like AON, traditional valuation metrics often fail to capture the company's long-term value creation potential. However, even by conventional metrics, AON presents an intriguing opportunity for patient investors.
Current Valuation Metrics
As of May 2025, AON trades at:
Forward P/E ratio: ~20x (vs. S&P 500 average of ~19x)
EV/EBITDA: ~15x
Free Cash Flow Yield: ~4.5%
While these metrics don't suggest a deep value opportunity, they represent a reasonable price for a business with AON's quality characteristics. For context, many lower-quality businesses with inferior economics and weaker competitive positions trade at similar or higher multiples.
Cash Flow Generation and Capital Allocation
AON's valuation becomes more compelling when considering its exceptional cash flow generation and capital allocation strategy:
Free Cash Flow Conversion: AON consistently converts over 90% of net income into free cash flow, substantially higher than the S&P 500 average of approximately 80%.
Capital Allocation Excellence: Management has demonstrated discipline in capital deployment through:
Strategic acquisitions (like NFP) that expand capabilities and market reach
Consistent dividend growth (15 consecutive years of increases)
Opportunistic share repurchases that have reduced share count by approximately 30% over the past decade
Reinvestment Runway: While some critics view share repurchases as evidence of limited growth opportunities, the reality is more nuanced. AON generates more cash than it can productively reinvest organically, but the fragmented nature of the global insurance brokerage market (70% controlled by non-major brokers) provides substantial consolidation opportunities.
Valuation Through Different Lenses
Looking beyond traditional metrics provides additional perspective on AON's value proposition:
Owner Earnings Yield: Calculating Warren Buffett's preferred "owner earnings" (net income + depreciation & amortization - maintenance capex) yields approximately a 5-6% annual return at current prices – attractive in an environment of 4% long-term government bonds, especially considering AON's growth potential.
Long-term Compounder Analysis: If AON can achieve:
5-6% organic revenue growth
1-2% margin expansion over time
2-3% contribution from share repurchases
This creates a pathway to 8-11% annual EPS growth, which could generate total returns of 10-13% annually when including dividends – significantly outpacing likely market returns.
Private Market Value: In private transactions, insurance brokerages typically sell for 12-15x EBITDA. AON's superior scale, technology, and global reach would likely command a premium to these multiples in a private transaction.
Margin of Safety Considerations
While AON represents a high-quality business, every investment requires consideration of downside protection:
Recession Resilience: As demonstrated during both the 2008-2009 financial crisis and COVID-19 pandemic, AON's business model maintains stability during economic contractions, limiting downside risk.
Balance Sheet Strength: Despite recent acquisition activity, AON maintains an investment-grade credit rating and manageable leverage ratios.
Structural Competitive Position: The insurance brokerage industry's consolidation trend favors scale players like AON, with regulatory complexity creating additional barriers to entry.
Valuation Verdict
At current prices, AON represents fair value for a high-quality business with durable competitive advantages. While not offering a significant margin of safety for deep value investors, the company's combination of quality, stability, and growth makes it attractive for long-term investors seeking compounding returns with limited downside risk.
The recent market reaction to Q1 2025 results has improved the valuation picture, creating a potentially attractive entry point for investors with a multi-year time horizon. For those building a portfolio of quality compounders, AON deserves serious consideration as a cornerstone holding that can deliver market-beating returns over full economic cycles.
This blog post represents my personal views and is not investment advice. Readers should conduct their own research before making investment decisions.Access my complete watchlist in our community.
Would you like to stay ahead of opportunities like this? Join our community where we share real-time trade alerts and deep-dive analyses of businesses with true competitive advantages. Don't just trade the market - invest in excellence.
Want to receive our trade alerts and detailed analysis in real-time? Join our community of value investors who understand that pricing power is the ultimate competitive advantage. Receive our trade alerts on your phone? Download the app here