Short Thoughts

As many of my readers know that I am short some stocks that I have written about on HypeZero:

With the market trending up the last couple of months, both Pandora and SHOS have skyrocketed costing me some money. However, Orchard has really tanked which has helped my short portfolio pretty much break even. Not bad in this market. 

I am keeping all three shorts as nothing fundamentally has changed from a business perspective at any of these three companies.

Because the market has gone up quite a bit, I am looking to add to my short portfolio. Here are some companies that have caught my eye as possible short candidates:

Zillow/Trulia

I have written that Zillow is better than Trulia based on sheer numbers. However, as I read more about this industry and these companies a couple of things concern me:

  • When I search for real estate in my area, I don’t use Zillow/Trulia because their information does not come from MLS so it is sometimes inaccurate or outdated. I use the realtor site run by Move Inc (MOVE).
  • I don’t see much of a difference between Move’s business plan and that of Zillow or Trulia. In fact, Move has better data.
  • Move has been around for a while and they have been struggling growing annual revenue past $200 million. Zillow is half the size at only $116 million in annual revenue, but worth 4+ times as much. As Zillow gets to Move’s size it will have similar growth problems.    
  • Sales and Marketing expenses are going up at a faster rate than revenue. If the market is so big and these companies have such a small percentage of the market size, why is it so hard to grow revenue? In 2012, Zillow revenue grew over 75+%, but sales and marketing grew over 100%. 2013 forecast calls for 45% revenue growth and 70% growth in sales and marketing expenses.
  • Both companies are trying to enter other markets by acquiring companies at premium prices. This is a big hint that the current business model does not justify the current valuation.
  • Zillow is barely profitable and Trulia is not profitable.

One thing that these companies have going for themselves is that the housing industry is bouncing back. This could result in real estate agents increasing their advertising spending on sites like Zillow. 

Moneygram (MGI)

I wrote that Wester Union is a value trap a couple of months back. Moneygram is Western Union’s biggest competitor, but it is smaller and does not enjoy Wester Union’s premium pricing. A couple of things concern me about this industry:

  • They charge the poorest people high prices to transfer small amount of money. Every year fees per transaction keep going down and there is constant pricing pressure. They need to increase the number of transactions per year just to keep revenue and profits from going down. Western Union, a huge cash cow, has been making $1 billion in profits for over 8 years.
  • Wester Union is performing price cuts across certain corridors and this should have an impact on Moneygram in 2013. 
  • New competitors (Xoom) and the wide adoption of smart phones will impact this industry in the future.

Monster/Dice

LinkedIn (LNKD) is hitting on all cylinders and the by-product of this that sites like Monster (MWW) and Dice (DHX) are hurting. Monster is at a 52 week low and I think Dice, a career website for technology professionals may be next. Even though the technology market is hot, Dice is barely growing revenue and profits. 

I will do more research on these companies before I short any of them.

Disclosure: I am short Pandora, Sears Hometown and Orchard Supply 

Wester Union Undervalued or Value Trap?

Western Union LogoWestern Union (WU), the money movement and payment services provider, recently reported third quarter results this past week. Although the results were not bad, the outlook was grim. In order to gain market share, the company expects to take restructuring costs, and more importantly lower prices. This will lead to lower earnings for the rest of 2012 and 2013. Investor reaction was swift, knocking the stock price from $18 to $12. At a 52 week low, is the stock now cheap?

Business

Western union has two business segments:

  • Consumer-to-Consumer. As you may have guessed, this is money transfer from one consumer to an another. This segment accounted for 84% of revenue and 95% of operating income for fiscal year 2011. 
  • Global Business Payments. This segment allows clients to make “one-time or recurring payments for consumers or businesses to other businesses.” This segment accounted for 14% of revenue and 10% of operating income for fiscal year 2011. (Note: Operating income numbers do not add up because rest of company lost money.)

Moat

Although they are trying to grow the smaller Global Business Payments segment, the valuation largely depends on the Consumer-to-Consumer business. In the Consumer-to-Consumer business, Western Union is the market share leader, garnering around a 17% market share in a fragmented industry. Moneygram International (MGI), its biggest competitor, accounts for just around 5% of the market.

Although, some investors are concerned about Western Union losing market share to digital competitors such as PayPal, the core company consumer sends money to a cash receiver. In this market, Wester Union is king. Their biggest advantage or moat if you will, is that they have a global network of 510,000 agents. Moneygram has less than 300,000 agents.

Their big network and presence allows them to charge a premium rate over their competitors. In some remote parts of the world, Western Union enjoys a monopoly since they are only agents in the area. As a result, they enjoy 60% of industry profits even though they only have a 17% market share. 

It is not easy for any company create this global network, and Western Union will continue to enjoy a premium price advantage due to it.

Industry

The global remittance volume is dependent on the global economy. It has been growing at a double digit CAGR rate and is expected to grow at around a rate of 7% over the next couple of year. See figure below.

Global Remittance VolumeSource: MoneyGram from World Bank 

Valuation

With a growing industry and premium pricing, one would think that Western Union’s net income would grow through the roof. However, that has not been the case. Net income has been fairly stagnant at around $1 billion/year since 2005.

Even though Western Union enjoys premium pricing over its competitors like MoneyGram, there is general pricing pressure in the industry. As a result to keep market share, Western Union’s revenue per transaction has been going down at a CAGR rate of 4.16% since 2006.  See figure below.

Wester Union Revenue Per Transaction  Source: 10K

Western Union has been able to grow revenue, maintain margins and maintain net income by increasing the number of transactions. Number of transactions per year has been growing at a CAGR rate of 8.95%. See Figure Below.

Wester Union Number Of TransactionsSource: 10K

If I could be confident that Western Union could at least maintain net income for a long time, I could assign a multiple to FCF and come up with a valuation. However, there are a couple of things working against Wester Union.

There is the constant pricing pressure on revenue per transaction that I just alluded to.

  • Customers that need to send money back home in remote parts of the world are paying super high fees to send just a couple hundred dollars.
  • Moneygram and other competitor’s prices are already lower than Wester Unions. Moneygram’s number of agents are growing at a higher rate than Wester Unions. Although, they will not catch Western Union anytime soon, they are putting more and more pricing pressure on certain corridors.
  • The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 already had an effect on this quarters revenue as 7,000 agents were dropped because they could not made compliant. Although, this act will not have significant revenue ramifications, there could be future acts that could have more of a lasting effect.
  • Although it does not affect Western Union’s core customers, competitors like PayPal are allowing consumers to send funds electronically very easily. In fact, PayPal and MoneyGram just signed a partnership where PayPal users can send funds to any MoneyGram location. This should have an effect on Western Union’s pricing and market share. 

The main reason for the gloomy forecast in the latest quarterly report is that management intends to lower prices to increase the number of transactions and gain back lost market share. The competitors will have to react to Western Union’s price cuts next year and they will cut prices. Then the price cutting vicious cycle will continue.

If you add the fact that global remittance volume is going to grow at a slower rate over the next 3 years than it has in the past, the best investors can hope for is that Western Union can maintain their net income of around $1 billion.If they can do that, then yes the stock is cheap at the current market capitalization of over $7 billion.

However, it is not worth investing in something that has limited upside and has so many things working against it. Therefore, even though this stock looks cheap from all valuation metrics, I am not investing in the company because I believe it is a value trap. 

Disclosure: I do not own WU.