Western 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?
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.)
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.
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.
Source: MoneyGram from World Bank
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.
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.
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.