Western Union (WU) is an iconic company and brand, having been around since 1851. The days of telegraphs and the like are long gone, but the company still thrives as a global money transfer and payment business. Western Union has a simple yet profitable business model. More than 80% of revenues come from consumer-to-consumer money transfers. Worldwide there are more than 500k agents who use the Western Union sign (could be a bank, retail store, grocery store, etc). Simply put, a customer will go to one of these locations and specify some information about the recipient and amount to send. On the receiving end, someone will go to a WU agent and present the correct passcode to receive their funds. WU makes most of its money from a small fee imposed on the sender for this service, as well as another fee for currency exchange if required.
Western Union's stock has fallen on hard times recently, as the company forecasted reduced revenues in 2013 mainly due to pricing pressures and compliance issues in its Mexican business. In the past few months, however, the stock has now started to recover, but at the current price of $14.53, the company is still undervalued. As the company continues to show investors in the coming few quarters that the sky is indeed "not falling," the stock should appreciate nicely back towards fair value.
The Market for Consumer Money Transfers is Larger Than You Might Think
Admittedly when I first took a look at Western Union's business, the initial thought that popped in my head was: "Doesn't everyone use banks to make money transfers?" What may come as a surprise to some, but makes perfect sense when you think about it is that as many as 50% of the world's adults still do not have bank accounts. That is an incredible 2.5 billion people. As indicated in a recent article in The Economist, this is largely skewed towards developing nations where only 41% of the population have bank accounts. In many of the world's poorest countries people live financially from day to day, and a bank account is a luxury that they don't have. In the developed world, close to 90% of adults have accounts with some sort of financial institution. Despite ever increasing electronic payments, this puts into perspective how the market for in person money transfers continues to remain strong. With an ever increasing flow of immigrants from poor countries into developed countries, there will remain a need for these people to have a means of sending money home to their families. For generations, Western Union has provided this means, and it should continue to do so for the foreseeable future. According to the company's most recent annual report, the industry trends in 2013 show cross-border growth in remittances of nearly 6%, which is largely driven by migrant workers transferring money home to their families. The top 4 countries in the world receiving inbound transfers are India, China, Mexico, and the Philippines, which together receive about $160B annually.
The Western Union Brand and Scale Gives the Company A Leg Up on Competition
According to the Brand Directory, the Western Union brand name has a value of about $1.5B, which on its own is about 12% of the current market cap. Besides having one of the oldest and most recognizable brand names in the US, the company also has a huge scale advantage over competition in the money transfer business. Western Union does about 4x the transaction volume of its nearest competitor, MoneyGram (MGI), and with its approximately 500k agents worldwide in 200 countries its reach is massive. To put this into perspective, there are 15 Western Union agents for every McDonald's restaurant. Overall Western Union has only about 20% market share, as the consumer to consumer transfer business is highly fragmented with lots of small local players. However, this is still more than double the share of MoneyGram, and the sheer size and financial position of WU allows it to periodically take aggressive pricing actions in order to maintain or even grow market share. The company consistently maintains impressive FCF margins of close to 20%.
Current Valuation - An Overreaction Caused By Issues in Mexico
With a strong brand and a stable long-term business having attractive economics, you would expect the company to trade for more than 6x EBITDA. Even in 2008-2009 during the depths of the financial crisis, the company traded between 7-9x EBITDA. In recent years, it was as high as 12x in early 2011. The main cause for concern by investors and Wall Street has been the announcement during the Q3 2012 results that there were troubles in the Mexican business. At the time the company revealed that it had revenue declines of 20% in Mexico, and it expected to remain at these lower levels for the first half of 2013. This was due to compliance issues with its Vigo and Orlandi Valuta brands, resulting in the termination of 7000 Vigo agents. The US to Mexico corridor is a major part of Western Union's business with an estimated 33m people of Mexican heritage living in the US. Besides Mexico, the company also stated there was general softness in transaction revenues worldwide with increasing competitive pressures. The European region was particularly challenging in 2012 with revenue declines of 6% (although transaction volume only decreased 1%, indicating the decline was due primarily to smaller average sizes of each transaction sent). To counter this the company is taking aggressive pricing action measures in 2013 - pricing investments are targeted at mid single digits as a percentage of revenues which is up from only 1% in 2011 and 2012. The company has executed similar initiatives many times, and management has a lot of experience and success with these maneuvers. I expect to see positive revenue growth returning by late 2013.
Growth Will Be Slower - But Still Positive Going Forward
Western Union has operating margins close to 25%. Looking back over the past 5 years, this has been relatively steady (yes, even during the great recession), and has only recently dipped a few hundred basis points in 2012. As discussed above, due to recent pricing pressures in its Mexican and worldwide businesses, the company has cut pricing to regain market share. In the Q4 conference call the management seemed upbeat about progress in this area saying the first few months of this initiative were going better than expected. The stock has already started to respond positively, as it has retreated from lows of about $12/share to the current price of $14.53.
The beauty about the WU business model is that it scales by transactions, as the revenues received are always a fixed percentage. This means very steady margins with stable cash flows. Over the past 10 years, the company has grown revenues and EPS about 10% per annum. WU has also consistently repurchased shares, retiring about 25% in 10 years. I do think growth is likely to be much slower going forward due to increasing competition for electronic payments via services such as PayPal or for example from mobile payment services. But remember, with 50% of the world's adults not even having a bank account, many of those same people also do not have access to computers or even mobile devices. Even the ones that do, the simplicity of doing WU transfers without needing any type of financial account is very appealing for many. Maintaining a strong brand name and huge scale advantages over competition, I still expect that Western Union can grow earnings and FCF about 5% per annum long term, taking into account low single digit revenue growth, steady margins, and inorganic growth averaging 2% per year through share repurchases. This seems a quite reasonable assumption, especially how even in 2013 cross border remittances grew 6%.
Risks to this thesis would primarily be prolonged economic weakness in Europe and other trouble spots which keep the average size of transactions down. However, continued economic improvements in the US and any signs of life in Europe will be a strong positive for the stock. I also think this growth assumption is a quite reasonable figure especially when you consider that the westernunion.com online business is growing at nearly 50% per year, and management predicts this to be a $500m business by 2015. Granted that is still small compared to the $5.6B in total revenues in 2012. However, strong growth in online sales could serve to offset some of the weaker consumer to consumer markets in the traditional business, thereby preserving top line growth.
The Bottom Line
5% growth may not seem all that exciting, but it is when you realize the market is now pricing the company for less than 0%. On a cash flow basis, I would value the shares at nearly $22, which is an attractive upside of about 50% from current levels. Looking at a relative valuation, probably the most similar competitor as stated previously is MoneyGram. Both companies actually have an almost identical value of just over 6x EBITDA. However, Western Union is a much better business, where its brand and scale (8x the size of MGI) allows it to command far superior operating margins - 25% vs. 14%.
For me this one is a no brainer. With a strong brand name, huge scale advantage over the competition, positive growth prospects, and a safe dividend yield of more than 3%, Western Union is a very attractive buy today at these levels.