There is nothing too complicated about my decision to purchase a stake in Western Union. I have been tracking this spin-off from First Data (FDC) at Fat Pitch Financials Contributor’s Corner for several weeks since this is a special situation opportunity.
Western Union is not just a spin-off opportunity. It also has a wide moat. Western Union is a global leader in money transfer services. This company has the ability to send money to more than 245,000 Western Union Agent locations in over 200 countries and territories. Now that grants this company a network effect and economies of scale. Western Union’s brand is also widely recognized and instills trust in users of their service, which is very important for cash transfers.
The network effect comes from the fact that the more people that use the Western Union money transfer network, the more valuable it becomes. The economies of scale comes from the fact that it would be very costly to recreate a similar large scale money transfer network and smaller networks would be less profitable because they would not provide the same service capabilities.
The costs of maintaining the money transfer network is fairly low, so increasing the number of users increases the amount of profit exponentially. In economic terms, the fixed costs are high but the marginal cost of processing each money transfer is low. Therefore, I believe that Western Union could dramatically increase their earnings in the future if they get creative at expanding the uses of their money transfer network. For example, Western Union might even be able to expand its service offerings by facilitating cash purchases of online products, a niche that could become increasingly important as those without credit access start to shop online more frequently. Also, the growth potential of cash transactions occurring over the Western Union network looks very promising.
Sadly, in the near future we will likely see easing of U.S. immigration enforcement and anti-terrorism measures, if no further terrorist attacks occur in the U.S. Relaxing these measure will likely boost Western Union’s cash flows.
To estimate the value of Western Union, I used a 12 percent growth rate for 2007 estimated net income of $1 billion. I projected out net income (assuming it’s close to owner’s earnings) for 10 years and then I calculated the terminal value using a 10 percent discount rate and 3.5 percent stable growth rate. That gave me an intrinsic value per share of $32 after adjusting for net debt of $2.1 billion ($3.5 billion in debt minus $1.3 billion in cash). That’s a 46 percent discount to what I bought the shares for if I did a good job of estimating intrinsic value.
WU 1-yr chart:
You can read some of the stories that helped me come to my decision about Western Union at Value Investing News.
Full Disclosure: I now own shares in Western Union.