By Jeff Bailey
Companies that can claim technologies that hold the promise of disrupting large and established markets seem to collect true-believer investor followings, and we have spent a good part of 2014 writing about how the disruption fetish has pushed some of these stocks past what seem to be reasonable valuations.
A disrupter that caught our eye in recent weeks is Xoom (NASDAQ:XOOM), which provides consumer-to-consumer international money transfers and is thus aimed at taking business away from Western Union (NYSE:WU). In a recent issue of Barron's, hedge fund manager Mario Cibelli named Xoom as his second largest holding, equal to 12% of his fund's assets. Cibelli told Barron's he expects Xoom's pre-tax profit to rise eight-fold by 2017, and sees the stock more than doubling.
There's little doubt that Cibelli is smarter than yours truly, but before you similarly load up on Xoom shares - and by inference dismiss Western Union as a has-been - some investment research is called for.
Xoom's growth is decelerating. Its revenue rose 53% last year to $122.2 million. But it forecast 2014 revenue of $157 million-to-$162 million, at best a 32% increase. It also expects a loss for the year. On the basis of those numbers, Xoom has a market cap of about $800 million and its stock trades at about five times 2014 projected revenue.
XOOM data by YCharts
Western Union had 2013 revenue of $5.5 billion and enjoys a lush profit margin, with $798.4 million falling to the bottom line, or $1.43 a share. But let's put that aside for now and focus on Western Union's own electronic payments venture: it accounted for about 5% of those revenues last year, or about $275 million. That's more than twice the revenue of disruptive Xoom. And get this: Western Union's revenues from electronic fund transfers are accelerating. After rising 25% for all of last year, they were up 36% in the first quarter of 2014.
As a stand-alone company named Boom or some such, the Western Union electronic transfer business might fetch a market cap of more than $1.5 billion. But long-term it probably has more value operating as part of Western Union, which can let its tens of millions of customers choose exactly how they want to send cash.
Oh sure, the B-School student in us all supposes, even after seeing these numbers, that Western Union will have difficulty using electronic payments to compete against its own, dominant in-person money transfer business supported by 500,000 agents it does business with in more than 200 countries. We've studied the encyclopedia case histories where the poor bastards couldn't let go of their multi-volume print editions and door-to-door salesmen, and so were cannibalized by crappy online competitors.
But Western Union tells us in its nicely-informative 10-K that agent commissions represent two-thirds of cost of service, or more than $2 billion a year. Western Union also employs 10,000 people in large part to oversee all those agents, a workforce that could shrink in a shift to electronic payments. And agents who get involved with unsavory customers - governments monitor the money transfer business for signs of money laundering, drug running and terrorism finance - bring costly and time-consuming grief to Western Union.
Like airlines before it, Western Union has every incentive to steer business away from agents and toward its own electronic transfer site. Unlike the saps in the airline business, Western Union won't likely invite competitors like Xoom to handle its business in the way that Expedia (NASDAQ:EXPE) and others were with airlines.
Western Union handled 242 million consumer-to-consumer money transfers last year, with an average amount of $338. The number of transactions has risen 24% over the past five years, while revenue grew a more modest 9%. Western Union has been and continues to cut prices in competitive markets to hang onto customers. That doesn't make it a bad business, just one emerging from a long period of ridiculously fat margins.
WU Profit Margin (TTM) data by YCharts
It's dull. It's big. It makes a lot of money. And it's probably not the sitting duck the Xoom fans hope it is.
WU Revenue (TTM) data by YCharts
YCharts has been compelled to write about Western Union several times in the past - earlier this year, for instance, when its dividend yield topped 3% (it's at 3.1% now), and last September in a discussion about what Morningstar (NASDAQ:MORN) calls wide-moat stocks.
Western Union enjoys, for now at least, a regulatory status that allows it to richly reward shareholders. It's not a bank holding company, so it isn't subject to banking industry capital requirements, but rather must maintain favorable credit ratings, which it does. But that hasn't stopped it from being a huge buyer of its own shares in recent years, reducing shares outstanding more aggressively, say, than American Express (NYSE:AXP).
WU Shares Outstanding data by YCharts
Between buybacks and dividends, the shareholder yield is running about 8%.
WU Shareholder Yield (TTM) data by YCharts
Western Union operates with a fair amount of debt, small-ish equity and a big slug of goodwill on its balance sheet, so tangible net worth is hugely negative. Bank regulators wouldn't go for that, but thus far the company has stayed out of the clutches of the regulators.
WU Total Long Term Debt (Annual) data by YCharts
The dividend has risen sharply and the payout ratio is at around 35%. The annual dividend tab last year was about $277 million. Buybacks last year were about $400 million.
The effective tax rate is super low because most of the profits are booked overseas. More than 85% of consumer-to-consumer money transfers involve at least one country other than the United States.
WU Effective Tax Rate (TTM) data by YCharts
Finally, Western Union shares, by historical standards and relative to the market, are cheap.
WU PE Ratio (Forward) data by YCharts