Western Union: Walmart Crashes The Party

Summary

• Likely buried in the news flow of recent market volatility was the announcement of Walmart-2-World, an international money transfer platform.
• In 2014, Walmart-2-Walmart caused waves in domestic transfers. Western Union cut prices, but this was less than 10% of the company's business.
• Walmart-2-World is much different; 30% of consolidated revenue is impacted (and a larger percentage of operating income).
• MoneyGram International is clearly willing to cede margins in order to gain share in partnership with Walmart. 2018 and 2019 expectations for Western Union are too high.

The Western Union Company (NYSE:WU) has a great capital light business model with stellar margins and has long been considered a value stock. It owns a commanding share of the global financial market, particularly within people to people transfers. The business forms a foundation for capital infusion into developing nations, yet there are kinks appearing in the armor. While disruption has been posited to come from disruptions in financial technology, the elephant in the room continues to be Walmart (WMT). At first glance, an unlikely player, Walmart brought disruption to domestic money transfers in the United States through its partnership with MoneyGram International (MGI) and it has decided to move onto bigger fish: global transfers outbound out of the United States. These transfers make up a not so small part of Western Union's business: 37% of Consumer-to-Consumer Segment revenue in 2017 was outbound from the United States and Canada to foreign countries, primarily developing nations.

The news of this announcement was seemingly missed by the market - perhaps investor focus was on the extreme volatility that was taking place market-wide last week. I don't think investors are giving enough credit to what will be an upcoming price war. If history is any guide, this could get ugly for Western Union very quickly.

Western Union, MoneyGram, and Walmart

While Western Union has some exposure to business solutions and bill payments, the vast majority of operating income (91% in 2017) is generated from the Consumer-to-Consumer operating segment, or individual money transfers from people like you and me to another. A significant portion of these transfers were cross-border transactions, facilitating the movement of money between countries. This, up to now, has been a business dominated by MoneyGram International and Western Union, with the two controlling a substantial portion of market share. Cash flow and margins, at least historically, have been built off of these foreign transfers. Domestic transactions (e.g., New York to Los Angeles) contributed less than 10% of 2017 revenue for Western Union.

Last week, Walmart and MoneyGram International announced the launch of Walmart-2-World, a new money transfer service. This builds off of the foundation formed by a prior agreement and Walmart-2-Walmart which allowed customers to send money between Walmart locations based in the United States. Instead, Walmart-2-World will allow customers to send money from any of Walmart's nearly 5,000 stores to any MoneyGram location in 200 countries. While MoneyGram itself stands to lose in this deal (potential cannibalization of existing business), Western Union has the most to lose. A pricing war on US outbound activity (transfers from the United States to abroad) risks stressing relatively stable operating results. Shareholders already know that Western Union has finally returned to profit improvement and revenue growth, coming off the $464mm impairment charge in 2017 and a $601mm settlement with the New York Department of Financial Services ("NYDFS") in 2016.

Walmart is set to make waves and a price war seems inevitable. While details are sparse before the roll-out, the announced fee structure of Walmart2World is set to be flat no matter the destination ($4 to send up to $50, $8 to send $51-1,000, $16 to send $1,001-2,500) and currently lower than the rates charged by major players. This is quite obviously consumer-friendly and reduces some of the nickel-and-diming present in the current model for both of the entrenched players. However, the reduced fee structure isn't even the largest potential driver in my view. One of the largest issues with how MoneyGram and Western Union make money, at least from a regulatory point of view, is making profit off the back of foreign exchange. Headline fees charged to the consumer are often low, but both Western Union and MoneyGram are in the habit of making substantial profit based on giving consumers unfavorable foreign exchange conversion. In 2017, Western Union (conveniently) began not breaking down what percentage of its revenue was derived from foreign exchange, but investors can see the contribution from the 2016 Form 10-K:

While no details have been set yet, Walmart had this to say about the foreign exchange rates it would charge:

Walmart is committed to ensuring customers receive a more competitive foreign exchange rate when transferring money using Walmart2World. The new Walmart2World low fees, combined with these great exchange rates deliver incredible value for international sends.

Looking To The Past

Walmart-2-Walmart triggered price cuts among rivals when it launched in 2014, with management at Walmart pushing even more cuts as recently as 2017. Today, sending $500 through Western Union will run a consumer between $12.50 and $40 depending on what fees Western Union tries to obfuscate on consumers depending on what rates agents charge; a transfer via Walmart-2-Walmart runs $8 flat. While Western Union likes to take the stance, it has not been impacted by pricing pressures, facts point otherwise. In 2014, the company booked 255mm consumer-to-consumer transactions, or $17.60 per transaction in revenue. By 2017, that figure had fallen to $15.78 per transaction on 276mm transactions, a fall of more than 10%. That is despite a move in mix towards more cross-border transactions (higher revenue per transaction) as a result of Walmart-2-Walmart taking market share. Management was able to shrug off Walmart-2-Walmart in 2014 during the Q1 2014 conference call, stating this about the company's entry initially (before eventually cutting pricing):

Just putting under perspective, it's only 8% of our total company revenues [domestic transfers]. And putting things on perspective, we have many, many agents globally, which gives us 500,000 locations… don't know how many Walmart has, about 4,000 locations or something like that. So our 46,000 locations do serve customers. The customers value the speed. The customers value our brand. The customers value our locations. But we do also pricing actions if you need it quarter-by-quarter, band by band.

All of this changes with Walmart-2-World:

• 8% of total company revenue? Cross-border is much more material: $1,611mm in revenue, or nearly 30% of 2017 consolidated results, faces competition from Walmart-2-World (transfers from the US/Canada to global overseas locations)
• 4,000 locations? Walmart-2-World can now leverage MoneyGram International's more than 350,000 locations, the majority of those located internationally.
• Speed? MoneyGram International transfers have similar transaction times to Western Union.

There is significant potential for disruption. Western Union is likely to cut prices, pay higher agent commissions, and increase customer acquisition costs - all of which will reduce the margin profile. As a capital light business, this could impair cash flow.

Even before this announcement, sell-side analysts expected just 3% revenue growth from Western Union in 2018. That figure is more likely to come in at flat to down in my opinion, with 2019 seeing more impact as consumers adapt to a new payment option. For international transfers, these are consumers with very little means: small differences in fees matter. Price competition will inevitably drive lower profitability. By and large, most expectations were for low single digit EBITDA growth in 2018. That figure, too, is more likely to come in flat to down. While certain areas of its business are not impacted - international money transfers outside of the Walmart footprint - significant pressure remains. Walmart is likely to advertise this roll-out heavily leading into launch and immediately after. My expectation is for 2018 guidance to get walked down by Western Union management, and the equity is likely to see selling pressure as the market comes to terms with the new realities present here.

Analyst’s Disclosure: I am/we are short WU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.