Western Union: My Favorite Short As Disruption Is Poised To Destroy The Business
- The pace of technological innovation has quickened post the beginning of the Covid pandemic.
- My investment philosophy is to focus on the disrupters as long-term market outperformance can be had.
- Periodically, an interesting short candidate can appear as the business model is about to become irrevocably hampered.
- I believe Western Union falls neatly in the short camp as will be described below.
Shorting Western Union
Before delving into the short thesis on Western Union (NYSE:WU), I wanted to give some insight into the characteristics I am looking for in a short candidate. WU in its current form is in my view an impaired entity with scant avenues for growth.
Source: Seeking Alpha
As I delved into the financials of WU, it became very evident the structure of the business is impaired with a failure to grow revenue over the past decade. I like to use revenue growth as a measuring stick due to the inability to manipulate sales with accounting gimmicks. WU is about to leave off an additional source of revenue as it has agreed to sell its Business Solutions division, which accounted for 7% of the overall company's asset base. In fairness, margins were in the single-digit range which, coupled with a quick infusion of $910 million in cash, makes the deal in my view a minor win. WU's entire focus will be squarely on cross-border payments as evidenced by the quote below.
"With this divestiture, Western Union will be fully focused on maximizing the strength of our global cross-border payments platform and financial network," said Hikmet Ersek, President and CEO of Western Union.
Source: Western Union
My problem is what will the management team do with the new infusion of cash? The disposition of the Business Solutions division, in my opinion, is a tacit admission the deals consummated in 2009 for Custom House and Travelex Global Business Payments in 2011 did not meaningfully grow sales or profits.
Source: Seeking Alpha
If past history is taken into account, my fear is the infusion of cash will be earmarked for financial engineering to hide the true extent of challenges facing the business. WU has been adept at buying back stock and paying a higher dividend while, in my view, failing to meaningfully grow the core business. Now as the threat of digital disruption arises, I fear it will be too late for WU. The decline in EBITDA is very telling, even with the dramatic decrease in outstanding shares, earnings have barely grown.
The greatest challenge facing the WU business model is the rise of digital payments, most notably the use of crypto as a means of moving money. WU will be levered to the consumer-to-consumer transfers once the Business Solutions unit is disposed of. The first shot that piqued my interest was the move by El Salvador to accept Bitcoin as a means of digital remittance/payment.
Source: Seeking Alpha
Typically, I wait for a bit to see the impact of the news.
Western Union (WU -0.4%), MoneyGram (MGI +3.7%), and other service providers are estimated to lose $400M a year or more in remittance fees, says El Salvadorian President Nayib Bukele.
Approximately 70% of the country's population receives remittance payments and many El Salvadorians rely on payments from family members abroad. Collectively, $6B, or ~23% of the country's GDP, was transferred into El Salvador from outside the country. Western Union charges fees of up to 33% for online transfers, which cut into the amount customers actually receive.
Source: Seeking Alpha
The El Salvador move is the first of what I suspect will be many that will follow in their footsteps. El Salvador has gone down the Bitcoin (BTC-USD) rabbit hole, although for the short case in WU this is not an absolute necessity. My suspicion is stable coins will become the primary means of moving money.
For example, Tonga receives over 35% of its GFP via remittance payments per IMF data. The incentive to dramatically reduce fees or eliminate them would provide an immediate boost for the citizenry. I am a firm believer people will search out solutions that allow them to maintain the vast majority of their income. Even if adoption begins to ramp over time, my fear is WU is at imminent risk for digital disruption. How can they compete with nearly free when they have overhead to pay, salaries, etc.? In many ways, the crypto market has the potential to permanently disrupt cross-border payments to the benefit of the third world who are the overwhelming recipients of these payments.
Assuming the thesis plays out, I believe a longer-term time frame is necessary to allow ample time. In my personal portfolio, the use of long-term put options is optimal to allow the idea to come to fruition. A put is a contractual right to sell the shares at a predetermined price (strike price of the option). The beauty of an option is it limits the capital at risk while allowing you leverage to the upside if the idea works out.
Shorting equity opens an investor/speculator to some unique risks that are worth mentioning. In the case of WU, the sudden infusion of cash may embolden the management team to double down on their consumer business and launch and attempt to acquire its chief rival MoneyGram (MGI). The cash infusion post the disposal of its business unit would pave the way for this type of transaction. It does not in my view address the challenges facing the industry, instead, it bulks up WU in an attempt to help stave off competition. An announcement of this magnitude may light a fire under WU followed by a quick pop and pain for put holders. I do not believe the rally would last for a while hence longer-dated puts are optimal.
Part of the impetus to compose this article is the glowing reviews WU from the SA community. The last eight articles are all bullish yet the equity is down nearly 30% in 2021! The dramatic underperformance comes in a year where the overall market has posted high double-digit gains. That's correct, the 4% yield is not helping you, the shocking performance should give everyone reason at the bare minimum to re-evaluate their thesis on the equity. If the best reason to hold is the dividend, ask yourself this question. What would happen if WU cuts its dividend? Because if they don't come up with a credible answer and pivot the business, a cut can happen as disruption takes hold. Thanks for reading and I look forward to a lively debate!
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Analyst’s Disclosure: I/we have a beneficial short position in the shares of WU either through stock ownership, options, or other derivatives. 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.
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