For many decades, migrant workers have been willing to pay Western Union (NYSE:WU) a significant fee to send home (remit) relatively small sums of money. WU is by far the oldest and largest player in this business. Its brand is well recognised and respected. It has by far the greatest number of corridors to transfer small sums to and between underdeveloped countries safely and quickly. http://en.wikipedia.org/wiki/Western_union
Western Union (NYSE:WU) is a wonderful business at an attractive price.
Is the price attractive ?
I use round numbers, my source for the numbers in this case is gurufocus. The numbers are in line with the SEC filings. Since it was spun out of FDC, WU generated about $ 1B p/a of FCF under terrible conditions. Millions of migrant workers have lost their source of income. Meanwhile the company spent about $ 0.5B annually on capex. Interestingly, capex is more than PP&E ! From the high level of capex, we deduce FCF understates owner earnings. With a market cap of $ 12B, let's say WU has an earnings yield of 10%.
Is this a Wonderful business ?
ROE, ROA, ROTA, ROIC, ROCE, CROIC…… I leave it as an exercise to the reader to come up with precise numbers but they will be satisfactory. We conclude that a dollar retained in WU generates satisfactory returns. Alas, Western Union does not have enough opportunities to retain all the dollars it earns. The company has spent $ 0.6B annually buying back shares. It also paid a hefty $ 3B dividend to its former parent (FirstData corp FDC). This $ 12B company has returned ± $ 7B to its owners in 5 years.
But that's just numbers… what actually drives this business ? Simple..... WU profits from charges associated with the principal being transferred as well as income derived from a spread between the exchange rate used in the transfer and the exchange rate that the company pays.
In practice WU goes to say ..... Uganda with $ 50m and hands those dollars to the local authorities (a term I use losely to include post offices and big banks). In the case of Uganda, the dollars are converted to Shillings at a rate that is somewhat profitable to Western Union and very profitable to the local authorities. The money is then "virtually deposited" at local points of presence. The money is released as soon as a migrant worker abroad pays. It's in the interest of all parties in the network to make sure the money runs out quickly. For some reason, the Shilling always becomes more expensive round christmas and at the start of school years. This is when migrant workers send home money. Migrant workers in the US pay fees in the US so earnings are not locked out like with other highly profitable global franchises. As a percentage of Ugandan GDP, remittances are > 5%.
This is a winner-take-all business.... the two major expenses are commissions (a % of revenue) and SG&A and Marketing (fixed). WU has higher margins because:
1) The company can charge higher prices, making commissions a lower percentage of revenue, because it has better brand recognition and more options to offer customers. Moneygram for example states that their strategy is to undercut WU. Alas, commissions paid to agents must be comparable to attract and retain quality agents.
2) WU is 4 times the size of its closest competitor (NASDAQ:MGI) making the fixed cost component a much smaller percentage of revenue.
In short, as WU grows, so do its competitive advantages. A wonderful business.
What are bears saying ?
1) Innovative technology.
Mr. Market worries that business of transferring cash abroad is a "newspaper business". WU saw the arrival of such trivial innovations as trains, (jet)planes, automobiles, credit cards, phones, the Interweb.... but now we have smartphones and Google.... this time is different ! http://www.vrl-financial-news.com/bpa/banking--payments-asia/issues/bpa-2009/bpa6/innovations-to-drive-remittanc.aspx
Mr. Market says it's no bargain. p/e = 14 p/b = 25 p/s = 2.3 financial services..... ehm next stock.
3) We have a motivated seller. http://www.gurufocus.com/forum/read.php?2,110537
Why are the bears wrong ?
1) Smartphones and Paypal. Let's see if we can get a thread going... IMHO mr. Market confuses WU with a company that sells wallets.
Bears argue that as more customers in developing countries obtain cellular phones with increasingly sophisticated capabilities, the need for physical agency locations diminishes. For example, typical PayPal fees for international transfers are in the 4 percent range. Well....
- There is a dig difference between developing countries and underdeveloped countries. Migrant workers know this.... Eritrea in the eighties, Zimbabwe now.
- Also, who is going to pay for that smartphone in the first place ?
- And guess who has got the greatest number of prepaid cards outstanding in the migrant community ? No bank account required...
- Lasty, the franchise value is in the relationship with local authorities. It's usually the local "authorities" that run the local network. Post offices In Pakistan and India to name just two. If the local network can get the stream of money to the recipient faster (digitally) and with fewer points of presence.... great. It's very much in their interest. The franchise value of WU is not in the number of points of presence, it's in the number of profitable corridors it "owns".
2) GAAP..... WU has been expanding aggressively. As it deposits (or lends) money to its foreign partners the cost is expensed immediately while the revenue is recognised as migrant workers actually pay for the service provided. GAAP earnings are understated. As for book value..... this is a high ROE business. Book value can and does go negative; compare this to MCO.
3) The motivated seller may become a buyer in the near future just with more funds and less turnover.
WU is the largest player by far. It has a 20% market share. It competes directly with MGI which has a 5% market share. MGI however fooled around with subprime stuff and has had problems since 07. http://www.smartmoney.com/investing/stocks/moneygram-awaits-rescue-after-debt-fiasco-22405/
As I have explained, cold cash is important to secure relations in the underdeveloped countries with the high margins and long-term prospects. Mexico used to be the place to be in the eighties for this business. Now that there are many businesses with networks crossing the US/Mexican border, that corridor is less profitable. MGI uses the network of Walmart between Mexico and the US to compete. WU on the other hand owns its own network in corners of the world where it matters most. Over the next few years, WU will take market share from MGI because MGI is strapped for cash.
In the long term, underdeveloped countries can develop. Revenue rises and margins fall as a country does more business with the country migrant workers went to. This is the game WU has been playing for more than a century. At first within the US now internationally. WU forges its relationships in the least developed countries. No big deals in Mexico with Walmart... what you need for the long term is small deals in Benin, Uganda, Haiti and not so small deals in Bangladesh and Sri Lanka.
- Rapidly appreciating dollar; WU buys foreign currency upfront.
- Scare or actual mistake damaging the brand.
- Venezuela type risk.
- Credit risk of partners.
- The 789342 other risks I have not thought of yet.
Any and all questions welcome as usual.