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I Am Long Western Union - Here Is Why

November 19, 2012 | About:
Nistka

Nistka

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Background: On Oct. 30, Western Union (WU) released their earnings report, recording a profit increase of 12% quarter over quarter, but with a grim outlook, causing the stock to drop around 30%, which in turn made me look into the stock.

The basics: It has a yield around 4%, a P/E around 6 and a normalized of P/E of around 7.5. They are in the business of providing money transfers — people walk into a branch and transfer a given amount of money for someone else to collect at a different branch. Most of the transfers are made to people in countries that don't have reliable banking systems. Western Union then collects a fee, which is 100% of their profit.

In terms of moat they are the market leader, but have only hold around 20% of the market share, so there is plenty of room to grow. Their moat is primarily in terms of real estate — they have more locations than any other money transfer business, they are more visible than any other of their competitors and in turn they have a better brand.

Their primary competitors include Euronet, Moneygram and Wex, but in my eyes WU definitely has a stronghold on this business, and I don't see the competition as a threat to declining margins.

Over the last 10 years its profit has been relatively stable, around $900 million, with cash flow pretty much corresponding to the profit. In the same period they have reduced their shares outstanding from $750 million to $600 million, and increased the dividend to $0.38 cents per share. The yield is currently at 4%. All of the key personnel have been with the company for 10 or more years, and having been promoted from within the business, it is fair to assume that they have a good idea of what's going on in the different branches of the company, and how to improve them. Furthermore, most members of management have a lot of their net worth in the stock, and this is part of the reason for the friendliness towards shareholders.

Risks:

The risks are primarily macro risks — further decline in the global economy, improvement of the banking systems in the third world (which will take time), and on the micro side, there is always the risk of new and old competition cannibalizing the business. I don't see this as a major threat as the barriers to entry are relatively high, in terms of high costs, primarily related to real estate, but also in terms of networking around the globe, and building a brand.

Valuation:

I see this stock as very undervalued. A very conservative estimate of the intrinsic value of the business is 10 B, which would imply a margin of safety of 30%. This assumes no growth and a P/E of 10 (WEX and euronet's P/E is in the mid 20s). In my eyes this is still extremely low for a shareholder-oriented company, with a sizable moat, solid management, good profitability and overall a very robust company.

I see this company as being worth around $15 billion. Throw in a 4% yield and a minimum of risk, and I have all the reason I need to invest in this great business.

Disclosure: Long WU.

Rating: 2.3/5 (14 votes)

Comments

stevenramsey
Stevenramsey - 2 years ago
I realize that WU has a solid ROC, high margins and generates a ton of Free Cash Flow. What have they historically done with the FCF? And what has CapEx been and will there need to be much more over the next 2-3 years?

And what are your thoughts on this service becoming unnecessary? For instance, could Google wipe them out by coming up with a service themselves.

What I'm getting at, I guess, is that is the moat around the business really strong? I'm interested in the idea though.
hardcorevalue
Hardcorevalue - 2 years ago
The biggest risk is not macro, its new entrants destroying market share.

batbeer2
Batbeer2 premium member - 2 years ago
>> For instance, could Google wipe them out by coming up with a service themselves.

And how is Google going to get local currency in Malawi?

stevenramsey
Stevenramsey - 2 years ago
Because they're Google...just joshin'.

I'm just considering the wide basket of risks possible to companies. Google can interrupt a number of industries. I don't know the odds of Google shaking up the financial services business, but the "cat risk" is one of the first questions Buffett considers when an idea comes to him.

Per the "local currency in Malawi" is a good point. Maybe Google can't right now. But could they do it later?

But they are a possible "new entrant" that could be overlooked when considering owning Western Union.

batbeer2
Batbeer2 premium member - 2 years ago
1) There are a lot of rules and regulations to deal with if you want to send money to Pakistan. Basically you need to log the transactions for all sorts of government agencies to check. Don't get me started on Iran, Indonesia or Nigeria. In Europe it's worse. Those are the barriers to entry on the upstream side.

2) Many developing countries "take their cut" as money is transferred to locals. They have all sorts of "rules" to comply with. Maintaining good relations downstream is important. Many developing countries have a national postal service. WU has been doing business with them for more than a century. This creates barriers to entry downstream.

Google has problems getting information in and out of China, Iran and Brazil, let alone cash.

- If Moneygram, with a double digit market share, is struggling to make a profit, at what point does a new entrant hope to turn a profit?

- If Google really wanted to enter this busienss, why not buy WU?

- Apps on smartphones may make wallets obsolete but they are unlikely to create a single global currency overnight.

Just random thoughts.

P.S. Intel, Dell and Cisco have heaps of cash abroad. Buying (or partnering) with WU would solve the problem of repatriating that.
stevenramsey
Stevenramsey - 2 years ago
Great thoughts batbeer2. I hadn't thought of those thingsthat nor did I know the intricacies of what you just discussed at the top there.

So here is a question: why would Berkshire not just buy the whole business? I know Buffett likes offers to come to him, but let's just say the WU CEO did come to him with an offer. What would that phone call be like?
stevenramsey
Stevenramsey - 2 years ago
Great thoughts batbeer2. I hadn't thought of those thingsthat nor did I know the intricacies of what you just discussed at the top there.

So here is a question: why would Berkshire not just buy the whole business? I know Buffett likes offers to come to him, but let's just say the WU CEO did come to him with an offer.

What would that phone call be like?
batbeer2
Batbeer2 premium member - 2 years ago
>> What would that phone call be like?

Very short.

The CEO is not the owner. I think Buffett wouldn't spend 5 secs discussing a sale with someone who doesn't own what he is selling. Also, Buffett has probably known this business longer than Hikmet Ersek is old.

The only thing I don't love about WU is management. The company was spun out of First Data some years ago. They had to pay First Data a 3 billion special dividend in 2006. It's not an uncommon arrangement but management (Hikmet Ersek was not yet promoted to CEO then) weren't as upfront about the matter as I would like to see. It seems to me their loyalties were with the former parent (former bosses) and less with the new owners (shareholders).

I think Hikmet Ersek et al are the best operators in the business. I just don't feel they have an absolute focus on the interest of shareholders. I would not be surprised to see these managers accept a nice bonus for themselves and allow the company to be taken under.

This is just a feeling I have after listening to some conference calls, looking at the CVs and seeing how they leveraged the company to pay the special dividend. It's the only reason I don't own WU and it's very subjective.

Just random thoughts.
batbeer2
Batbeer2 premium member - 2 years ago
By the way, the author of this article is a lot smarter than I. I was bullish on WU at much higher prices.


That feeble attempt at an article has thankfully been forgotten but the thread should be worth reading for anyone interested in this discussion.
Nistka
Nistka - 1 year ago
@ Batbeer: I gained as much insight from your article and comments than i did in my own research. I am a young student, looking to learn as much as possible, and you helped put more perspective on my thesis, and I appreciate that. Out of curiosity; were you long WU when you published your initial article, and what changed your time from that time till now? And thank you for the hat-tip.

I agree with the fact that Google still has a long way to go until they can compete with this business. They may be able to in time, but the technological state of the developing countries is lightyears away from being at a point where I see them as a real threat.

Taking the points from the thread into consideration I still have yet to see arguments that breaks the thesis. I stil see the moat as incredibly strong, and I see this more as a Coca-Cola type business, than a Nokia-kind.

I appreciate the counter-arguments and I hope more discussion is spurred from this thread in spite of the mediocre write-up :)

batbeer2
Batbeer2 premium member - 1 year ago
Hi Nistka,

>> Out of curiosity; were you long WU when you published your initial article, and what changed your time from that time till now? And thank you for the hat-tip.

No. At the time it did not meet my hurdle rate (I try to get a 30% yield on earnings power). That's 3x sustainable earnings. This probably explains why I have a relatively concentrated portfolio.

As for WU...as I kept tracking it, I developed a bad feeling about management. It's subjective though. I have found no evidence of stupidity or even worse, personal enrichment at the expense of shareholders.

Also, I currently have more ideas than cash.
Nistka
Nistka - 1 year ago
I agree that the gutfeeling can at times be one's most valuable tool of analysis, but it is not one I share. Also, with regards to earnings yield - I understand that paying 3x sustainable earnings is a very temtpting proposition, one that I have almost never found, but how do you calculate that?
batbeer2
Batbeer2 premium member - 1 year ago
I understand that paying 3x sustainable earnings is a very temtpting proposition, one that I have almost never found, but how do you calculate that?

LOL, I can't help you out on that one. I don't do calculations.

I just wrote about one idea here. Most sites (including GuruFocus) will tell you the stock trades at less than 3x FCF. The calculation of the yield (or multiple) is not the problem. In the comments on that thread, someone crunched the numbers and concluded it's 4x. OK, that's fine by me.

At those kinds of yields, it's not the math that's hard. The hard part is sifting through dozens of companies like that and figuring out if the earnings are sustainable. Obviously, if you find a company at 3x and you believe earnings to be sustainable, that will probably not be the consensus view.

In the case of COCO, like WU, I had it in my sights years ago. I had an opinion about the business already and the market now offers me the stock at less than 3x.

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