Someone who reads my articles wrote this email:
"I noticed in your postings that you were looking into WU. While I really don't have any special insight to share, I do want to share my thinking about this one. I think the one thing that will probably hold me back from investing in WU at this time is I think WU's competitive position in the C2C money transfer business will deteriorate in the future due to the ever-increasing popularity of other more efficient and economical means of transferring money (i.e. prepaid card, mobile payment, etc.). Years ago the under-banked/migrants really didn't have any better ways of transferring their money back home, etc., and this effectively allowed WU to dominate this niche-market. I think that's about to change, witnessing the fast expansion of card usage and card networks globally and the growing popularity and affordability of smartphones. I understand that WU still does great volume of traditional C2C business, but I just think that any reasonable consumer will eventually realize that there are better means out there to do a cross-border transfer and the switching cost is quite low, honestly. It seems WU knew its challenges and has entered some of these newer transfer areas, but I am not yet convinced how it could differentiate itself down the road. At less than 10x P/E perhaps we have some margin for error, but I don't think I can get comfortable as time goes by that WU's intrinsic value will go up."
That is obviously my major concern with Western Union (NYSE:WU). However, I am not sure I share your concern
— or the concern that many people have emailed me — that Western Union is actually an inferior way of doing cross-border money transfer. There is no switching cost. That is true. However, Western Union has the lowest costs of anyone in the business. They also charge the highest prices — and by far the highest prices relative to their costs — but they still have lower costs than others.
I have not found other companies that can do what Western Union does for less other than, say, MoneyGram (NASDAQ:MGI). And, in fact, MoneyGram is not an effective competitor in many places. For example, Western Union is very strong in transfers that don't touch the U.S. at all (about two-fifths of their business, very little of anybody else's business).
I have thought about who could compete with Western Union. It is hard to find real competitors. Yes, PayPal can compete with Western Union. But PayPal is based on the idea of a bank account. So they have to do exactly the same thing Western Union does now. They need to either get the receive side to have a bank account (which is almost never the case in cross border money transfers) or they need to sign up banks, etc. around the world to put their name in physical locations exactly the way Western Union does.
The obvious competition on the receive side could come from banks (which have been in and out of the business over the years) and mobile phone companies. Obviously, mobile phone companies can take advantage of phone numbers of email addresses in place of bank accounts. But they still need either a bank account or a physical location to take out the money.
The network aspect of the business is very important. Citibank (C) and American Express (AXP) were the two most aggressive companies in entering this business in the late 1980s. Citibank spent a ton of money trying to offer higher signing bonuses to attract agents. They ended up failing. And it cost them a lot of money.
American Express succeeded. That is where MoneyGram came from. It is the old American Express business. American Express was able to succeed because they had the American Express card and they advertised heavily. So they could sign up agents wherever the card was popular and they could support agents with a lot of brand building. In the U.S., it ended up being only Western Union and MoneyGram and both businesses had been attached to other payment processing businesses (First Data and American Express).
It's a very interesting business. I have heard from many people that they think it will change. It might. But Quan (in Vietnam now) has been talking to everyone he knows who has worked in one country and sent payment back to their home country and has not found the same concerns expressed by investors in developed economies. So I think there is a disconnect between reality as Western Union’s customers see it and as Western Union’s investors see it.
Basically, they have all said that their families back home vastly prefer cash. They do not have bank accounts. Yes, they have mobile phones. But they are often using prepaid mobile phones. And so on.
Western Union and MoneyGram together account for less than half of the money transfer business across borders. So called "informal" transfers account for the majority. Over the last 10 years, Western Union has cut prices by about 50% and they basically plan to keep doing that as volume increases — if volume increases with price cuts.
That additional volume comes from informal transfers. Informal transfers are often very inconvenient. They are time consuming. They sometimes involve going to a different town to find a bank etc. Remember, Western Union receive locations in places like rural India are not banks or post offices. They are everything from little shops to actually just big farms. There is a big difference between rural and urban locations.
Anyway, this problem of the last hop to receive locations is the key to the business. A huge number of Western Union locations (about one third) get almost no traffic most of the time. They are merely there to increase convenience for send locations. Otherwise, the network would be weak in rural areas.
That is the most interesting part of the business. If you compare Western Union to a bank you see a big difference in terms of network economies. As a rule, the bigger and more diffuse a bank becomes the less business it does in each location. Because each added location is a less ideal choice than previously developed locations. Small, local U.S. banks do more business per branch than large national banks. Some very concentrated, high market share banks have much higher deposits per branch than their big national competitors.
Now, the interesting thing about Western Union is that despite having more agent locations than anybody else they also generate more transaction volume — and therefore more fees for agents — per location.
Finally, while I agree with you about switching costs for customers — I believe switching costs are high for agents. And agents are the only point of contact for most customers with the money transfer business. And certainly the only point of contact ever on the receive side.
Most of Western Union's business is driven by agents who have been with the company on average for about 15 years. They are usually under contract for several years (about five) and get a signing bonus for a new contract.
An agent that leaves its network will suddenly be unable to transfer money using the same network for its customers. Customers are often visiting agents once every month.
Because other companies — with the exception of MoneyGram — never share Western Union's footprint on both sides of a transaction anyone who leaves a network can no longer promise its old customers the same receive location or even a very similar receive location. That's only possible in a few key corridors like U.S. to Mexico where it is easy to substitute pretty similar locations.
Anyway, it is a major concern of mine. Because it has to do with technology. I think it is very overblown as a concern of investors though. Because I think the ideas they have about what the receive side thinks is convenient is very different.
There is a big difference between what the send and receive sides view as convenient. I live in the U.S. I never carry a single dollar of cash on me. I only have debit cards, credit cards, etc. I pay all bills by automatic monthly money transfers for the outstanding amount. And so on. This is perhaps a bit more electronically extreme than most Americans. But it is the direction the country is going in. So the idea of Western Union does not make much sense to people who were born and live in the U.S.
However, the lack of bank accounts, popularity of prepaid services, popularity of cash, and popularity of paying for certain things in person still exists in some countries.
Most importantly, I think people tend to think about cities in receive locations rather than rural areas. But a lot of migration comes from rural areas.
Finally, cross border money transfer is harder to do than money transfer inside the U.S. There is more regulation. More risk of facilitating illegal activity. And so on.
Right now, Western Union has the best system for making these transfers. Now, I agree that certain of Western Union's capabilities — like essentially instantaneous transfer — aren't really needed by most customers. But I think the history of the business shows that this is something where banks think they are better able to compete than they really have been. Most banks do not have a footprint, brand equity, etc. on both sides of a transfer. And they are no better — probably worse — than a non-bank payment processor in all other respects.
I am very worried about the issue. Because I can not see far into the future. And I worry that technology developed for other customers may — through the Internet — end up being offered to Western Union's core customers.
Still, I'm not sure. The time between when a technology has been invented and commercialized and when it has been widely adopted in financial services within just one developed economy is often long. Worldwide there are still plenty of technologies that have never been adopted outside of the most financially complex economies. For example, technology that was common in U.S. financial services when I was born still has not been adopted in most of the world.
I haven't come to a conclusion on Western Union. It is cheap. But at about 6 times EBITDA it is not insanely cheap. There are risks. I think the technology risk is overstated. If it was cheaper I would be confident in taking the other side of that bet (that technology will hurt them slower than people think). But right now I am most afraid of buying a relatively cheap stock in an absolutely expensive stock market environment.
A price of 6 times EBITDA is low for a sure thing. But is Western Union a sure thing? Just because it is more attractive than most stocks does not mean I should buy it.
There is always the option of staying in cash. So I haven’t decided whether to buy Western Union stock or not.
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