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Western Union (WU) and Netflix (NFLX)

June 25, 2007 | About:
10qk

Mike Price

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Western Union fell 5% yesterday on News that Verizon was letting customers transfer money with their phones. Western Union said they thought the technology was interesting and will be exploring the possibility of using it. I doubt this will have any lasting effect and it won't be long before Western Union partners with a cell phone company to do this. Even if they don't I doubt the majority of their current customers have phones or can afford them.

To see if this drop will finally allow me to average down I updated my valuation, using the intrinsic value model Pabrai writes about in Mosiac.


Current Excess Capital On Hand $1,749.0
Starting FCF $1,094.50
Next Year Growth 12%
Year 2 - 4 10%
Year 5 - 7 10%
Year 8 - 10 8%
Discount Rate 9%


Shares Outstanding in Year 1 768.00
Shares Outstanding Compound Rate (Optional) -0.50%
PV 10 Year Sale, Years 1-10 FCF, and Excess Capital 24,895.99
Year 10 Shares Outstanding 730.45

Price/Share $34.08
Price/Share w/50% margin of safety $17.04


Year FCF PV of FCF
Start $1,094.50 $1,094.50
1 1,225.84 1,124.62
2 1,348.42 1,134.94
3 1,483.27 1,145.35
4 1,631.59 1,155.86
5 1,794.75 1,166.47
6 1,974.23 1,177.17
7 2,171.65 1,187.97
8 2,345.38 1,177.07
9 2,533.01 1,166.27
10 2,735.65 1,155.57
sale 27,356.54 11,555.70
fcf 19,243.80 11,591.29
Total 46,600.34 23,146.99


In this DCF I use assumptions of 12% growth next year,
then 10% every year before years 8-10 when I predict 8% growth.

I also assume Western Union will buy back .5% of its shares every year.

This puts the value at 34.08, not the 50% discount that Pabrai looks for but 40% discounted which is enough for me in a business I like and I've bought more today.

Netflix

Munger said checklists should be used in investing which is why once again I'm using Buffett's checklist according to Hagstrom to look at Netflix.

Business

Simple, Understandable

Yup. They are an online movie rental business. They have over 75,000 titles available to rent online and multiple different paying options depending on how many movies one would like to rent at once. They also have started with digital downloads of movies that customers can watch in their web browser.

Consistent History

Um, younger than me so not really long. But it is consistent.

Favorable Long-Term Prospects

Excuse my French, but Hell Yes! Uncertainty on this is what is depressing the price, but they did so well fending off Wal-Mart that Amazon.com decided to can its business renting DVDs. People also think Blockbuster will kill Netflix but so far its spent hundreds of millions of dollars on its Online Rental business only to get it not as good as Netflix and to have less then a third of the share of Netflix, still. Right now it is basically giving away movies Blockbuster will probably have to choose online or stores pretty soon, if not it will have to raise its price on Total Access which will allow Netflix to gain a lot of Blockbuster's subscribers.

Management

Rational

Yes. Netflix knows exactly what it's doing and what will happen to its business in the future.

Candid

They have the best IR Site I've seen. Even including Videos with the executives discussing the business.

Resist Institutional Imperative

Management appears to be more focused on finding shareholders for the long haul and not on short term results.

Financial

Return on Equity

Currently Netflix has an OK ROE of 16%, I believe in the future as its marketing expenses dip relative to revenue ROE will rise to a very god number reflecting its dominance in the industry.

Owner's Earnings



Income 49,082
+ D&A 88,204
- CapEx 15,720

=Owner's Earnings - $121,566

Profit Margins

Currently Owner's Earnings Margins are at 24%, very high and it will only rise in the future as marketing and technology expenses fall.

Value

Using the same method I used for WU with growth next year of 20%, and then growth of 18% until year 8 when it reduces to 10% and a discount rate of 12% I get a value of $48 per share, which is way above the current price, but also just a starting point.

Conclusion

The valuation model I used was set-up to be aggressive, because Mohnish was using it to show how overvalued some tech stocks were, which is why I used such conservative inputs with WU, but I also believe my Owner's Earnings estimates for Netflix may be high, I will continue looking at it, I definitely believe it is a value stock flying under the radar.

__________________
Orginally Published at Mike Price's investment blog: http://mikesnewsletterinvesting.blogspot.com/

About the author:

Mike Price
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.8/5 (6 votes)

Comments

ccyork
Ccyork - 7 years ago
WU seems to be bouncing back and forth between $21 and $24. Today it's even a little under $21. If it drops significantly from here I'll be very suprised, but if it does drop a couple more bucks, it would be a GREAT time to scoop up some shares, because it will probably be the last time we see it so low.

How long will it keep bouncing off of $21 an $24?

I think your estimate of intrinsic value is right on the money, though it would require a multiple of about 27x TTM.

-- ccyork

ndl11
Ndl11 - 7 years ago
People who are wiring money can afford cellphones. Many people have cellphones and do not have land lines in this socioeconomic group.
darps
Darps - 7 years ago
I don't agree with the favorable long term prospects over here. Basically with downloading of movies from the internet coming sooner or later, their business model will have to change.
JJINVEST
JJINVEST premium member - 7 years ago
The people who are the recipients (such as those living in rural Mexico or China) might not have cell phones. Anyway, even if they do, there is no reason why Western Union cannot get into that business (sending money over the phone) itself. Lastly, many immigrants would like human touch/contact. Not sure if they trust the technology all that much.

When is WU going to drop below $20?? I have been waiting for 7+ months already. It is a bummer that it went up today. But be patient. It should come right back down.

I personally wouldn't touch Netflix. I know that they lost me because they couldn't turn over their movies fast enough. In fact, they intentionally mailed me movies late (I was flagged for being a heavy user of their services). Say, since I paid only a flat fee, if I watch the movies fast, and mail them back to Netflix right away, they can only make a profit if they delay my next set of movies (to save on postage). I find that appalling and will never use their service again (with Hollywood and Blockbuster monthly flat fee, that's not an issue because I can just go to their stores and wouldn't cost them any postage). but other than that, again, who knows how fast online downloading will involve. Netflix is just like a tech company; you cannot predict on how that business will look like 10 years down the road. So why bother trying to predict its discounted free cash flow? It is good as a trade, but not a good investment.
munger
Munger - 7 years ago
It has to be much cheaper for me to initiate a position. I question the durability of the business model and I don't like the fact that is it a huge company post-spin. I will look for the next small company with a disruptive force business model.

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