Monday, February 14, 2011

Western Union and MoneyGram Value Traps?

Cash in Western Union Stock?

Western Union $WU has all the makings of a value trap investment. This research article will focus on Western Union but much of it is equally applicable to $MGI MoneyGram. Western Union stock is, on a superficial basis, very attractive for a portfolio, yet it contains danger. Any analyst research report should discuss these issues. On balance, I decided that this stock was not worth buying. Having said that, it is worthwhile to articulate the risk and reward profile of this stock in order to monitor.

Western Union Profit Drivers

The stock actually has a number of things going for it. I will outline these points in the context of the results. Western Union has...
  • Good exposure to the expected rise in employment this year
  • Very favourable demographic trends of globalisation and migrant workers
  • Increasing utilisation of technology to capitalise on the potential of things like pre-paid cards and mobile money transfer
  • An expanding network of 80,000 agents and 16,000 corridors and a global leading position in money transfers
  • Highly cash generative business model
It's not hard to see why many would conclude that Western Union is a great stock to buy. As employment picks up in the developed economies, the kind of low level service personal that uses Western Union services will see an increase in income. Furthermore, increasing growth encourages more migration and this helps Western Union in its remittance business. For example, around 9% of Western Union's business involves remittances from USA to Mexico and, 85% of revenues are c2c. Putting all of these things together and, it is likely that Western Union will see a lot of potential upside this year.

Western Union Growth Strategy

Essentially, Western Union flourishes in environments whereby its customers do not have access to existing banking facilities. This is why international remittances of lowly paid workers are the core business for the company. Whilst this end market is guided by macro economic considerations (as discussed above) it is also being affected by technological changes. Western Union are seeking to stay ahead of the technology curve by expanding sales of pre-paid cards and establishing a long term position in mobile money transfer.

This is laudable but, I think, will prove challenging for Western Union. The world is full of companies of who, in recent history, suffered as their business models became obsolete as a consequence of technological changes. What is surprising, is how quickly these companies succumb to these pressures. Similarly, Western Union and its main competitor MoneyGram are facing significant challenges.

The Future of Money Transfers?

Here are five main challenges to companies like Western Union and MoneyGram. Most of which are coming from technological developments that threaten the core business of these companies
  1. Increasing banking penetration in emerging markets, for example, Latin American banks servicing workers with branches in US
  2. Email transfer banking and internet based transfers
  3. Micro Finance companies (many which are non-profit) expanding activities/lending in emerging markets
  4. Mobile phone based transfer payments
  5. The Federal Reserve may force them to fully disclose fees and exchange rate charges, in line with the Dodd-Frank laws
Every one of these factors is a long term threat to Western Union. Whilst the results and conference call contained many positives, the 2-4% drop in pricing is a cause for concern. Western Union's management are arguing that this is part of a strategy to win market share via promotions.

However, I have my doubts. I think the company is trying to stem back the advance of inevitable technological change. History does not look too kindly on companies that have tried to do this.

Western Union Evaluation

Listening to the latest conference call, it is clear that Western Union expects to generate between $1-1.2bn in free cash flow for 2011. Analyst consensus is for EPS of $1.51 and operating margins are expected to expand by 100 basis points to 27%  The forecast EPS growth of 6.3% is not great but should be put in the context if a higher tax rate (impact forecast at negative 6-8c for EPS) plus $50m or 6c negative impact from restructuring charges. Adding these effects back in would give EPS growth of 15%

With an EV of $15bn and a stock price of $21.4 this would put Western Union on a forward FCF/EV of 7.3% and a PE ratio of 14.2x which is attractive. Furthermore, Western Union is set for positive upside from employment gains and a growing economy. The management is doing all the right things in engaging in share buy backs and looking to return cash to shareholders.

All of this is fine and, short term I would expect the stock price to go higher. However, longer term there are structural challenges here and I don't like trying to time when they are going to hit.

I'll take a pass on Western Union.


Bloomberg Website "Western Union, MoneyGram May Lose as Fed Sets Remittance Rules"  (Accessed 14 Feb 2011)

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