Western Union is Grossly Misunderstood

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Western Union (NYSE: WU) is the undeniable leader in money transfers through its global network of more than 5,000 agents.  Despite the company's evident competitive advantage as the world's leader in money transfers, Western Union is priced for decline, trading at just 6.7 times forward earnings estimates. Fortunately for long-term investors, this conservative valuation has little merit.

Western Union and Immigrants

Many U.S. citizens rarely, if ever, use Western Union's services. This is one reason the stock can be easily misunderstood. For many individuals Western Union's service is not just a privilege--it is a necessity. For instance, many immigrants come from poorer countries in search for better jobs, often sending money back to family members who need support. 

So investors shouldn't turn their back on Western Union simply because they rarely use the company's services. There is a growing population of 200 million immigrants across the world that can benefit from the company's services. 

Scale = Power

Probably the most significant concern weighing on Western Union's stock price is the threat of alternative money transfer channels, like cell phones. Wall Street is worried that technology could suddenly give these channels the power to steal market share from traditional money transfer companies like Western Union. This is simply not realistic.

According to Morningstar's analyst report on Western Union (sign-in required), size has significant advantages in Western Union's scalable business. In fact, size is beginning to matter even more. As regulation increases, small competitors are often priced out of the industry. Plus, Western Union can use its cash and size to make sensible investments and/or acquisitions to adapt to technological changes.

Furthermore, Western Union has less than 20% market share yet processes three times the transactions of MoneyGram International (NASDAQ: MGI), the world's second largest money transfer business. So not only is Western Union in an excellent position to make acquisitions as the industry consolidates, the company also has plenty of room to grow by consolidation.

A Bargain Price For Reliable Future Cash Flows

As the most recognized brand in the industry, Western Union is able to maintain premium pricing. As a result, the company is a cash cow, converting 16.7% of every dollar of sales into free cash flow (FCF). Despite the company's profitability, Western Union is dirt cheap, even more so when compared to its peers:

<table> <tbody> <tr> <td>Company</td> <td>Market Cap</td> <td>Price/Cash Flow</td> <td>Dividend Yield</td> <td>Forward P/E</td> </tr> <tr> <td>Western Union</td> <td> $8.2 billion</td> <td> 7.3</td> <td> 3.11</td> <td> 6.7</td> </tr> <tr> <td>MoneyGram International</td> <td> $751 million</td> <td> 12.3</td> <td>  -</td> <td> 14.5</td> </tr> <tr> <td><strong>Euronet Worldwide</strong> <span class="ticker" data-id="203369">(NASDAQ: <a href="http://caps.fool.com/Ticker/EEFT.aspx">EEFT</a>)</span></td> <td> $1.2 billion</td> <td> 7.4</td> <td>  -</td> <td> 14.4</td> </tr> </tbody> </table>

Typically, highly profitable industry leaders trade at a premium to peers--especially when the industry leader has such a significant lead over competitors. But Western Union is an exception. Despite its ability to throw off plenty of cash, it is the only company in the table with a dividend; and its forward P/E ratio isn't even half of its peers.

The Bottom Line

Western Union is a grossly misunderstood business. If technology throws Western Union a curve ball, the company can use its "muscle" to make sensible investments and/or acquisitions. In the meantime, Western Union will continue to price out small competitors and reap the benefits of industry consolidation.


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