There's Upside Potential for This Money Transfer Business

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

Recently, the investment community seemed to get excited about MoneyGram International (NASDAQ: MGI) when there were rumor that the company was putting itself up for sale and has talked to several potential buyers. Since the beginning of the year, MoneyGram International has delivered an impressive gain of more than 56.4%, beating the S&P 500’s return of only 15.6%. Is MoneyGram a good buy now? Let’s take a closer look and find out.

Revenue grew but operating income dropped

MoneyGram is considered one of the leading companies in global money transfers, bill payment solutions and financial paper products under The MoneyGram brand. It has around 310,000 agent locations in 197 countries, operating in two main business segments: Global Funds Transfer and Financial Paper Products. Around 82.2% of the total operating income, nearly $150 million, came from the Global Fund Transfer segment, while the Financial Paper Products segment contributed only $32.7 million in 2012 operating profit.

In the past three years, while MoneyGram experienced consistent growth in its revenue from $1.16 billion in 2010 to $1.34 billion in 2012, its operating income keep declining. The operating income dropped from $158.4 million to only $52.4 million during the same period. The decline in the operating income was due to the much higher commissions expense and higher transaction and operations support.

What I worry about with this company is its weak balance sheet. As of March 2013, MoneyGram had the negative equity of $(172) million, nearly $3 billion in restricted cash, $849 million in long-term debt and as high as $4 billion in payment service obligations. The company is trading at around $20.90 per share, with a total market cap of more than $1.2 billion. The market values MoneyGram at 7 times its trailing EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and 0.88 times its sales.

Western Union seems to be a better buy

Compared to its much bigger peer Western Union (NYSE: WU), MoneyGram is a bit cheaper. At nearly $17 per share, Western Union is worth $9.5 billion on the market. The market values Western Union at 7.3 times its trailing EBITDA, and 1.71 times its sales. Western Union is really a global market leader with 15% market share while MoneyGram ranks second with only 5% of the market. Western Union had many more agent locations, of 437,000 in wider coverage of 200 countries than MoneyGram. Thus, it should deserve a higher valuation. In the first quarter 2013, Western Union experienced sluggish EPS of $0.37 per share, a bit lower than the EPS of $0.40 per share in the same quarter last year. However, its EPS still beat Wall Street’s estimates of $0.33 per share. Looking forward, Western Union estimated to generate around $1.33 to $1.43 per share.

The physical location money transfer business is getting more and more competition from online money transfer. One of the new emerging players is Xoom (NASDAQ: XOOM), which has operations in around 30 countries. Because Xoom conducts most of its business online, it was easier for the company to scale up its business than it was for its competitors. Consequently, Xoom has been growing very fast. In the first quarter of 2013, Xoom grew its revenue by 43%, to $24.3 million while its GAAP net loss has been narrowed down, from $494,000 last year to $79,000 this year. For the full year, Xoom expected to generate around $104 million to $106 million in revenue. The net loss might stay in the range of $0.37 to $0.32. As Xoom generated negative TTM EBITDA, its EBITDA multiple is not valid. Xoom seems to be valued quite high on the market at as high as 8.22 times its sales.

My Foolish take

Income investors might like Western Union the most as it is the only dividend-paying company among the three, with a nice dividend yield at 2.9%. With its huge location network with wide coverage, I personally think Western Union should be worth much more than MoneyGram. Both of them are trading at more than 7 times its trailing EBITDA. If MoneyGram got acquired, its share price will jump higher. Consequently, Western Union’s share price will also move higher because of MoneyGram’s acquisition.

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Anh HOANG owns shares of Western Union. The Motley Fool recommends Western Union. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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