The Bears Are Wrong About This Stock
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Western Union's (NYSE: WU) stock price has been hit hard by investors' fears that the company's business model is outdated. However, investors who believe this fail to understand the nature of Western Union's business.
A significant portion of Western Union's business comes from immigrants to rich, developed countries sending cash to relatives in their home country. These transactions are usually non-discretionary -- the money is often used to buy necessities like groceries and shelter. In fact, transaction volume actually increased during the recent recession.
Not only is Western Union a stable company in a recession-resistant industry, it's also the best company in the industry. Its margins are twice that of its only other global competitor -- MoneyGram International (NASDAQ: MGI).
Western Union is so much more profitable than MGI due to its superior scale and broader network. Here is a chart showing the number of agents in each company's network (in thousands):
The competition between Western Union and MoneyGram is akin to that of Intel and AMD; if MoneyGram makes some headway, Western Union will price it out of the market or spend money to make similar headway.
So MoneyGram should not be a concern at all for investors--it will never be able to seriously threaten Western Union's long-term profitability.
Fear of the Unknown
New technologies, however, might be something to fear. After management lowered guidance for 2013 due to promotional pricing, Western Union's stock took a 30% haircut.
A drop like that probably was not in response to fears over MoneyGram gaining significant ground -- everyone understands that's not a real possibility.
The fear is that guidance was lowered due to competition from internet and mobile phone transfers. However, this fear is unfounded.
Both Sides of the Transaction
The reason I'm not concerned about Western Union's technological obsolescence is that most of its customers are unbanked, so they need to receive cash.
In order to send money to an unbanked customer, an internet company like PayPal needs to have a physical location where the recipient can withdrawal cash. Western Union as literally hundreds of thousands of these all over the world and in the most remote places you could possibly imagine. PayPal has none.
The real question is not whether online transfers are more efficient -- they are. Instead, the question is how long will less-developed countries continue to be largely cash economies.
If you look at how banks decide where to place a branch, it's almost always "following the money." That is, banks go to where the money already is. Banks do not locate branches in poor neighborhoods. As long as less-developed economies remain underbanked, Western Union will have a thriving business.
What's It Worth?
Since 2005, Western Union has shown it can consistently earn free cash flow in the range of $900 million to $1 billion. This is despite facing pricing pressure from MoneyGram that is expected to alleviate after 2013.
Free cash flow will undoubtedly be lower than $1 billion this year due to an IRS settlement, but $1 billion is a pretty good -- if conservative -- estimate of Western Union's earning power.
The company's enterprise value is currently about $9 billion. So, investors who buy today will get an 11% annualized return even if (1) the company pays down all of its debt, (2) free cash flow never grows -- not even with inflation, and (3) the company does not repurchase a single share of stock.
Of course, this assumes intelligent capital allocation -- a big assumption for a company that paid 4x revenues for a company that has 30% EBITDA margins.
However, Western Union is cheap enough where -- once the fears of obsolescence pass -- the stock should experience a massive re-pricing.
Ted Cooper has no position in any stocks mentioned. 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!