Despite being more than 160 years old, Western Union Co. has been, until recently, a growth story. As global immigration increased, so did the need for workers to send money home. Revenues at Western Union (and its smaller rival MoneyGram International Inc.) gained accordingly.
That growth story is now broken. Global “remittances,” as they are called, continue to increase, but revenues at the established money-transfer companies haven’t kept pace. Western Union added to its woes with disappointing 2012 results, and a series of price cuts that suggested its position of global leadership is under threat.
The sexy new name in the sector is now Xoom Corp., an online-only upstart that went public in February and has traded at more than 60 per cent in excess of its IPO price. While Western Union and MoneyGram drift toward value territory, the yet-to-make-a-profit Xoom is priced, as one analyst says, as an “online disruptor” in the mould of Netflix or LinkedIn.
Is this a changing of the guard? Investors who buy Xoom thinking it will be next generation’s giant might end up disappointed. In contrast, those who are willing to wait through a difficult 2013 for Western Union will likely be rewarded.
As recently as the mid-2000s, Western Union posted double-digit revenue gains and increases in profit that topped 20 per cent a year. It was never the low-cost provider; it instead traded on its unparalleled network of agents that, today, has reached nearly 500,000 locations across 200 countries and territories.
The company, like many, ran headlong into the global recession. Its customers are primarily “unbanked” immigrants who work in the developed world and send money back to relatives in less-developed countries. As joblessness grew in the U.S. and Europe, Western Union’s clients had less money to send – or settled for cheaper services. Revenue for 2013, expected by analysts to come in around $5.5-billion (U.S.), will be just a couple hundred million dollars more than 2008 levels.
The problems haven’t all been macro, however. The company lost nearly half of its Mexican agent network last year because of compliance issues, an event that allowed MoneyGram to make gains from its larger rival and post healthier growth numbers in 2012.
The event that most spooked the street, and chased away growth-oriented investors, was the third-quarter announcement that the company would need to cut prices. The reductions averaged 5 per cent across the company’s markets, but were as much as 25 per cent in certain areas, says analyst Kevin McVeigh of Macquarie Capital.
Adds analyst Brett Horn of Morningstar: “They’ve been stingy with price decreases, and they finally realized they’d gotten a little bit out of line, so this is a catch-up year.”
The hope now is that the price cuts will fuel increases in transaction volume. “We’re only part way through the new strategy implantation, let alone having any proof that it’s working,” says analyst Larry Berlin of First Analysis Securities Corp. “I think it’s going to take a few quarters to show potential investors that it’s working, that it’s not going to result in more price cuts six months to a year from now, and they can grow the top line in the high single digits and the bottom line a little faster.”
What has been consistent is Western Union’s ability to generate cash. The company posted at least $1-billion in free cash flow (operating cash flow minus capital expenditures) in six of the last seven years. That is about $2 per share, which, at recent share prices around $14, represents a tempting proposition for value hunters. Mr. Berlin figures Western Union’s cash flow yield will be 13 per cent this year, roughly double the sector average.
Meanwhile, market pessimism has driven Western Union’s forward price-to-earnings ratio down to about 10, and its dividend yield to nearly 3.5 per cent.
Mr. Horn, of Morningstar, has a “fair value” estimate of $25 on Western Union shares, calling them “materially undervalued.” The company’s EBITDA, or earnings before interest, taxes, depreciation and amortization, is nearly 30 per cent of its revenue, and he believes that industry-leading margin is sustainable because of Western Union’s scale. “Even in a world where it loses all it pricing premium, you’re looking at a company that’s much more profitable than its peers.”
In today’s markets, many see the challenger to Western Union as not being the debt-heavy, pricier MoneyGram, but Xoom.
Xoom eschews an agent network, using an online platform that’s accessible via mobile phone as well as computer. What that means, however, is that its customers need to have a bank account or credit card. By contrast, Western Union’s customers only need to show up at an agent location to send or collect cash. “Western Union’s whole value proposition has historically been penetrating the under-banked population, and that’s why they’ve been able to enjoy the spreads they do,” says Macquarie’s Mr. McVeigh.
For now, Xoom’s customers must send money from the United States, and nearly all the company’s transfers go to the Philippines, Mexico or India. There are an estimated 16,000 “corridors” in the world’s remittance business; Xoom operates in just 30 or so of them.
These two limitations either mean the company has the potential for amazing growth or has a long, long way to go.
The analysts at R.W. Baird have a “buy” rating and $29 target price on Xoom shares, about 25-per-cent higher than recent trades around $23. Their target price is 6.7 times revenue, as Xoom has about $100-million in expected 2013 sales but no positive EBITDA, much less net income. “We believe Xoom will continue to benefit from structural efficiencies and competitive advantages over traditional money transfer companies, providing consumers with lower-cost transactions, more convenient online transfers, and faster delivery of funds,” they say.
However, Mr. Horn of Morningstar notes that “Western Union offers something very similar, and it generates almost twice as much revenue from it than Xoom does, and Western Union actually makes money from its online product, which Xoom doesn’t.
“There’s always this idea that someone’s going to come in and completely disrupt the [Western Union] business model, but I don’t think the data supports that view,” he says, noting Western Union and Moneygram combine for just 25 per cent of the world’s remittance market.
“I don’t see Xoom’s success and Western Union’s success as mutually exclusive. The long arc of electronic payments is toward variety, not a dominant method.”