Western Union
Analyst Report
December 8, 2011
By John Steele with contributions from
Matthew Trautman, Brad Greenwell, and Dave Fenz
Western Union
Analyst Report
The company
Western Union was formed in 2006 as a spin-off from First Data. As the worldwide leading
provider of money movement services, Western Union has proven itself to be a strong generator
of free cash flow. The company provides its services via a vast network of third-party agents,
minimizing its need for long-term reinvestment. Western Union processes five times more
transactions than its closest competitor, MoneyGram International. Western Union currently
possesses a 20% share in the money transfer market and is in a great position to steadily increase
its share. Western Union trades on the New York Stock Exchange with the ticker WU.
Business model
Western Union operates two distinct business segments, consumer-to-consumer and global
business payments. The consumer-to-consumer segment allows migrant workers to transfer
funds across borders for a nominal transaction fee. The increase in migrant workers throughout
the world has greatly benefited this business segment because these workers regularly transfer
funds to their families in their native lands. The global business payments segment focuses on
providing both consumers and businesses a safe, efficient, and cost-effective method to pay bills.
To determine the importance of each business segment, an analyst should examine its
contribution to consolidated revenue. The consumer-to-consumer segment provides 84% of
Western Union’s revenue. Global business payments contributes 14% of revenue, and the
remaining 2% is simply labeled “other.”
Western Union | 12/8/2011
In its annual report, Western Union claims that the key factor to increasing revenue is raising its
transaction volume. Transaction fees account for 78% of revenue but are inversely related to
transaction volume. Company management is trying to determine the extent to which lowering
transaction fees would lead to higher profit via increased transaction volume.
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Western Union transacts money transfers through its enormous network of third-party agents.
The company has over 445,000 agent locations worldwide. Many value investors prefer
companies with business models similar to Western Union’s because they are not capital
intensive. About 70% of the company’s total cost structure is composed of agent commissions.
This global network of agents serves as an important component in Western Union’s sustainable
competitive advantage in the money movement industry.
Economic moat
Western Union possesses a wide economic moat in most part due to its scale—it is significantly
larger than its competitors. In Western Union’s industry, scale is a significant factor because the
industry contains high fixed costs. Western Union’s large scale allows it to increase its revenue
at relatively low marginal costs, which has allowed Western Union to post operating margins
close to twice that of its competition. Western Union’s large scale also offers a competitive
advantage through its network effect. As the industry’s largest money transfer company, Western
Union has a huge global network of agents and locations to process transactions. It would be
extremely difficult for a competitor to replicate the sheer global reach of Western Union’s
network. Western Union’s economic moat is also strengthened by its strong brand name. A
respected brand name is vital in the money transfer industry since customers require confidence
in the company with whom they trust their money. Western Union’s established and well-known
name offers a level of consumer confidence not easily matched by its competitors.
Management
Christina Gold was the CEO of Western Union from 2002 to 2010. Hikmet Ersek, previously the
COO, replaced Gold and is the current CEO. Ersek has been with Western Union since 1999,
and his recent comments and actions lead investors to believe that there will not be any major
shift in the company’s business structure in the foreseeable future. Multiple analysts have
expressed concern with the company’s level of executive compensation, mainly because
Christina Gold earned $8 million the year before she retired. Compensation has been scaled back
since Ersek took over—his salary was $3 million in 2011. Western Union’s management has
made prudent decisions with excess cash by repurchasing undervalued stock and increasing the
dividend paid to shareholders.
Profitability & Efficiency
Western Union | 12/8/2011
Western Union is a very profitable company with an operating margin of 26.4% and a net margin
of 17.9%. These numbers are impressive relative to the margins from Global Payments (GPN)
and MoneyGram (MGI). Although MoneyGram is Western Union’s main competitor, it is
beneficial to examine financial ratios from Global Payments as well. The following table
highlights Western Union’s superior profitability:
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Key statistics
Western Union’s stock appears to be undervalued according to its forward P/E of 10.45 and PEG
ratio of 0.95. The company’s market value D/E is a reasonable 36% in contrast to MoneyGram’s
outrageous market value D/E of 97.7%. The following chart provides key statistics needed to
compare Western Union, MoneyGram, and Global Payments:
Western Union | 12/8/2011
Two Perspectives from Morningstar
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Bulls Say
 Increasing regulatory burdens and price competition are driving out smaller rivals,
leading to higher market share for the industry leaders.
 The fact that money transfer transaction volumes have continued to grow throughout the
downturn suggests the historical drivers of Western Union's business will reassert
themselves once a recovery takes hold.
 Smaller money transfer companies don't have the capability to keep up with regulatory
requirements, which should lead to market share opportunities for the bigger players.
Western Union spends about $40 million annually on its compliance efforts, a level
higher than some of its competitors' revenue bases.
 Money transfers sent by immigrants back to their home countries typically are not
discretionary but cover the subsistence needs of their families. For instance, money
transfers sent to El Salvador equal more than 15% of that country's gross domestic
product.
Bears Say
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A weak global economy could limit immigrants' employment opportunities and damp
money transfer volume.
Higher growth in Western Union's lower-margin international segment will pressure
margins.
Alternative channels for sending money, such as cell phones, could cut out money
transfer companies like Western Union.
The decline in the construction industry has slowed growth in the U.S.-to-Mexico money
transfer corridor, which is Western Union's most profitable corridor.
Valuation
Using an average of the dividend discount and residual income models in my Excel spreadsheet,
I calculated a conservative fair value of $25.72 for WU stock. I used a P/E target of 13 because
WU has averaged trading at 16 times earnings (source: Value Line). I used dividends, earnings,
and book value growth of 8%, 8%, and 10% respectively. Value Line’s beta assigned to WU is
1.1, which is more realistic than higher betas given by other sources. At the current stock price of
$17.89, WU is more than 40% undervalued. The following table provides varying opinions of
the proper target price, matched with the corresponding margin of safety:
Analyst
Target price
Margin of safety
Yahoo Finance
Bloomberg
$22.15
$22.44
23.8%
25.4%
Morningstar
$29
62.1%
John Steele
$25.72
43.8%
I recommend selling all 271 shares of Northern Trust Corporation (NTRS) because it has
negative operating cash flow. Additionally I want to scale back Landstar (LSTR) by 129 shares
to raise the capital needed to purchase 929 shares of Western Union, making WU 5% of the TVA
portfolio. Western Union is an excellent long term buy due to its wide economic moat,
impressive profitability, and undervalued stock.
Sources
Bloomberg
Western Union | 12/8/2011
Recommendation
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Morningstar
Yahoo Finance
WesternUnion.com
Value Line
Western Union | 12/8/2011
Western Union 10-K, 10-Q, and 8-K
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