Western Union Purchased

Western UnionWestern Union (WU) has been added to the Fat Pitch Financial Portfolio.  This paper port, which is similar to my actual holdings, is tracked at Marketocracy. I added 2,290 shares of Western Union this morning for an average price of $21.86.

There is nothing too complicated about my decision to purchase a stake in Western Union. I have been tracking this spin-off from First Data (FDC) at Fat Pitch Financials Contributor’s Corner for several weeks since this is a special situation opportunity.

Western Union is not just a spin-off opportunity.  It also has a wide moat.  Western Union is a global leader in money transfer services. This company has the ability to send money to more than 245,000 Western Union Agent locations in over 200 countries and territories. Now that grants this company a network effect and economies of scale. Western Union’s brand is also widely recognized and instills trust in users of their service, which is very important for cash transfers.

The network effect comes from the fact that the more people that use the Western Union money transfer network, the more valuable it becomes.  The economies of scale comes from the fact that it would be very costly to recreate a similar large scale money transfer network and smaller networks would be less profitable because they would not provide the same service capabilities. 

The costs of maintaining the money transfer network is fairly low, so increasing the number of users increases the amount of profit exponentially. In economic terms, the fixed costs are high but the marginal cost of processing each money transfer is low. Therefore, I believe that Western Union could dramatically increase their earnings in the future if they get creative at expanding the uses of their money transfer network. For example, Western Union might even be able to expand its service offerings by facilitating cash purchases of online products, a niche that could become increasingly important as those without credit access start to shop online more frequently.  Also, the growth potential of cash transactions occurring over the Western Union network looks very promising.

Sadly, in the near future we will likely see easing of U.S. immigration enforcement and anti-terrorism measures, if no further terrorist attacks occur in the U.S.  Relaxing these measure will likely boost Western Union’s cash flows.

Western Union reported 2006 third quarter earnings on October 23rd.  Revenues were up 12 percent from last year.  This is in line with management’s previous guidance for future earnings growth.

To estimate the value of Western Union, I used a 12 percent growth rate for 2007 estimated net income of $1 billion.  I projected out net income (assuming it’s close to owner’s earnings) for 10 years and then I calculated the terminal value using a 10 percent discount rate and 3.5 percent stable growth rate.  That gave me an intrinsic value per share of $32 after adjusting for net debt of $2.1 billion ($3.5 billion in debt minus $1.3 billion in cash).  That’s a 46 percent discount to what I bought the shares for if I did a good job of estimating intrinsic value.

You can read some of the stories that help me come to my decision about Western Union at Value Investing News.

Full Disclosure: I now own shares in Western Union.

10 thoughts on “Western Union Purchased

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  • November 9, 2006 at 10:08 pm

    I just want to point out that WU has less and less moat.

    For example, when I want to send money to my family in Eastern Europe, I don’t use WU with its bloated fees. I use an extra debit card I left there specifically for this purpose. It can be used at any VISA ATM. Cost of transaction: less than 4$.

    The more VISA/MC extend (and it does), the less relevant WU will be. Investing in WU is, nowadays, like investing in a check-to-cash shop.

  • November 9, 2006 at 10:28 pm

    Correction: “and it does” should be “and they do”.

    Anyway, I just calculated the cost of sending $200 (the usual amount my family retrieves from the ATM) to my country through WU: a whopping $22. The Economy version costs at least $11, but it’s not available for my country.

    WU has no moat because it has no brand loyalty and no price advantage. They still exist only because they are the best means of sending money to some monkeylands and/or to strangers and/or because some people are uneducated.

    PayPal is expanding in Europe and around the world. Between PayPal and WU, PayPal wins hands down. It beats even the debit card method I described above, in fees.

  • November 10, 2006 at 9:25 pm

    I’m mixed on Western Union. For one, I do believe the shares are highly discounted but WU is not levered for the long term.

    As Ervin pointed out, Paypal is much cheaper and is expanding in key markets like Europe, Southern Asia, and parts of Africa. Paypal members can transfer funds for free, without worring about those costly Western Union fees.

    I like the stock now because it’s still cheap. I don’t like all the unnecssary fees they charge their customers. I’d stick with eBay for the long term.

  • November 10, 2006 at 9:42 pm

    The one thing you forget is that I believe you need to have a bank account to establish a working PayPal account. Also, with PayPal there is a significant delay in receiving physical cash.

    With Western Union, you just go to one of their counters when you receive a transfer, and they hand you cash. I’m pretty sure you can’t do that with PayPal, especially in developing countries.

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  • November 15, 2006 at 9:34 am

    You only need a bank account to confirm your account. The only use for your bank account is if you need to transfer money into your account.

    Also, Paypal transfers between customers are instant transfers, no delay exists. Although there is a delay when requesting a money transfer. If the only downside to Paypal is owning a bank account (which virtually is a piece of cake to obtain), then what’s the point of paying all those extra Western Union fees?

  • November 15, 2006 at 5:01 pm

    The poing of paying extra WU fees is that in international wires done in a bank the fees are larger. and also no strings are attached. western union is a cash business.

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