Western Union and Its Shrinking Runway

A long runway is a key item we look for when evaluating a potential investment. What do we mean by long runway? Does the industry the business operates in have a continued pathway for growth over the next 5 years to 10 years? Does the underlying business trend bode well for the company as long as it can stay in market leading position?

We know the future is unpredictable and business models that look unassailable today may be vulnerable tomorrow. Look at the cable television business. 5 years ago cable networks minted money. Today people are questioning the viability of some cable network companies. Can we, given some basic and simple assumptions, reasonably expect the industry the business operates in to be larger than it is today?

Favorable Trends

For example, one of the big trends in today’s economy is the move to cashless transactions. Around the world, cash and checks are being used less and less for daily purchases. People are using their debit and credit cards more and for increasingly smaller purchases as the chart below highlight.

Chart from The Henry Fund Presentation. Click image to enlarge.
Chart from The Henry Fund. Click image to enlarge.

We don’t see this trend ending. Using cards and digital wallets are more convenient and quicker than paying with cash. Visa and Mastercard dominate this trend with their payment networks. As long as their networks and their technology are needed for cashless transactions then both companies will continue to prosper.

A new competitor or technology can always come along and disrupt Visa and Mastercard but that takes time. We can reasonably assume that over the next 5 years or so Visa and Mastercard will still be in a prime position to ride this cashless transaction trend.

Western Union’s Shrinking Runway

What we are trying to avoid are companies with short runways. Companies operating in an industry that is in decline because of disruption by new trends and technology. Or the industry may still be growing but a company’s leading market position is in jeopardy as the cost to compete against it are lower because of new technologies.

We think Western Union (WU) has a short runway.

Western Union is a market leader in remittance and it looks very cheap with a good dividend yield.

  • P/E Ratio = 12
  • Dividend Yield = 3.35%
  • EV/EBITDA = 8.23

Western Union has also grown its quarterly dividend at a compound annual rate over 17% for the last 6 years.

However, when we look at revenue and operating income over the last few years a different story emerges.

Data from S&P Capital IQ. Click image to enlarge.
Data from S&P Capital IQ. Click image to enlarge.

Western Union’s dividend growth has slowed down because of this trend too. Over the last three years, Western Union has grown its dividend at a compound annual rate of 8.5% and Western Union only raised its dividend 3.23% from a year ago.

Lowering the Cost to Compete

Technology is disrupting the remittance and money transfer industry. There is Xoom, an online transfer company. Xoom operates exactly like western Union and Moneygram but it is all online and can charge less than Western Union. PayPal (PYPL) bought Xoom back in July 2015.

The rise of smartphones and money transfer apps like Venmo and Square Cash is taking another bite out of the money transfer industry. Xoom has its own app and so does Western Union but the point is the barrier to entry to compete in the money trasnfer industry has been permanently lowered.

Cheaper smartphones are helping this trend too. A migrant worker here in Southern California doesn’t need a cell phone data plan to transfer money through apps. He or she just needs a used smartphone and their local Starbucks.

Then there is the Blockchain. The costs to transfer money using Blockhain will be cheaper, quicker, and more reliable. Abra has launched a U.S. remittance app based on blockchain technology.

Western Union’s Leading Position in Doubt

The overall remittance and money transfer industry is still growing. Money needs to be moved around. For the longest time, Western Union lead this industry but technology has permanently transformed it. The barriers to entry and costs to compete against Western Union have declined significantly. Western Union’s leading position is slowly eroding away. While its current dividend and past dividend growth look attractive, its future growth does not.

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