Sunday, February 13, 2011

Western Union (WU) Investment Thesis / Stock Analysis

Western Union is one of the world's largest C2C cash-to-cash money transfer companies. While it also offers C2B, B2B and account-based and debit-card based transactions, the C2C cash-to-cash transfer business is still its largest line of business and its core.

Economics of the core business are excellent

Western Union has the world's largest network of agents signed up to its money transfer network. The growing base of agents creates a network effect for the agents, as it makes it possible for them to serve an ever increasing pool of consumers whose home towns (remittance destinations) are being added to the WU network. This network effect is likely to keep WU's agent network growing for sometime.

The economics of Western Union's business are also attractive. As primarily a data processing network, it is generally able to scale up its volume without scaling up its capital expenditures proportionally. Agents also typically have mainline businesses (retail stores, banking etc) which fund the overhead expenses of running the WU agency. The WU agency largely serves as a source of incremental revenue for them, and a means of maintaining foot traffic.

These factors create a business model whose economics are attractive: a network effect and low capital reinvestment needs. In so far as inflation increases wages, the amount of money handled through the Western Union network is also likely to increase in line with inflation. If Western Union is able to maintain its value to consumers relative to its competitors, this provides the means to keep its income growing in line with inflation.

Competitive Position

Money transfer is essentially a commodity business, and the competitor offering the lowest prices wins out eventually. As a business where economies of scale apply, Western Union is in the best position to offer the most competitive rates. Whether it chooses to do so is a question of how much profit vs market share it decides to go for. Western Union's structure, which is a single company clearing payments from one consumer to another, also gives it a structural cost advantage compared to arrangements where money is transferred from a company in a sending country to a company in a receiving country. To draw an analogy with the credit card industry, Western Union is to these competitors, as to what American Express is to Visa/Mastercard.

This economic and structural ability to achieve the lowest cost of operations allows WU the option of lowering prices to fend off competitors. Even a niche competitor focusing on a single transfer corridor (for example, Seattle to Manila, which is the only money transfer price and capability that a Filipino expatriate from Manila working in Seattle might be concerned with) is unlikely to be able to achieve a lower cost position, considering the distribution, data processing and back-room infrastructure that WU is able to amortize over a much larger global volume.

As a business that deals with a physical item (cash), distribution and reach are also a competitive differentiator. Like the retail business, it is essential to be accessible and located where the customer is. In this respect, Western Union's ever growing network of agents in everyday locations, operating on extended hours, is a strong competitive differentiator.

These 2 factors put Western Union in a very strong competitive position, which in turn improves the economics of the business as more agent come on board and greater economies of scale kick in. This positive feedback loop puts Western Union in a strong competitive position.

Sustainability of this ecological niche / prospects for growth

The real threat to Western Union is whether its core market will continue to exist and grow in the next decade or two. Western Union's core market and strength is in servicing migrant workers who deal in cash. This is the group of migrants who are not served by banks, which in most cases are persons with lower income levels (which is often related to lower literacy levels and a history of bad checks or credit) , or those without the documentation needed to open and maintain bank accounts.

The prospects for continued growth in migrants is good, with the global distribution of age groups being relatively unequal. Many countries today have aging populations, while others have too many young people looking for work. While political forces may stunt migrant flows from time to time, the long term economic reality makes it very likely that migrant flows will increase in the long term.

What is less certain is the continued existence of the un-banked, cash dealing migrant population (this is the same consumer group that is served by payday lenders and check cashiers). Political forces may call for post offices or community banks to offer low cost banking facilities to this niche. Competition may force banks to start targeting this niche of migrants with new service offerings. And innovations like low cost debit cards may offer this group a practical way of reducing the usage of cash.

Were this to occur, Western Union's growth prospects could be curtailed significantly. Western Union has a much weaker competitive position when it comes to processing funds transfers between electronic endpoints, such as bank-account to bank-account transfers, or debit/credit card to bank account transfers. A large agent network is far less important in handling transfers between electronic endpoints; agents are mainly useful when cash has to be paid-in or paid-out. Electronic transactions can be initiated with a phone call, over the Internet, or through some other electronic device.

In the realm of transfers between electronic endpoints, Western Union faces competition from PayPal, the SWIFT network between banks, and any number of payment processors handling Visa and Mastercard transactions. This ecological space is competitive, and some respected players see room for disruptive competition. Sequoia Capital has backed Xoom for processing electronic endpoint remittances. (ref: Xoom backed by Sequoia Capital). American Express has acquired RevolutionMoney, with its electronic C2C money transfer technology. Western Union's success in this space is far from certain. Many of these competitors may have a lower cost position, or have cross sell/cost-distribution opportunities that allow them to offer better price propositions. For example, a Filipino bank may be able to offer cheaper funds transfers between a migrant's offshore bank account and his/her family's bank account in the Philippines if both accounts are with the same bank.

Western Union has been trying to expand out of its core business to become a financial services provider. It has taken on the C2B business (payments) and B2B payments (its Custom House acquisition). It has also move into funds transfers between electronic endpoints with debit cards, and account-to-account remittances.

What Western Union has going for it in this new space is its brand recognition and distribution channel to introduce new products to its core customer base. However, this is unlikely to translate into a structural competitive advantage.


In short, the core determinant of Western Union's prospects and valuation is whether there will be continued growth in the cash-dealing (un-banked) migrant population. This relies on an assessment of:
(1) whether the low-income cash-dealing migrant population will continue growing, and
(2) whether competitors or legislation will move it to provide them with banking (electronic endpoints) facilities.

If one of these situations change, then Western Union's prospects may change significantly for the worse. Otherwise, if the ecological niches persist, then things can go wrong for WU only if:
(1) regulations restrict its business
(2) it fails to execute properly, and causes consumers to lose money or otherwise experience service lapses