A Wire From Western Union (WU)

By Stephen Brown | May 25, 2007 AAA

Certain business names - Standard Oil, U.S. Steel (NYSE: X), Wells Fargo (NYSE: WFC - pre-banking), American Telephone & Telegraph (NYSE: T), - conjure images of tycoons, robber barons, and monopolists from the laissez faire days of the nineteenth century.
Another name you could add to this nostalgic list is Western Union (NYSE: WU), which has been around in one form or another since 1851.

Yesterday and Today
Western Union's modern incarnation isn't much different from its predecessor. Having been spun off from First Data Corp. (NYSE: FDC) last September, the company remains a leading provider of consumer money-transfer services. But today it operates on a much broader scale, offering these services through a network of 305,000 agent locations that span 200 countries.

Most of Western Union's revenue is derived from fees that consumers pay when they send money. The business can be divided into two segments: consumer-to-consumer (84% of revenue) and consumer-to-business (16% of revenue).

The core consumer-to-consumer segment allows customers to transfer money to other individuals.

The majority of these transfers originate in cash at a Western Union agent location, but other delivery options include the internet, telephone, credit or debit card and, in some cases, bank debits.

Similar options are available in the consumer-to-business segment, where the company has long-standing relationships with utilities, auto finance companies, mortgage servicers, financial service providers and government agencies.

Although transferring money is a relatively straightforward business, Western Union does it well and does it profitably. The company's revenue has increased at a compound annual growth rate (CAGR) of 12.3% over the past three years, driven by transaction fees that have grown at a 10.9% CAGR. Foreign exchange revenue, which makes up 13% to 15% of total revenue, has increased at a 20.6% CAGR.

The Risks
The pursuit of growth through international expansion is a key tenet of Western Union's growth strategy. The company estimates that about 85% of its consumer-to-consumer transactions involve at least one non-U.S. location, but that can create problems as well as opportunities.

Western Union has experienced a slowing in its United States-to-Mexico business, hurt by sluggish U.S. construction activity and, more importantly, legislation concerns. Management has acknowledged that Mexican immigrants in the United States are increasingly hesitant to send money to Mexico. The heightened debate over immigration legislation worries illegal immigrants, who fear they'll attract attention if they use a service like Western Union's money transfer.

Increased competition is another concern. As any student of economics knows, profits attract competition. Firms such as Moneygram (NYSE: MGI) and Global Payments (NYSE: GPN) are probing Western Union's markets for a slice of the action, as are traditional commercial banks Wells Fargo and Bank of America (NYSE: BAC).

Fortunately, Western Union has a jump on the competition. It's twice the size of Moneygram and Global Payments combined. Plus, it has greater brand recognition in the money-transfer market than any of its competitors.

Future Value
Management expects earnings per share (EPS) of $1.07 to $1.11 for 2007, and 10% revenue growth, which puts 2007 revenue estimates at $4.92 million.

EPS will be pressured over the next 24 months from interest expense paid on debt incurred to transfer $3.5 billion in cash and debt securities to parent First Data. But Western Union is expected to bring the outstanding debt down to $3 billion by year's end and continue to substantially amortize it over the next 36 months, thanks to its ability to generate copious amounts of free cash flow.

Based on my down-and-dirty net present value model, which I consider conservative, I can easily see $25 within the next 12 months - a 13.6% increase from current levels. The model assumes a discount factor of 10% and EPS growth rate of 6%. At that level, shares would trade at a forward P/E of about 22.5 multiple of current 2007 EPS estimates, a modest premium to peers, but one justified by its superior position.

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