Description

Western Union (NYSE:WU)

A structurally challenged business that offers a compelling ‘short’ investment opportunity (22nd August, 2013)

 

A. Summary of Western Union and the investment opportunity

Western Union (market cap. $9.9bn; EV $12.4bn) is the global leader in consumer-to-consumer money transfer and payment services, processing 231m retail transactions worth $79bn in 2012. With over 510,000 agent locations in 200 countries, the company’s scale and network advantages create high barriers to entry and produce attractive economics, leading to strong free cash flow generation ($1.1bn in 2012A) and high returns on invested capital (22% in 2012A).

The company is also one of the largest non-bank, non-credit card providers of cross-border payment solutions for corporations; a market where Western Union’s focus on small and medium sized enterprises (SMEs) presents a potentially undervalued opportunity to gain share from larger banks and grow revenue.

						CAGR
($m; FYE Dec-31)		2009A	2010A	2011A	2012A	2006-12
Consolidated revenue		$ 5,084	$ 5,192	$ 5,491	$ 5,665	6.0%
Operating income		1,283	1,359	1,445	1,373	2.6%
	Operating margin (%)	25.2%	26.2%	26.3%	24.2%
Net income		849	969	1,225	1,068	4.4%
	Profit margin (%)	16.7%	18.7%	22.3%	18.9%
Free cash flow		1,233	1,176	1,231	1,144	3.5%
	FCF conversion (NOPLAT to FCF)	123.8%	110.9%	96.9%	96.9%
ROIC		27.2%	24.6%	26.1%	21.9%
ROTC (ROIC excl. acquistion-related intangibles)		50.6%	44.9%	63.3%	48.7%

Western Union appears to be a powerful franchise business that still enjoys considerable barriers to entry in its key markets and should benefit from a number of profitable industry developments in the mid-term future. Support for this view is provided by careful analysis of Western Union’s businesses and the competitive dynamics of the money transfer industry, which reveals a business model that benefits from a number of positive supporting factors; some of which are well-recognised whilst others are potentially underappreciated by the market:

(a)    Competitive advantage from Western Union’s “last mile” network of 510,000 physical agent locations deeply integrated into the economic fabric of over 200 countries;

(b)    Considerable stronger preference for physical cash vs. electronic payment methods as well as the definition of “convenience” to money transfer recipients in the developing economies that comprise the vast majority of Western Union’s “receive” markets; and

(c)    Potential to significantly reduce operating expenses if the percentage of transactions in Western Union’s “send” markets made via electronic-based payment channels (eg. online and mobile) can be grown to the mid-teens

 

Worryingly, though, Western Union’s long-term financial history paints a vivid picture of a steadily eroding competitive moat and raises serious concerns about the company’s long-term profitability. This is most clearly demonstrated by the company’s consistently declining historical operating margins and alarming return on capital trends. Return on invested capital has declined at an average of 190bps p.a. between 2004-12A (a negative 6.4% CAGR). The return on tangible capital has declined even more rapidly: an average of 690bps p.a. between 2004-12A (a negative 9.4% CAGR).

[Click for chart showing Western Union's declining operating margin and ROIC]

Detailed analysis of Western Union’s current competitive position, business strategy and industry dynamics suggests that this downwards trajectory is likely to continue, with the intensity of competitive threats to Western Union likely to accelerate.

Poor historical share price performance. Even with global money transfer volumes recovering after the financial crisis (the World Bank estimates that remittances will increase by 6 to 8% p.a. to 2017E) and Western Union’s dominant position in the consumer-to-consumer market (c. 4x the size of MoneyGram, the next largest competitor), the company’s share price has continued to languish (down c. 40% from its 2008 high).

[Click for graph of Western Union's share price performance (2006 to present)]

This share price underperformance is largely due to the market’s concerns regarding (a) the risk of technological obsolescence for cash-based money transfers, and (b) the secular threat to Western Union’s profitability from new online- and mobile-based money transfer methods makes Western Union’s future look increasingly bleak. Compounding investors’ negative outlook is the difficulty with accurately forecasting how these major issues will likely affect Western Union over the long-term, creating further negativity around the stock.

The structural challenges that Western Union is likely to face over the mid- to long-term suggest that the company will struggle to meaningfully grow operating profits and analysis of the various plausible future paths for the business suggest that its intrinsic value is c. 25 to 35% below the current price. Given the anaemia of Western Union’s potential to grow operating profits (they have been almost flat since 2006) and the likelihood of returns on capital continuing to decline, the current $18.00 share price (representing 13.0x 2013E unlevered FCF, 10.6x 2013E EBIT and 11.7x 2013E P/E) offers no margin of safety for ‘long’ investors. DCF valuations also suggest a fair value share price of c. $11 to $14 (for details, see section M), considerably below the current share price.

Western Union’s current trading multiples suggest the company is overvalued:

(FYE Dec-31)				2012A	2013E	2014E	2015E
EV / EBIT				9.0 x	10.5 x	10.1 x	10.3 x
	Yield (%)			11.1%	9.5%	9.9%	9.7%
EV / FCF				10.8 x	12.9 x	13.1 x	13.3 x
	Yield (%)			9.2%	7.8%	7.7%	7.5%
P / E				9.3 x	11.6 x	11.1 x	11.3 x
	Yield (%)			10.8%	8.6%	9.0%	8.8%

 

The market’s short-term myopia means that it is not correctly pricing in the risks from long-term structural headwinds, meaning Western Union is exposed to the risk of sudden price corrections if – as we expect – earnings forecasts are revised downwards in the future. Q4 2012A provides a good example of the market’s proclivity towards negativity when dealing with Western Union. The share price dropped c. 33% in two days to c. $12 after management reduced earnings guidance and announced a c. 5% cut to consumer-to-consumer (“C2C”) pricing in 2013E. Whilst this pricing cut will negatively impact 2013E C2C revenue by c. 4 to 5%, these pricing actions have provided decent returns 12 to 18 months after their enactment historically (see section D for further analysis).

This sell-off meant Western Union’s valuation corrected to a more conservative 9.8x 2013E FCF, 8.1x 2013E EBIT and 8.1x 2013E P/E. Over the following six months the market digested the repercussions of the pricing cut and recognised the impact to earnings would be more muted than first expected, causing the share price to re-appreciate to 95% of pre-drop value (generating a 40% absolute return and an IRR of 75% for savvy tactical investors who invested opportunistically in December 2012). Even whilst recognising that Western Union’s longer-term investment potential is poor, a long-only investor who had conducted detailed analysis of Western Union’s business fundamentals and who was comfortable taking a tactical short-term position could be well placed to take advantage of the market’s short-term overreactions and establish a profitable tactical ‘long’ position in the stock if similar sell-offs occur again in the future.

Western Union exhibits many of the characteristics of an attractive risk-adjusted ‘short’ investment, with an intrinsic value c. 25 to 35% below the current price. The company is exposed to numerous long-term structural headwinds but is currently trading at a valuation more normally attributed to a highly-rated business, suggesting the market has not yet factored in the considerable challenges to Western Union’s profitability that lie ahead.

Combining Western Union’s full valuation and vulnerability to downwards earnings revisions with the company’s track record of delivering earnings disappointments (and the significant market sell-offs that have subsequently occurred) suggests that Western Union is vulnerable to share price corrections to the downside, increasing its attractiveness as a ‘short’ investment.

Further enhancing the ‘short’ investment’s asymmetric risk-reward profile is the market’s demonstrated nervousness towards Western Union, suggesting that the company’s share price is at greater risk of large movements downwards than upwards, providing a further margin of safety for a ‘short’ investor.

But, at $18.00, the margin of safety is not as large as we’d traditionally look for in a ‘short’ investment. As always, the issue on the ‘short’ side is that the market’s short-term myopia means that positive news flow from management may obscure the long-term secular challenges to Western Union’s profitability, potentially stabilising the company’s share price in the short-term. Furthermore, the 25 to 35% discount from the current share price of $18.00 to fair value at c. $12 to $14 is not as wide a margin of safety as we’d traditionally like for a ‘short’ investment.

That said, our downside scenario suggests a materially lower fair value share price (c. $4, implying 70 to 80% returns) whilst the upside scenario’s fair value is c. $20, only offering a small premium to today’s share price. Whilst a range this wide a range would normally be uninformative for the purpose of making investment decisions, the key takeaway is that the majority of the range is substantially below the current share price of $18.00, suggesting that the majority of the uncertainty surrounding Western Union’s future is substantially to the downside, further supporting the case for a ‘short’ investment.

Negative news flow surrounding the company and/or further evidence that Western Union’s competitive position continues to weaken have the potential to prompt a share price rerating, adding support to the ‘short’ thesis and potentially catalysing the market’s realisation of the seriousness of Western Union’s secular headwinds and its rapidly reducing competitive advantage. As such, we’ll continue to closely assess (a) how the company responds to the evolving secular industry trends and developing competitive threats, and (b) the company’s success at executing on its growth strategies, and scale into our ‘short’ investment accordingly.

 

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B. Report structure

 C.          Drivers of historical segmental revenue growth

D.         Historical revenue build up by type

E.          Three key secular trends that are likely to affect the stability of Western Union’s recurring revenue in the future

F.          The economics and profitability of Western Union’s business model

G.         Returns on capital are well in excess of Western Union’s funding costs but have been steadily declining

H.         Sources of Western Union’s competitive advantage

I.           Risks to Western Union’s recurring revenue streams

J.           Mobile money transfer initiatives, posing major competitive threats and potential growth opportunities

K.         Mixed management quality is a ‘red flag’ and cause for concern

L.          Western Union’s low capital intensity allows the company to scale easily if growth opportunities present themselves

M.        Valuation, investment recommendation and conclusion

 

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C. Drivers of historical segmental revenue growth

Western Union is the leading provider of money transfer and payments services globally. The company operates three main businesses: Consumer to Consumer (C2C), Consumer to Business (C2B) and Business Solutions or Business to Business (B2B).  Collectively, these three businesses generated $5.7bn in revenue in 2012A and consolidated revenue has grown at 6.0% p.a. since going public in 2006.

The C2C segment accounted for 83% of consolidated revenue in 2012A. Money transfers from one retail customer to another are Western Union’s core business, with the “sender pays” business model generating $4.7bn in 2012A. Western Union processed 231m C2C transactions in 2012A, 85% of which involved at least one location outside of the United States and 15% of which were sent domestically in the US.

22% of C2C revenue was generated in Europe and the CIS; 20% in North America; 15% in the Middle East and Africa; 12% in Asia Pacific and 9% in in Latin America. Growth of c. 3% in the Middle East and Africa, Asia Pacific and Latin America in 2012A was broadly offset by declines of c. 5% in Europe and 3% in North America, largely reflecting underlying economic conditions in each of the regions. No more than 7% of C2C revenue was generated in one country in 2012A (unlike some smaller online-based competitors, such as Xoom, where two or three countries account for more than 95% of revenue).

Remittances volume is forecast to grow by 6 to 8% p.a. to 2017E. Of the estimated $514bn of formal (ie. recorded) cross-border remittances sent in 2012A, the World Bank and Western Union estimate that c. $175bn were sent to the top four inbound destinations of India, China, the Philippines and Mexico. The World Bank forecasts remittances to grow by 6 to 8% p.a. to 2017E and also estimates that the volume of informal (ie. unrecorded) global money transfers is 50 to 100% the size of formal volumes, suggesting considerable scope for Western Union to grow its transaction volume over the long-term, even without taking share from other formal means of international money transfers.

Western Union’s market share has been relatively constant. In 2012A, Western Union processed c. 15.4% of total cross-border formal remittance volumes (three times as much as MoneyGram - Western Union’s direct competitor in the C2C segment - with 5-6% market share, though still a fraction of the broader cross-border payments market). This suggests potential for Western Union to grow market share over time. MoneyGram generated $1.3bn of revenue in 2012A, making it c. ¼ the size of Western Union. Other competitors include regional money transfer operators (MTOs), banks and post banks, credit unions, online payment processors (eg. Paypal), and informal money transfer networks (eg. the hawala and hundi value transfer systems, which are particularly common in the Middle East and North Africa).

The typical C2C ‘send’ customer is an economic migrant looking to remit money to family in his or her home country. The World Bank and IMF estimate there are over 230m migrants globally. Over 40% of C2C transactions in 2012A were initiated by a customer with a Western Union loyalty card (19m customers in 2012A, 3.0x as many as in 2006A). The loyalty card typically enables faster transfer processing at physical agent locations and these customers tend to execute more transactions and exhibit higher retention rates than non-loyalty card users.

Electronic transfers will likely be a major source of future revenue growth. 79% of consolidated revenue was generated by Western Union’s traditional ‘brick and mortar’ network of c. 510,000 agents and 100,000 ATM locations. A small but fast-growing percentage of consolidated revenue (4% in 2012A, up from 3% in 2011A) was generated through electronic channels, which includes online (eg. westernunion.com), mobile- and account-based money transfers. We estimate that 6% of transaction volume was sent via electronic channels in 2012A. Western Union currently reports its online revenue in the C2C segment and its mobile- and account-based revenue in the Other segment.

[Click for a chart showing forecast C2C electronic channel revenue]

Online, mobile and account-based transfers share many similar economic characteristics. Therefore, to better model the future C2C business we have re-categorised these revenue streams into a new reporting segment, ‘C2C Electronic Channels’ (and renamed the C2C business sent via physical agent locations as ‘C2C Traditional Channels’).

In 2012A, 80% of customers using westernunion.com were new to the Western Union franchise. This implies relatively low levels of existing customer cannibalisation. Revenue generated by C2C Electronic Channels was c. $221m in 2012A.

$0.6bn ofC2B revenue in 2012A accounted for 11% of consolidated revenue. It was predominantly generated in the domestic United States. Historically, over 90% of segmental revenue has come from charging customers transaction fees to make one-off or regular bill payments to businesses and other organisations, including utilities, auto finance companies, mortgage servicers, financial service providers and government agencies. The typical customer is financially constrained, normally under banked, and often struggles to make regular payments to these businesses via their bank account, hence the use of Western Union’s services.

C2B revenue has declined at 3.5% p.a. in recent years, in line with competitors. Having steadily grown segmental revenue to $720m in 2008A, revenue has since declined at a 3.5% CAGR since the onset of the financial crisis.  This performance has been largely mirrored by MoneyGram’s competing C2B business.

Transaction volumes have remained roughly flat between 2007-12A at c. 400 to 430m, whilst the average transaction fee has declined by c. 4% p.a. over the same period. This is largely due to the proliferation of alternative online-based payment methods in recent years (which have caused Western Union to reduce prices to remain competitive). These competitive pressures are likely to continue to impact Western Union: C2B revenue is forecast to trend gently downwards in line with recent history, declining at a 4% CAGR in our base scenario.

B2B revenue grew to $0.4bn in 2012A as a result of the acquisition of Travelex Global Business Payments (TGBP),which was completed in 2011 for c. $1,000m. The B2B segment generates revenue by facilitating payments – primarily cross-border and/or cross-currency - and foreign exchange services for SMEs and other organisations. Western Union’s B2B services were used by c. 100,000 customers in 30 countries in 2012A, with no customer accounting for more than 10% of 2012A segmental revenue.

Global cross-border B2B money transfer revenues are primarily driven by international trade volumes, which have grown at c. 9% p.a. over the past decade. Global cross-border B2B revenues totalled c. $34bn and – supported by a secular tailwind of increasingly globalised trade - are forecast to grow at c. 11% p.a. in the mid-term (as per Boston Consulting Group estimates). Of this B2B revenue, McKinsey & Co. estimate that the opportunity related to SMEs is c. $24bn (though it should be noted that the two consultancies’ methodologies are different. The broad takeaway is the same: the revenue opportunity for Western Union is sizeable).

Of the $24bn of cross-border SME-related revenues, c. 80% is earned by large international banks such as HSBC, JPM Chase, Citigroup, etc., who benefit from their global infrastructure and extensive relationships with large corporations. Another c. 10% of the revenue is accounted for by card-based services, sometimes in partnership with the banks.

Bank payment solutions have historically been cumbersome and excessively expensive for SMEs, more suitable for large corporations with established treasury and finance functions. At the other end of the spectrum, very small enterprises have benefited from the growth in alternative payment providers, such as Paypal and credit cards, over the past decade.

In between the two extremes of multinational banks and alternative payment providers is a large market of SMEs that is currently underserved, presenting an opportunity for Western Union. Western Union’s B2B business is the result of two acquisitions: Custom House in 2009 for $370m and Travelex Global Business Payments (TGBP) in 2011 for $1,000m. Combined, these two businesses have c. 1.1% of the total cross-border B2B market, with Hi FX and Currencies Direct the next largest SME-focused competitors (generating revenues of c. $60 to 70m). In 2012A, c. 90% of B2B revenues were generated by foreign exchange spreads, with the remainder from transaction fees. The B2B business presents a potentially underappreciated long-term opportunity for Western Union to grow revenue, with the B2B segment forecast to become the second most important source of revenue (behind C2C) for Western Union by 2015E.

The TGBP acquisition was met with dismay by investors when it was announced in 2011 (Western Union’s share price dropped 4.4% on the day of the announcement). This reaction is understandable – the integration of Custom House in 2009 for $370m proved to be more complicated than first announced and execution risk related to the integration of TGBP remains, with B2B operating margins still negative.

  

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D. Historical revenue build up by type

Consolidated group revenues are primarily generated by (a) transaction fees and (b) foreign exchange spreads. Transaction fees accounted for 75% of 2012A consolidated revenue, foreign exchange spreads accounted for 23% and a further 2% was generated by commissions, prepaid cards and other ancillary forms of revenue.

Foreign exchange spreads account for 23% of consolidated 2012A revenue. Foreign exchange revenue is ‘spread’ generated by charging retail and corporate customers a less favourable exchange rate than Western Union can itself acquire the currency for in the financial markets.

Western Union’s C2C segment’s foreign exchange revenue has consistently been c. 1.2% of the amount transferred, which in line with MoneyGram and other MTOs. It is slightly lower than some online only competitors: Xoom, for example, typically targets a c. 1-3% spread but also charges a lower transaction fee than Western Union. Overall, the quantum of the c. 1.2% foreign exchange spread is likely to unlikely to meaningfully decline in the future and, therefore, the amount of Western Union’s future C2C foreign exchange revenue is largely dependent on future transaction volumes.

B2B segment revenue is primarily derived from foreign exchange spreads (historically > 90%). Foreign exchange is likely to remain the dominant means by which the B2B segment generates revenue: Western Union has recently developed and launched a number of innovative products for SMEs engaged in cross-border payments, such as an easy-to-use method of hedging recurring foreign exchange risk related to recurring cross-currency payments via a simplified combination of forwards and options (a service previously only offered by banks but typically too expensive and/or complicated for many SMEs to use).

Western Union’s earnings are (surprisingly) unexposed to foreign exchange risk. The majority of Western Union’s business is conducted in USD and EUR, with exposure to foreign currencies predominantly caused by the gap in time between the sending and receiving of a money transfer, which is typically measured in days.

Currency fluctuations have a negligible impact on Western Union’s profitability, having impacted reported revenues vs. a constant currency basis by less than 2.5% every year since going public. The difference between cumulative reported and constant currency revenues between 2006A and 2012A is a relatively insignificant $17m vs. cumulative revenues of $36.1bn – far less than many international consumer products companies, for example.

Transaction fees account for the majority of consolidated 2012A revenue (75%). Western Union charges senders a fee alongside the majority of transactions the company processes. Transaction fees typically increase with the size of the principal amount being transferred, though the fees on small transfers are often more as a percentage of the principal transferred. This model is typical of MTOs, banks and other payment processing companies (eg. Paypal).

Western Union’s C2C business has typically charged customers transaction fees of c. 4.5 to 4.7% of the amount transferred. To drive volume growth, Western Union has tended to reduce this fee by low single digits annually (with MoneyGram following a similar strategy).

Whilst the C2C business model has historically pushed through annual price cuts averaging c. 6% p.a. between 2004A and 2012A to grow transaction volume, management has repeatedly misrepresented these historical declines as being c. 2 to 3% p.a. In 2012A, Western Union announced a c. 5% price cut to be completed by 2013E (the announcement of which sent the share price down c. 30%). Management characterised this price cut as more aggressive than usual, but our analysis shows that Western Union’s historical price reductions are a percentage point or two larger than management indicates.

The consistency and magnitude of Western Union’s greater-than-reported decline in pricing power since going public is a major concern for the business’ long-term prospects: its pricing power is even worse than the 2 to 3% number quoted by management.

Precedent price reductions of this magnitude historically took two to four quarters for the desired increase in transaction volumes to occur. Management have therefore guided for this price action to negatively affect C2C revenue growth in 2013E (the base case scenario forecasts a c. 6.0% annual decline in C2C revenues). The most relevant precedent was the introduction of a new low-value pricing band in Q4 2009A, which caused C2C transaction growth to increase from c. 3% p.a. in Q1 to Q3 2009A to 9% from Q2 2010 onwards, more than offsetting the negative effects of price cuts on total revenue. 

 

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E. Three key secular trends are likely to threaten the stability of Western Union’s recurring revenue in the future

1. Growth in the popularity of electronic channels (online, mobile and account-based money transfers) as a means of sending remittances from developed economies (Western Union’s C2C “send” markets), with Western Union potentially able to lower agent commission costs (the largest component of opex);

2. Competitive threat from alternative electronic (ie. cashless) formats for receiving remittances (including mobile-based initiatives, prepaid cards and account-based solutions) in developing economies (Western Union’s C2C “receive” markets), though the likely take-up of these methods remains uncertain and hard to predict; and

3. Growth in the B2B cross-border payment market (a revenue opportunity estimated to be worth $24bn by McKinsey & Co.), coupled with a focus from Western Union on SMEs, who have typically been underserved vs. large multinationals by large commercial banks

The effects of these trends are examined in more detail in the remainder of this write up.

Base case scenario - consolidated revenue growth is forecast to decelerate to 2.5% p.a. to 2017E vs. the historical growth rate of 6.0% between 2004-12A. The deceleration in the forecast base case consolidated revenue growth rate is largely driven by increased competition from online and mobile-based competitors in the C2C segment (eg. telecom operators in Western Union’s “receive” markets and MoneyGram and other money transfer agents in “send” markets).  

In the base case, C2C transaction volume growth accelerates (as electronic channels take market share) which is offset by price reductions of c. 5% p.a. (more negative than management’s long-term guidance of 2 to 3% p.a. but in line with historical pricing trends), leading to 2.4% C2C revenue growth p.a. to 2020E (vs. 6.3% historically from 2004-12A.)

The market share in the B2B segment is forecast to marginally increase as a result of investment in new services targeting SMEs, with revenue growth of 11 to 12% p.a. to 2017E largely driven by forecast growth in cross-border B2B market revenues (in line with Boston Consulting Group’s forecasts).

High case scenario - consolidated revenue growth accelerates to 4.4% p.a. to 2020E, driven by strong C2C transaction growth and increased market share in the B2B segment.

Western Union successfully captures a growing share of the online- and mobile-based cross-border C2C money transfer market whilst C2C prices decline by 4% p.a. (still above management guidance of 2 to 3% p.a.) , leading to 4% C2C revenue growth p.a. to 2020E. In the B2B segment, share grows from 1.1 to 1.3% of the market in 2020E as a result of successful targeting the SME segment.

Low case scenario - consolidated revenue growth decelerates to 0.7% to 2020E as market share and pricing are pressured by existing and new competitors. C2C transaction volume and average fees per transaction decline more rapidly, reducing C2C revenue growth to 0.9% p.a. to 2020E. In the B2B segment, share declines from 1.1 to 0.9% in 2020E, owing to increased competition from large international commercial banks and card-based payment methods.

 

[Click for a chart showing historical and forecast revenue estimates (for base / high / low scenarios)]

[Click for a chart showing historical and forecast operating profit estimates (for base / high / low scenarios)]

 

Side-by-side comparison of key financial line items in the three forecast scenarios (more details in appendices)

				Base case				High case				Low case
				2013E	2014E	2015E		2013E	2014E	2015E		2013E	2014E	2015E
	C2C Traditional Channels			$ 4,272	$ 4,369	$ 4,469		$ 4,263	$ 4,418	$ 4,579		$ 4,195	$ 4,210	$ 4,212
	C2C Electronic Channels			404	463	525		403	479	563		396	437	478
	C2B			579	554	529		588	576	564		570	531	494
	B2B			407	455	508		420	482	553		393	418	444
	Other			14	14	14		14	14	15		14	14	14
Total revenue				$ 5,675	$ 5,854	$ 6,046		$ 5,688	$ 5,969	$ 6,273		$ 5,569	$ 5,610	$ 5,642
	Increase / (decrease) vs. base case (%)			n.a.	n.a.	n.a.		0.2%	2.0%	3.8%		(1.9)%	(4.2)%	(6.7)%
		Agent commissions		$ (2,370)	$ (2,419)	$ (2,545)		$ (2,281)	$ (2,327)	$ (2,422)		$ (2,345)	$ (2,410)	$ (2,514)
		Depreciation		(46)	(53)	(59)		(46)	(53)	(60)		(46)	(52)	(59)
		Amortisation		(203)	(220)	(244)		(202)	(212)	(231)		(202)	(213)	(235)
		Other cost of sales		(755)	(779)	(801)		(756)	(794)	(822)		(741)	(743)	(756)
	Cost of sales			$ (3,374)	$ (3,470)	$ (3,649)		$ (3,287)	$ (3,387)	$ (3,535)		$ (3,335)	$ (3,419)	$ (3,563)
	SG&A			(1,126)	(1,160)	(1,192)		(1,129)	(1,189)	(1,237)		(1,110)	(1,123)	(1,129)
Operating profit				$ 1,175	$ 1,224	$ 1,204		$ 1,272	$ 1,394	$ 1,501		$ 1,124	$ 1,068	$ 950
	Operating profit margin (%)			20.7%	20.9%	19.9%		22.4%	23.3%	23.9%		20.2%	19.0%	16.8%
	Increase / (decrease) vs. base case (%)			n.a.	n.a.	n.a.		8.3%	13.9%	24.7%		(4.4)%	(12.7)%	(21.1)%
Normalised EBITDA				$ 1,424	$ 1,496	$ 1,508		$ 1,521	$ 1,659	$ 1,793		$ 1,372	$ 1,334	$ 1,243
Operating profit				1,175	1,224	1,204		1,272	1,394	1,501		1,124	1,068	950
NOPLAT				1,009	1,055	1,038		1,093	1,202	1,296		964	920	815
Enterprise free cash flow				963	949	935		1,046	1,108	1,194		924	842	735
	FCF conversion (NOPLAT to FCF)			95%	90%	90%		96%	92%	92%		96%	92%	90%
Return on invested capital (ROIC)				17.6%	17.6%	16.6%		19.1%	20.2%	20.8%		16.8%	15.4%	12.9%
ROTC (ROIC excl. acquistion-related intangibles)				40.2%	40.0%	37.6%		43.6%	46.0%	47.7%		38.3%	35.0%	29.3%

 

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F. The economics and profitability of Western Union's business model

Western Union’s historical operating margins have historically been c. 10 to 15% above competitors, but the trend has been steadily declining. Western Union’s historical operating margin has eroded from 31.9% in 2005A to 24.2% in 2012A. In comparison, MoneyGram’s operating margin has never risen above 16% and has fluctuated between c. 11 and 13% since 2010A.

 

[Click for a chart showing historical and forecast operating margin estimates]

 

The difference between the two MTOs operating margins is largely due to differences in scale. Western Union is the clear leader in the C2C money transfer market, which is an industry where size tends to confer significant advantages. The money transfer business is inherently scalable because the incremental costs of processing additional transactions are minimal: largely related to additional agent commissions (which comprise c. 70 to 75% of consolidated cost of sales (or c. 48% of C2C segment revenue). The rest of the revenue should drop straight through to the bottom line. 

Western Union’s historical financials show that the operating leverage one would expect from an MTO business is absent. One would expect Western Union to have a cost advantage over its rivals, being able to spread similar amounts of fixed costs over a larger revenue base. This has contributed to the company’s historical operating margins roughly twice that of MoneyGram.

Yet, Western Union’s margins have all steadily declined as revenue has grown, indicating a lack of operating leverage. The historical financials also contradict comments from the CFO that the business has strong operating leverage, who claims that “65% of the company’s operating expenses are variable and c. 35% are fixed, with a greater than average amount of operating leverage in the B2B business”.

 

Western Union’s historical profit margin development is steadily negative

																CAGR
($m; FYE Dec-31)						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A		2004-12A
	Profit margins (%)
		Gross margin				47.7%	46.9%	45.6%	42.7%	43.0%	43.5%	42.9%	43.7%	43.6%		(1.1)%
		Operating margin				31.5%	31.9%	29.4%	27.0%	27.2%	25.2%	26.2%	26.3%	24.2%		(3.2)%
		PBT margin				31.1%	33.8%	29.9%	25.0%	25.0%	22.3%	23.2%	24.3%	21.4%		(4.6)%
		Profit margin				21.3%	23.4%	20.5%	17.5%	19.0%	16.7%	18.7%	22.3%	18.9%		(1.5)%
	(Costs) / other income as % of revenue
			Agent commissions			(39.2)%	(39.8)%	(40.8)%	(43.0)%	(42.7)%	(42.4)%	(40.0)%	(39.4)%	(39.5)%		0.1%
			Depreciation			(1.0)%	(0.8)%	(0.8)%	(1.0)%	(1.2)%	(1.1)%	(1.2)%	(1.1)%	(1.1)%		1.6%
			Amortisation			(1.3)%	(1.2)%	(1.5)%	(1.5)%	(1.6)%	(1.9)%	(2.2)%	(2.4)%	(3.3)%		12.5%
			Other			(10.9)%	(11.3)%	(11.3)%	(11.8)%	(11.5)%	(11.1)%	(13.7)%	(13.4)%	(12.6)%		1.9%
		Cost of sales				(52.3)%	(53.1)%	(54.4)%	(57.3)%	(57.0)%	(56.5)%	(57.1)%	(56.3)%	(56.4)%		0.9%
			Marketing and advertising			n.a.	(6.8)%	(6.5)%	(6.0)%	(5.4)%	(4.7)%	(4.0)%	(4.1)%	(4.1)%		(6.7)%
			Other SG&A			n.a.	(8.3)%	(9.8)%	(9.7)%	(10.4)%	(13.5)%	(12.7)%	(13.3)%	(15.2)%		9.1%
		SG&A				(16.2)%	(15.0)%	(16.3)%	(15.7)%	(15.8)%	(18.2)%	(16.7)%	(17.4)%	(19.4)%		2.3%
		Operating margin (%)				31.5%	31.9%	29.4%	27.0%	27.2%	25.2%	26.2%	26.3%	24.2%		(3.2)%

  

With historical margin trends since 2004A steadily negative, it is hard to see this trend meaningfully reversing. Western Union has grown revenue every year but one since 2004A, yet operating profits have remained between $1.3bn and $1.4bn every year between 2006A and 2012A (a 0.7% CAGR) whilst revenue has grown from $4.5bn to $5.7bn over the same period. Estimating whether Western Union’s operating margin will continue to decline towards MoneyGram’s low single digits or whether Western Union can stabilise (or even expand) its operating margin is challenging, given the uncertain created by challenging industry dynamics and the competitive threats facing the company.

The historical trend suggests that future operating profit growth is highly unlikely. Compounding this negative outlook, detailed analysis of Western Union’s current competitive position, business strategy and industry dynamics suggests that the intensity of competitive threats to Western Union is likely to accelerate, supporting the continuation of the historical downward trend in operating profitability.

SG&A costs (excl. marketing) have expanded rapidly (in absolute terms and as % of revenue) since 2004A, with many of these cost increases directly related to ongoing operations. This is largely driven by Other SG&A expenses, which have increased considerably every year but one since 2004A (from $330m in 2004A to $863m in 2012A). Part of this increase is due to gains or losses on derivatives and forward contracts related to C2C foreign exchange transactions, which are not operationally significant, but is also driven by (a) increased investments in regulatory compliance initiatives (Western Union now spends c. $100m p.a. in its regulatory compliance systems and processes) and (b) group-wide strategic initiatives.  

Expenses related to cost saving initiatives and increased provisioning for bad debt expenses have also negatively impacted operating margins in recent years.  Whilst there is potential for these costs to be contained in the future, the majority are related to the on-going operations of the business and are, therefore, unlikely to decline in absolute terms (and are in fact more likely to increase over time, given the negative long-term historical trend).

One potential driver of margin expansion is the aggressive expected growth of electronic payment channels. Given that agent commissions and marketing and advertising costs comprise the two largest expense items in the profit and loss statement, an investor might expect Western Union’s business to scale well.

The increase in online and mobile channels to send remittances can meaningfully reduce future agent commission costs. These costs, in turn, are likely to significantly reduce Western Union’s cost of sales expense. Agent commissions are paid to both sending and receiving agents and have historically accounted for the lion’s share of operating expenses: 70 to 75% of consolidated cost of sales (or c. 48% of C2C segment revenue).  c. 14m of the 231m C2C transactions in 2012A were sent via electronic channels (eg. westernunion.com and mobile- and account-based transfers). Importantly, these transfers only require commission to be paid to receiving agents, effectively halving agent commission costs. 

[Click for a chart showing the percentage of C2C revenue expected to come from electronic channels in the future]

[Click for a chart showing the historical and forecast agent costs (as % of C2C segmental revenue)]

The two charts above illustrate the positive impact on reducing agent commission costs as a % of revenue, suggesting that Western Union’s operating margin will materially benefit from an increase in the number of C2C transactions made via electronic channels.

The B2B segment has been a considerable drag on operating margins since 2010A. The acquisitions of Custom House and TGBP have also proved to be a major drag on consolidated group margins, with the B2B segment posting negative operating profits every year since the acquisitions were completed (including an operating profit of $(55)m in 2012A).

Over the mid-term, management are guiding for low- to mid-double digit operating margins for the B2B segment as the business grows and begins to benefit from its operating leverage. With operating costs in these businesses having proved consistently higher than initially forecast, though, a healthy degree of caution in management’s B2B guidance is needed.

 

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G. Returns on capital are well in excess of Western Union’s funding costs but have been steadily declining

Western Union has consistently generated high returns on capital. Operating in an industry with barriers to entry, scale economies, low capital intensity and limited working capital requirements has allowed Western Union to consistently deliver returns on invested capital (ROIC) significantly above its cost of capital, leading to considerable economic profits and strong historical free cash flow generation.

But alarmingly, Western Union’s return on invested capital has declined at an average of 190bps p.a. between 2004-12A (a negative 6.4% CAGR). The return on tangible capital has declined even more rapidly: an average of 690bps p.a. between 2004-12A (a negative 9.4% CAGR).

 

The speed and stability of this decline suggests that the significant weakening of Western Union’s competitive position is more secular than cyclical in nature.#

Given Western Union’s capex-light business model, the company has not had sufficient opportunities to internally reinvest its free cash flow at these high returns on capital. Since 2006A, the company has returned a considerable $5.3bn to shareholders (55% of its current market cap.): $4.6bn via share repurchases and – over the last three years - via $0.7bn of dividend payments (for more details on capital returns, see section K).

[Click for a chart showing Western Union's historical and forecast return on invested capital]

The above chart illustrates the possible range of ROICs that Western Union might generate in the future; the wide spread highlights the range of potential challenges to Western Union from existing competitors, new entrants and a number of secular headwinds.  It also shows the significant potential for Western Union’s returns to continue to decline to a level in line with its cost of capital. 

The high case forecast benefits from strong revenue growth which, combined with possible operating margin improvements, leads to a 2015E operating margin of 26.0% (vs. 20.9% in the base case) and significant NOPLAT growth (c. 30% higher than the base case by 2015E). In the low case, the company’s revenue growth is pressured (NOPLAT is c. 29% below the base case by 2015E) whilst the operating margin contracts to 16.5%, causing ROIC to decline dramatically.

 

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H. Sources and degree of Western Union’s competitive advantage

Western Union has a number of sources of competitive advantage, although many have been steadily eroding:

1. Operating the largest network of physical agent locations in the world acts as a significant barrier to entry for potential new competitors
2. Controlling the physical ‘first mile’ / ‘last mile’ of the person-to-person payment process means Western Union possesses unique access to the 3.0bn global ‘unbanked’ / ‘underbanked’ population; access which is in high demand from companies across a range of industries
3. Western Union’s deep, long-established relationships with local and national authorities in developing markets and its expertise in successfully working with legislators and regulatory bodies across 200 countries are extremely difficult to replicate in the short- to mid-term, yet are essential for transferring money across borders
4. Western Union’s network economics positively differ from those of most banks and financial institutions: a larger network of agents attracts more customers and creates higher switching costs for individual agents
5. Cash will remain ‘king’ for the foreseeable future in most of Western Union’s “receive” markets, even in the face of threats from new mobile-based payment networks

 

Operating the largest network of physical agent locations in the world acts as a significant barrier to entry. This allows Western Union to benefit from a mild network effect. Although customer switching costs in the MTO business are practically zero, all other things being equal, both send and receive C2C customers and agents prefer being aligned to a larger MTO agent network than a smaller one.

For the sender, there is the benefit of knowing that there is more likely to be a physical agent location conveniently located near to the recipient. It’s important to note that there’s a big difference between urban and rural receive locations in markets such as India or China. Many rural receive locations are anything from small shops to farms, with c. 30% having experienced no traffic over the past 12 months. They are simply there to increase the convenience for customers and, due to the commission-based economics of the contract between Western Union and the agents, do not incur costs for Western Union.

Western Union possesses the largest network of MTO agents globally, with 510,000 locations and over 100,000 Western Union linked ATMs. Western Union has grown its agent network at an 11% CAGR between 2006A and 2012A, though this growth rate has slowed to high single digits in recent years. MoneyGram has grown its network even more aggressively, expanding at an 18% CAGR between 2009A and 2012A and now operating c. 310,000 agent locations.

Western Union is still the dominant MTO, with c. 65% more agent locations than MoneyGram (down from 120% in 2009A). It has historically possessed a far stronger network of agents in the developing economies outside of the United States and Latin America, such as Africa, Central and Eastern Europe, the Middle East and Asia – all key growth markets for remittances - though much of MoneyGram’s growth in recent years has been to play catch up to Western Union in these markets.

Controlling the physical “first mile” / “last mile” of the person-to-person payment process means Western Union possesses a constrained resource in high demand. This unique access to many of the c. 2.5bn of the global adult population that McKinsey & Co. estimate to be unbanked (let alone the additional c. 0.5 to 1.0bn who are under banked) can be extremely valuable to financial companies who operate in the cashless money transfer ecosystem and who have difficulty interacting with these potential customers who predominantly use cash for money transfers and payments. This is illustrated by comments by Ajay Banga, CEO of MasterCard, made when discussing MasterCard’s recently announced partnership with Western Union:

“The biggest problem for MasterCard and most of its traditional clients has been the last mile and the first mile issue. The person-to-person contact. I see [MasterCard’s partnership with Western Union] as a five to ten year effort … covering person-to-person … SMEs and small ventures … mobile, e-commerce and e-wallets”.  

Similar logic drives Western Union’s (and MoneyGram’s) partnerships with mobile banking operators in many developing economies, such as Kenya’s Safaricom and its M-PESA initiative (an electronic wallet attached to the users’ mobile phone account).

M-PESA is perhaps the most successful example of a mobile banking system substituting the traditional banking system in a developing economy (for context, M-PESA now processes more transactions domestically in Kenya than Western Union does globally, with c. of 25% of Kenya’s GDP is transacted on it annually), though it should be noted that Kenya has the highest ratio of mobile penetration to financial services penetration of any country in the world, making it the ideal environment for an initiative like M-PESA to profit.

M-PESA been able to grow to its current size partly by partnering with Western Union. In Western Union’s “send” markets, Kenyan migrants can use the company’s agents and westernunion.com to transfer funds directly to family member’s M-PESA accounts. In Kenya, recipients can take their M-PESA transaction details from their mobile to one of 700+ Western Union agents to collect the cash.

Western Union’s decision to integrate itself with M-PESA, the number one domestic money transfer agent, has been strategically sound. Whilst Western Union may earn a lower fee per transaction it processes in conjunction with M-PESA, the sheer volume of transactions that M-PESA facilitates means that Western Union’s strategy of becoming an integrated part of the evolving electronic payment ecosystem in these developing markets is likely to prove profitable over the long-term.

Western Union’s deep, long-established relationships with authorities in developing markets aredifficult to replicate. Western Union also benefits from the fact that the company has been active in many of these countries for over 100 years and often has deep, established relationships with governmental and local authorities, as well as key local institutions (eg. banks and post offices).

The challenge for competitors to recreate these relationships with a myriad of local bureaucracies in the short- to mid-term should not be underestimated; these complexities present major barriers to new entrants in the money transfer industry in developing economies. It is this direct access to a burgeoning class of new customers - the under banked and unbanked - that is motivating other companies in the money transfer industry that do not operate physical networks to seek to partner with Western Union (and MoneyGram).

The larger an MTO’s network of agents, the higher the switching costs for individual agents. As previously discussed, switching costs for end customers are practically zero, which is a negative for Western Union and other MTOs. But the switching costs for agents are high, due to the proliferation of exclusivity agreements with agents. Other MTOs, with the exception of MoneyGram in certain corridors, almost never share Western Union’s agent footprint on both sides of a transaction. If a (sending) agent leaves Western Union he or she will be unlikely to be able to promise existing customers the same receive location and may even struggle to offer a nearby alternative.

Furthermore, the sending agent has no means to analyse the network of agents in the receiving geographies and quantify the financial impact of switching MTOs, meaning that – all other things being equal - agents will tend to partner with the MTO with the largest agent network (ie. Western Union, which has a 65% larger agent network than MoneyGram). The secondary benefit from this dynamic is that it creates considerable information asymmetry during the agent contract renewal negotiating process (which occurs, on average, every five years). When contracts are re-negotiated, Western Union uses the huge database it has built up over many years to determine how profitable the partnership with Western Union is to the agent as well as how profitable the agent is to the Western Union agent network as a whole, improving Western Union’s negotiating position.

This information asymmetry allows Western Union to conduct contract renewal negotiations on a more bespoke basis and negotiate with a higher degree of leverage specific to each negotiation. However, the rise in recent years of ‘super agents’ who operate large sub-networks of agents (see below) has eroded Western Union’s position of strength in some contract re-negotiation processes, a trend that is likely to continue.

The decision making process of remittance recipients in developing economies is likely to remain centred around “cash being king” for the foreseeable future. Many investors also misunderstand the importance of physical cash to recipients in developing economies (Western Union’s “receive” markets) and the primary motivations that govern the remittance receiving process.

Many investors, (often based in the US and Europe) associate financial “convenience” with the notion of an increasingly cashless society (eg. the ease of use of contactless credit cards and paying bills automatically by direct debit, etc.).

This is dramatically different to the notion of financial convenience to many end users in developing economies, many of which are under banked or unbanked. The picture to the right illustrates the demand in a typical provincial town in Azerbaijan for physical cash being remitted by Western Union after ‘pay day’ in a “send” economy.

For these recipients, being able to withdraw cash from Western Union locations allows them to perform essential activities such as food shopping, paying bills, etc., the vast majority of which must be done via cash.

Cash-based remittances remain considerably cheaper than alternatives. Supporting the argument for cash-based remittances remaining popular in the mid- to long-term, recent World Bank research shows that the cost (measured as fees as % of principal transferred) of remittances received in cash are considerably cheaper than other alternatives at c. 7.3%. This compares favourably to the average cost of account-to-account transfers of 14.1%. Even intra-bank account-based transfers still cost an average of 8.7%. The transactions costs of non-cash methods will need to decline considerably if these methods of money transfer are to take meaningful market share from cash-based transfers (bearing in mind that historical declines in global payment costs have only averaged 0.2% p.a.). The chart on P14 shows that the For reference, Western Union’s average cost in 2012A was 5.8%.

[Click for a chart comparing the cost of remittances by transfer method (% of total principal transferred)]

I. Risks to Western Union’s recurring revenue streams

Western Union is exposed to a number of major risks – some have been present historically whilst others have more recently evolved as new threats to the company’s profitability:

1. Western Union’s top agents are critical to profitability, with c. 60% of C2C revenue generated by the top 40 agents
2. Western Union’s traditionally exclusive relationships with some key agents appear to be eroding
3. A number of regulatory developments will likely harm Western Union by limiting the fees charged to C2C customers and increasing compliance costs, though this might impact Western Union less than smaller rivals 
4. MoneyGram is emerging as an increasingly competitive direct threat, as are online competitors such as Xoom
5. The rise of mobile money transfer initiatives – particularly in Western Union’s “receive” markets - is both a major threat and a possible growth opportunity

Western Union’s top agents are critical to future profitability, with c. 60% of C2C revenue generated by the top 40 agents. On average, Western Union’s top agents have been with the company for an average of 17 years. (Though there is obviously a degree of survivorship bias to these statistics, agents typically become more profitable with time as they build up their clientele base). These top agents are typically banks, post offices and chains of stores. And so, whilst the number of agents in an MTO’s network is a crucial indicator of an MTO’s scale economies and its competitive advantage, maintaining the key agents is critical to ensuring the stability of the MTO’s recurring revenue stream.

We’ve not been able to ascertain how many of Western Union’s top agents have left and/or moved to non-exclusive relationships over the past few years, nor how many top agents’ contracts are due to be re-negotiated in the next 12 to 18 months, but this is an area of critical importance to the stability of Western Union’s future C2C revenues.

Western Union’s traditionally exclusive relationships with some key agents – a major source of its competitive advantage vs. Moneygram and other competitors - appear to be eroding. For example, MoneyGram announced a partnership in late 2011 with the Indian Post Office (the largest postal network in the world) to provide MoneyGram transfers in over 5,000 post offices by 2014. Prior to this deal, Western Union operated an exclusive relationship with the Indian Post Office.

This is illustrative of a broader negative trend impacting the MTO industry: increasing legislation (particularly in Western Union’s “receive” markets) restricting MTOs’ ability to maintain exclusive agent relationships. Such regulation is already in force in India, Russia and some other CIS countries, and serves to dilute Western Union’s competitive advantage vs. MoneyGram and other MTOs, as well as reduce agents’ switching costs.

This trend is likely to more impact Western Union more severely than MoneyGram and other competitors as Western Union has a greater number of agent locations and has historically focused on maintaining exclusive agent relationships more actively than MoneyGram. As a result of this trend, it is likely that that capitalised agent costs will increase (perhaps by c. 50% from historical levels) as Western Union is forced to offer more attractive financial terms to agents.

Regulatory developments that will likely harm Western Union include potential legislation from both the “send” and “receive” markets that will limit the fees charged to C2C customers. The majority of MTOs’ customers typically have a low income and are often under banked or completely unbanked (particularly in “receive” countries). The World Bank estimates that c. 40 to 50% of the global adult population is unbanked, with the situation not limited to developing economies: 29% of adults in Italy and 12% in the United States are unbanked, for example, whilst a further 12% in the United States are under banked, according to the FDIC.

In developed economies (Western Union’s “send” markets), other financial services firms that have targeted under banked customers - such as pay day lenders - have increasingly been accused of “predatory” pricing policies. Given that some Western Union agents are located in pawn shops and other less reputable venues, there is a risk that developed markets’ governments and consumer protection groups increasingly categorise MTOs alongside companies that ‘profit from the poor’, which could put pressure on the fees that Western Union charge C2C and C2B customers.

[Click for a chart showing the average fee per C2C transaction vs. peers and World Bank targets]

This regulatory pressure is being compounded in developing economies, led by the World Bank, which notes that remittances have a “beneficial impact on developing economies three times their principal amount”. This has led to increasing scrutiny being place on the fairness of fees that migrant workers are being charged to send money home from abroad.

In an attempt to reduce remittance fees, the World Bank (with the support of the G8 and G20 nations) introduced the “5x5” initiative: announced in 2008/9, the initiative’s aim is to reduce the average transaction fee by 5% of principal transferred (from c. 10% in 2008/9) in five years (by 2014).

On one hand, the World Bank’s “5x5” target is unlikely to have a material impact on Western Union’s revenue as the company (a) has historically lowered prices by c. 3 to 5% a year to drive transaction volume growth, anyway, and has stated it plans to continue to do so, (b) Western Union’s fees are already c. 40% cheaper than many other formal cross-border transfer means (eg. banks, postal and credit unions, with informal money transfer networks, such as huwala often charging up 15 to 20% of the amount transferred), and (c) its fees are already lower than the vast majority of other remittance methods.

On the other hand, Western Union is an easy target for authorities to pressure to reduce remittance fees as the company is the largest and most visible transferor of cross-border remittances. Whilst the negative impact on Western Union is likely to be muted, the overall takeaway is that Western Union’s pricing power is likely to continue to erode over time.

Regulatory developments may benefit Western Union over the long-run: compliance costs and complexity will continue to increase, disproportionately challenging smaller rivals and potentially discouraging new entrants. The business of transferring money across borders is becoming increasingly complex and expensive, precipitated by events such as the recent financial crisis and the 9/11 terrorist attacks (amongst others).

This has led to increasingly stringent headline regulations, such as the USA PATRIOT Act, the Dodd-Frank Act and European Union Payment Services Directive, as well as the complicated and often idiosyncratic web of legislation related to transferring money across 200 national borders. For context, Western Union invests c. $100m p.a. in its regulatory compliance systems and processes, more than any non-bank, non-credit card in the money transfer industry. In comparison, MoneyGram has only spent c. $90m in total since 2009.

As the technological complexities of cross-border money transfer continue to increase, the associated costs of complying with both financial (and telecom regulations in the case of mobile-based payments) across borders will act as a barrier to entry to new entrants. As a result, partnerships between developers of new payment technologies (eg. mobile transfers) and existing financial service firms – both banks and international MTOs such as Western Union – are likely to increase in popularity. Examples include Western Union’s successful partnership with Safaricom and M-PESA in Kenya or MoneyGram’s recently announced partnership with First National Bank in South Africa.

MoneyGram is emerging as an increasingly competitive rival. MoneyGram has historically tended to undercut Western Union on price (though this is not always the case in certain corridors), with both MTOs providing retail customers with good value relative to other means of cross-border money transfer (explained in the following section).

More recently, though, the dynamic between Western Union and MoneyGram has shifted. For much of the past decade, Western Union was perceived as the premium brand (and charged customers accordingly) with MoneyGram operating as the smaller but more keenly priced competitor. As a result of this pricing policy and MoneyGram lacking the scale advantage of Western Union’s larger network, MoneyGram’s operating margin over the past decade has never risen above 16% and has remained between 11 and 13% since 2010A.

MoneyGram’s strategy has shifted in recent years, though, as it has aggressively expanded its agent network and built up an extensive number of partnerships (eg. MoneyGram’s mobile money transfer services are now offered via Lebara Mobile, a European mobile virtual network operator that targets economic immigrants and has over 3.0m customers).

MoneyGram is likely to increasingly challenge Western Union as it continues to (a) gain scale in its physical agent network, (b) sign mobile and online partners (eg. Paypal and South Africa’s First National Bank), and (c) establish relationships with agents that Western Union previously partnered with on an exclusive basis (eg. Indian Post Office, discussed below).

New, online-only competitors are a growing threat to Western Union’s C2C business. Companies such as Xoom are increasingly taking market share of the C2C market from established competitors (eg. Xoom has grown its market share over the past few years to c. 0.6% vs. 15.0% for Western Union). Xoom is currently small when compared to Western Union in general and westernunion.com specifically: generating revenue of c. $80m and just breaking even at the EBITDA level, Xoom processed 6.6m transactions worth $3.2bn in 2012A. This compares to $126m of revenue generated by Western Union.com, EBITDA margins of c. 28% and 14.4m transactions.

Whilst online-only competitors tend to focus on a specific few money transfer corridors (eg. Xoom transfers can only be sent from the United States) and therefore are likely to have a much narrower base of potential customers to compete with Western Union over, they pose a threat to the Western Union by offering a very keenly priced service. The challenge for Xoom and similar competitors is that Western Union is able to compete aggressively on price with Xoom in the corridors that Xoom targets (eg. USA to Mexico, which is of critical importance to Xoom’s revenue base but increasingly less so for Western Union) but not elsewhere, pressuring Xoom’s profitability and discouraging new entrants.

In a direct effort to neuter the threat from online-only competitors, Western Union is investing substantially in its online and mobile money transfer platforms, including having established an office in San Francisco with over 120 developers (33% more developers than there are currently employees at Xoom).

That said, Western Union is clearly going to be pressured by (new) competitors deploying new technologies and – even using conservative estimates - could feasibly lose 10 to 20 bps of market share a year for the foreseeable as a result of intensified competition. Furthermore, Western Union’s already weak pricing power (see P8) is likely to be incrementally eroded by low-cost online competitors, reinforcing the negative trend of Western Union’s operating margins.

Credit card companies are unlikely to be a threat to Western Union in the short- to mid-term, though they present a potential risk in the longer term. With the majority of adults in the developing world unbanked, credit card companies suffer from poor-to-no interaction with potential customers in these developing economies. As noted in the previous section, this lack of access is prompting companies like MasterCard to partner with MTOs such as Western Union to attempt to build economic relationships with these potential customers.

Though their threat to Western Union in the short-term is less worrying, the sheer scale of the networks that Visa and MasterCard companies have built up over the past three decades (30m+ locations) means that it is likely that the credit card companies will be involved in the cross-border person-to-person money transfer industry in the long-term. The exact form that their participation may take and the extent to which they will be able to utilise the scale of their networks to capture excess profits from the C2C money transfer value chain is harder to estimate, though shouldn’t be underestimated.

 

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J. Mobile money transfer initiatives: major competitive threats and potential growth opportunities

Providing cross-border money transfer facilities to mobile-led payment initiatives is a growth opportunity for Western Union, if it is executed correctly. The proliferation of mobile phones in developing economies (where the penetration of mobile phones is often two to five times higher than the penetration of financial services) is driving an increasing number of mobile-led payment initiatives.

As of mid-2012, there were c. 140 live operator-led mobile money initiatives globally, with another c. 100 in the planning stages (as per IHS Screen Digest research). This is a huge revenue source for telecoms operators (particularly as some of their traditional revenue streams have been shrinking) and it has spawned some highly profitable business opportunities; perhaps the most well-known has been previous discussed: the Kenya-based M-PESA initiative.

Telecom operators have struggled to date to roll out cross-border mobile money transfer initiatives, which has restricted the threat to Western Union’s business in the short-term. Many telecom operators have proved willing and capable to develop domestic mobile-based money transfer systems, as it typically requires working with one or possibly two regulators that the telecom operator already has existing relationships with (the telecom regulator and sometimes the banking or financial regulators).

Expanding the money transfer process to cross-border transactions, however, exponentially complicates the process, potentially exposing the telecom operator to the idiosyncratic rules of tens or even hundreds of foreign regulators and bureaucracies.

Furthermore, given that financial services are some of the most heavily regulated industries globally, it has often proved prohibitively complicated for telecom operators to attempt to internationalise their mobile-led payment initiatives themselves. As such, the development of these mobile-led payment initiatives has the potential to be a major growth opportunity for Western Union, whose pre-existing relationships with financial regulators and local authorities in over 200 countries allows telecom operators to relatively painlessly begin to integrate cross-border money transfers into their mobile-led payment initiatives. Primary research has shown that Western Union is currently actively involved in c. 20 to 25 mobile payment initiatives across Africa, Asia and South America (vs. c. 15 for MoneyGram), with the number having grown rapidly in the past 18 months.

National boundaries will continue to act as a major barrier to competition from emerging mobile-based money transfer initiatives in the short- to mid-term. As such, many emerging mobile-based payment networks are less of a competitive threat to Western Union’s business than might first be reckoned.

The key threat to Western Union’s recurring revenues in the next five to ten years is likely to come from (an as yet undeveloped) mobile-based, cross-border money transfer network. This would disintermediate Western Union, MoneyGram and online competitors (eg. Xoom) and erode one of Western Union’s key competitive strengths: it’s ability to efficiently and cost effectively help clients transfer money reliably and legally across borders. Whilst extensive primary research has yet to reveal any tangible implementations of such a cross-border network, a number of think tanks, research consultancies, international organisations and telecoms operators are heavily investing in potential initiatives. Though the implementation of such a project is still likely to be a few years away, it would have serious negative implications for the profitability of Western Union’s business model and the company’s ability to maintain its recurring revenue stream.

 

****

 

K. Mixed management quality is a potential ‘red flag’ and cause for concern

The management team is well regarded in the industry, yet they present considerable ‘red flags’ that give pause for thought. On the plus side, senior managers have considerable experience in the money transfer industry and the executives leading the development of the company’s major growth initiatives, such as innovative electronic payment channels, have all worked as managers of businesses in both “send” and “receive” markets, which should help increase the likelihood that new innovations are well-suited for the customers in end markets.  

Furthermore, management run the business prudently, with relatively conservative debt with a well-spaced repayment schedule, a sensible corporate strategy and the avoidance of any major missteps in recent years. This is in direct contrast to MoneyGram, for example, whose strategy of investing in risky asset backed securities in an effort to increase the yield it earned on its ‘float’ led to $1.5bn in subprime-related losses in 2008 and a calamitous loss in shareholder value.

The use of share repurchases to return cash to shareholders has been a very inefficient method of returning cash to shareholders. Western Union has returned $5.3bn to shareholders since 2006: $4.6bn via share repurchases and $0.7bn via dividends (largely in the last three years). Against the backdrop of Western Union’s share price steadily declining since being spun off from First Data at c. $25 in 2006, management has chosen to return cash to shareholders by reducing the number of shares in issue by 26% and paying an average price considerably higher than the current share price of $18.00.

Management’s strategy of having aggressively bought back shares at an average price of $32 to $33 in 2008 only makes sense if they believe that Western Union’s intrinsic value per share is substantially higher than the current share price. Given that Western Union’s share repurchase programme is deemed to be of such importance as to be continually referred to as one of management’s three key strategic priorities when it communicates with investors, it is extremely strange that management has never - as far as we’ve been able to ascertain - stated what they believe the intrinsic value of the company to be.

 

[Click for a chart showing Western Union's historical share price performance] 

 

Shareholders would have been substantially better off if management had returned the cash to shareholders via dividends and allowed shareholders to invest the cash themselves. With no tax reasons in recent years that would make one method of returning capital to shareholders preferable to another (assuming the dividends are held as qualified dividends), we can’t help wonder whether management prefer share buybacks to dividends (either of the regular or one-off varieties) because of the benefit share repurchases give to year-on-year EPS comparisons and their ability to provide support for the company’s share price.

Management communications with the market are heavy on business buzzwords and waffle and light on strategy and substance, raising serious concerns about their abilities to navigate the considerable business challenges ahead. Having listened to hours of interviews and read years of earnings call transcripts and analyst presentations, it is clear that the CEO, Hikmet Ersek, and other executives have a strong tendency to avoid answering questions put to them about the company’s performance and future strategy, often choosing to respond with vague, pre-rehearsed and often irrelevant ‘puff’ statements. The repetition and regularity of this behaviour raises serious concerns about management’s ability to guide Western Union through a challenging five to ten year future.

Lastly, management have, on occasion, proven to be over-bullish with their guidance. This has severely hampered share price performance when the guidance is missed (eg. Q4 2012A). The effects of missing guidance is likely to weigh on the share price for the coming quarters as many investors become more sceptical of management’s commentary regarding the operating health of the business.

 

****

 

L. Western Union’s low capital intensity allows the company to scale easily if growth opportunities present themselves

Western Union has enjoyed low historical capital expenditure requirements (averaging  c. 3% of revenue) though these are likely to increase due to higher capitalised agent contract costs and greater investments in software development. Western Union’s historical capital expenditure intensity is very low and has ranged from 1.4% to 4.7% of revenue. With the rent and management of Western Union’s 510,000 C2C agent locations paid for directly by the agents, the incremental investment required by Western Union to add additional agents is practically zero.

Similarly, the B2B segment requires very limited investment in physical infrastructure and equipment. Of the three line items that make up Western Union’s capex, the majority is related to capitalised C2C agent contract costs, followed by PP&E and software development costs.

Capitalised C2C agent contract costs are likely to increase with time. C2C agent contracts are typically renegotiated every four to six years, with the associated costs capitalised and amortised over this period. Capitalised agent contract costs have historically fluctuated between 0.5% and 3.1% of annual revenue. On a per agent basis, costs have typically averaged c. $200 per agent per year (c. $70m per year). 2012A was particularly costly for contract renewals ($175m, or c. $350 per agent), which management has stated was a one off increase. From 2013E onwards, costs per agent per year are likely to rise to $300 by 2015E, reflecting increased competition from MoneyGram and the greater financial incentives that will need to be paid to agents (particularly key agents), particularly if exclusive agent relationships are to be maintained in the future (which is very much in Western Union’s interest).

Capitalisation of software development costs set to meaningfully increase. Software development costs have historically ranged between 0.2% and 0.6% of revenue (between $8m and $32m). With the forecast growth of online, mobile- and account-based transfers, we estimate that the capitalisation of software development costs will increase from the historical average of 0.4% of revenue to 2.0% by 2015E in the base scenario (c. $121m). In the low scenario, costs rise to 2.8% of revenue (c. $157m) by 2016E as Western Union invests more heavily to try to counter aggressive competition from other online- and mobile-based operators.

Western Union’s acquisitive growth strategy poses execution risk in the future. Western Union has spent over $2.2bn on acquisitions since going public in 2006, most notably in relation to its expensive expansion into the B2B market with the acquisition of Custom House in 2009 for c. $370m and Travelex Global Business Payments (TGBP) in 2011 for c. $1,000m. Acquisitions have averaged c. $275m p.a. historically.

Western Union generates considerable free cash flow and can only reinvestment a fraction internally each year. Coupled with the uncertainty of Western Union’s competitive environment, it is likely that the company will make additional acquisitions in the future. As such, our base case scenario estimates that acquisitions average c. $200m p.a. in the future. In the low case, management is forecast to increase spending to c. $340m p.a. as they seek inorganic growth as a means to counter competitive pressures.

****

M. Valuation, investment recommendation and conclusion

Operating in an industry with barriers to entry, scale economies, low capital intensity and a market-leading competitive position should mean that Western Union will continue to deliver returns on invested capital above its cost of capital. But, with the company facing a number of strong secular headwinds and all the key financial KPIs steadily declining, Western Union’s returns on capital are likely to be considerably lower in the future.

 

[Click for a chart showing Western Union's historical negative operating margin and ROIC trends]

 

Trends in financial performance – return on capital and operating margins – have been consistently negative since 2004A. Return on invested capital has declined at an average of 190bps p.a. between 2004-12A (a negative 6.4% CAGR). The return on tangible capital has declined even more rapidly: an average of 690bps p.a. between 2004-12A (a negative 9.4% CAGR). Concurrently, the operating margin has steadily contracted from 31.5% to 24.2%.

Whilst Western Union’s business should benefit from operating leverage, the company’s lack of control over SG&A costs and the continued pressure on margins have meant that, whilst revenue has grown at a 6.0% CAGR between 2004-12A, operating profits have only growth at a 2.6% CAGR.

Detailed analysis of Western Union’s current competitive position, business strategy and industry dynamics suggests that the intensity of competitive threats to Western Union is likely to accelerate, meaning that there are no substantive reasons to believe that this trend will turn positive in the near term. The combination of (a) the structural challenges that Western Union is likely to face over the mid- to long-term, (b) the anaemia of Western Union’s growth potential and  continued pricing pressure, and (c) the likelihood of returns on capital continuing to meaningfully decline means suggest that the company will struggle to meaningfully grow operating profits in the future.

[Click for a chart showing Western Union's historical and forecast revenue growth]

 

[Click for a chart showing Western Union's historical and forecast operating profit growth]

 

Western Union’s current trading multiples suggest the company is overvalued

(FYE Dec-31)				2012A	2013E	2014E	2015E
EV / EBIT				9.0 x	10.5 x	10.1 x	10.3 x
	Yield (%)			11.1%	9.5%	9.9%	9.7%
EV / FCF				10.8 x	12.9 x	13.1 x	13.3 x
	Yield (%)			9.2%	7.8%	7.7%	7.5%
P / E				9.3 x	11.6 x	11.1 x	11.3 x
	Yield (%)			10.8%	8.6%	9.0%	8.8%

 

Fair value multiples suggest an intrinsic value of c. $12 to $14 per share, implying fair value is c. 20 to 30% below the current share price. With Western Union’s operating income growth predicted to remain largely flat in the base case scenario (it has grown at an anaemic 0.7% CAGR since 2006A), Western Union does not warrant the premium multiple at which it is currently trading.

Second, whilst the company’s marginal returns on capital are currently high, these returns look set to continue to decline (ROTC has declined at a dramatic average of 690bps p.a. since 2004A) and the business has limited opportunities for reinvesting capital at such high rates of return, suggesting an 8.0x EBIT multiple, 9.5x P/E multiple and 9.0% FCF yield is a more appropriate valuation at which Western Union should trade. If, as in the low scenario, operating profit growth turned negative then even greater multiple contraction would be warranted, further compounding the likelihood of a meaningful negative correction in the company’s share price.

 

[Chart showing that fair value multiples suggest intrinsic value is c. $12 to $14 a share]

 

DCF valuations suggest that the share price is fairly valued at c. $11 to $14 (based on an average of the three forecast scenarios), implying Western Union’s fair value is c. 25 to 40% below the current share price of $18.00. The uncertainty surrounding Western Union’s future recurring earnings, however, leads to a large variation in FCF estimates across the high / base / low scenarios and a corresponding fair value share price range between c. $4 (low case estimates) and $20 (high case estimates).

Whilst a range this wide a range would normally be uninformative for the purpose of making investment decisions, the key takeaway is that the majority of the range is substantially below the current share price of $18.00, indicating that even in an unlikely but bullish scenario the shares are only priced at a small discount to fair value (c. 10%) whilst in a more negative but plausible scenario the shares are substantially overvalued (by c. 75 to 80%).

 

[Chart showing DCF fair valuation between c. $11 and $14 (based on the base case scenario with explicit forecasts to 2020E and terminal value based on perpetuity growth rate method)]

 

All that said, at the current price of $18.00 per share the margin of safety is not as large as we’d traditionally look for in a ‘short’ investment. As discussed, the issue on the ‘short’ side is that the market’s short-term myopia means that positive news flow from management may continue to obscure the long-term secular challenges to Western Union’s profitability, potentially stabilising the company’s share price in the short-term. Furthermore, the c. 25 to 35% discount from the current share price (based on a blend of multiples and DCF fair values) is not as wide a margin of safety as we’d traditionally like for a ‘short’ investment.

Western Union is more vulnerable to share price corrections to the downside than the upside. Overall, Western Union’s full valuation, potential for further downwards earnings revisions and the company’s track record of delivering earnings disappointments (and the significant market sell-offs that have subsequently occurred) suggests that Western Union is more vulnerable to share price corrections to the downside than the upside. Compounding the ‘short’ investment’s asymmetric risk-reward profile is the market’s demonstrated nervousness towards Western Union, suggesting that the company’s share price is at risk of large movements downwards.

Negative news flow surrounding the company and/or further evidence that Western Union’s competitive position continues to weaken have the potential to prompt a share price rerating, adding support to the ‘short’ thesis and potentially catalysing the market’s realisation of the seriousness of Western Union’s secular headwinds and its rapidly reducing competitive advantage. As such, we’ll continue to closely assess (a) how the company responds to the evolving secular industry trends and developing competitive threats, and (b) the company’s success at executing on its growth strategies, and scale into our ‘short’ investment accordingly.

****

Appendix A: Summary financials (base case estimates)

($m; FYE Dec-31)																								CAGRs
Key P&L items						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A	2013E	2014E	2015E	2016E	2017E	2018E	2019E	2020E		2004-12A	2012-20E
		C2C Traditional Channels				$ 2,862	$ 3,280	$ 3,745	$ 4,093	$ 4,472	$ 4,301	$ 4,383	$ 4,518	$ 4,459	$ 4,272	$ 4,369	$ 4,469	$ 4,572	$ 4,633	$ 4,695	$ 4,757	$ 4,821		5.7%	1.0%
		C2C Electronic Channels				0	0	0	0	0	0	0	156	221	404	463	525	591	654	716	782	850		n.a.	18.3%
		C2B				576	600	637	720	720	692	611	616	604	579	554	529	505	483	461	441	421		0.6%	(4.4)%
		B2B				0	0	0	0	0	0	107	161	367	407	455	508	568	635	710	793	887		n.a.	11.6%
		Other				116	114	90	87	91	91	92	41	14	14	14	14	14	14	14	14	14		n.m.	0.2%
	Consolidated revenue					$ 3,554	$ 3,994	$ 4,472	$ 4,901	$ 5,282	$ 5,084	$ 5,192	$ 5,491	$ 5,665	$ 5,675	$ 5,854	$ 6,046	$ 6,251	$ 6,419	$ 6,596	$ 6,787	$ 6,992		6.0%	2.7%
		Annual growth (%)				n.a.	12.4%	12.0%	9.6%	7.8%	(3.8)%	2.1%	5.8%	3.2%	0.2%	3.2%	3.3%	3.4%	2.7%	2.8%	2.9%	3.0%
		Agent commissions				$ (1,395)	$ (1,589)	$ (1,823)	$ (2,106)	$ (2,258)	$ (2,156)	$ (2,074)	$ (2,164)	$ (2,236)	$ (2,370)	$ (2,419)	$ (2,545)	$ (2,676)	$ (2,785)	$ (2,898)	$ (3,013)	$ (3,131)
		Depreciation				(34)	(32)	(35)	(49)	(62)	(56)	(62)	(61)	(62)	(46)	(53)	(59)	(64)	(68)	(70)	(70)	(73)
		Amortisation				(45)	(48)	(69)	(75)	(82)	(98)	(114)	(132)	(184)	(203)	(220)	(244)	(265)	(304)	(325)	(336)	(354)
		Other cost of sales				(386)	(450)	(504)	(578)	(609)	(565)	(713)	(735)	(712)	(755)	(779)	(801)	(825)	(844)	(862)	(882)	(904)
	Gross profit					$ 1,694	$ 1,875	$ 2,041	$ 2,093	$ 2,272	$ 2,209	$ 2,229	$ 2,400	$ 2,471	$ 2,302	$ 2,384	$ 2,397	$ 2,421	$ 2,418	$ 2,441	$ 2,485	$ 2,531		4.8%	0.3%
		Gross margin (%)				47.7%	46.9%	45.6%	42.7%	43.0%	43.5%	42.9%	43.7%	43.6%	40.6%	40.7%	39.6%	38.7%	37.7%	37.0%	36.6%	36.2%
		Marketing and advertising				$ (576)	$ (270)	$ (290)	$ (295)	$ (285)	$ (240)	$ (210)	$ (225)	$ (235)	$ (244)	$ (246)	$ (248)	$ (250)	$ (257)	$ (264)	$ (271)	$ (280)
		Other SG&A				n.a.	(330)	(438)	(475)	(549)	(686)	(660)	(730)	(863)	(882)	(914)	(944)	(976)	(1,003)	(1,031)	(1,061)	(1,093)
	Normalised operating profit					$ 1,118	$ 1,275	$ 1,313	$ 1,323	$ 1,438	$ 1,283	$ 1,359	$ 1,445	$ 1,373	$ 1,175	$ 1,224	$ 1,204	$ 1,194	$ 1,158	$ 1,147	$ 1,153	$ 1,159		2.6%	(2.1)%
		Operating margin (%)				31.5%	31.9%	29.4%	27.0%	27.2%	25.2%	26.2%	26.3%	24.2%	20.7%	20.9%	19.9%	19.1%	18.0%	17.4%	17.0%	16.6%
		Finance income / (expense)				$ (14)	$ 75	$ 24	$ (100)	$ (116)	$ (151)	$ (155)	$ (110)	$ (162)	$ (167)	$ (173)	$ (173)	$ (176)	$ (177)	$ (180)	$ (186)	$ (192)
		Taxes				(347)	(417)	(421)	(365)	(320)	(283)	(235)	(109)	(143)	(151)	(158)	(155)	(153)	(147)	(145)	(145)	(145)
	Net income					$ 758	$ 933	$ 915	$ 858	$ 1,002	$ 849	$ 969	$ 1,225	$ 1,068	$ 857	$ 893	$ 876	$ 866	$ 834	$ 821	$ 823	$ 822		4.4%	(3.2)%
		Profit margin (%)				21.3%	23.4%	20.5%	17.5%	19.0%	16.7%	18.7%	22.3%	18.9%	15.1%	15.3%	14.5%	13.9%	13.0%	12.5%	12.1%	11.8%
($m; FYE Dec-31)																								CAGRs
Key FCF items						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A	2013E	2014E	2015E	2016E	2017E	2018E	2019E	2020E		2004-12A	2012-20E
		Normalised net income				$ 758	$ 933	$ 915	$ 858	$ 1,002	$ 849	$ 969	$ 1,225	$ 1,068	$ 857	$ 893	$ 876	$ 866	$ 834	$ 821	$ 823	$ 822		4.4%	(3.2)%
		Depreciation				34	32	35	49	62	56	62	61	62	46	53	59	64	68	70	70	73
		Amortisation				45	48	69	75	82	98	114	132	184	203	220	244	265	304	325	336	354
		Capex				(50)	(65)	(202)	(192)	(154)	(99)	(114)	(163)	(268)	(277)	(350)	(378)	(399)	(413)	(427)	(442)	(456)		23.5%	6.9%
		Change in OWC				76	25	91	122	191	215	68	(71)	(7)	(1)	(9)	(10)	(10)	(8)	(9)	(10)	(10)
		Subtract: post-tax net interest expense / (income)				9	(52)	(16)	70	88	113	124	101	142	142	147	147	150	151	153	158	163
		Add back: Post-tax restructuring / integration costs				0	0	0	0	(63)	0	(48)	(55)	(37)	(8)	(4)	(4)	(4)	(4)	(4)	(4)	(4)
	Unlevered FCF					$ 872	$ 921	$ 892	$ 982	$ 1,209	$ 1,233	$ 1,176	$ 1,231	$ 1,144	$ 963	$ 949	$ 935	$ 931	$ 930	$ 929	$ 932	$ 941		3.5%	(2.4)%

Appendix B: Summary financials (low case estimates)

($m; FYE Dec-31)																								CAGRs
Key P&L items						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A	2013E	2014E	2015E	2016E	2017E	2018E	2019E	2020E		2004-12A	2012-20E
		C2C Traditional Channels				$ 2,862	$ 3,280	$ 3,745	$ 4,093	$ 4,472	$ 4,301	$ 4,383	$ 4,518	$ 4,459	$ 4,195	$ 4,210	$ 4,212	$ 4,239	$ 4,265	$ 4,291	$ 4,316	$ 4,340		5.7%	(0.3)%
		C2C Electronic Channels				0	0	0	0	0	0	0	156	221	396	437	478	522	566	607	649	693		n.a.	15.4%
		C2B				576	600	637	720	720	692	611	616	604	570	531	494	460	429	399	372	346		0.6%	(6.7)%
		B2B				0	0	0	0	0	0	107	161	367	393	418	444	471	499	529	560	592		n.a.	6.1%
		Other				116	114	90	87	91	91	92	41	14	14	14	14	14	14	14	14	14		n.m.	(0.4)%
	Consolidated revenue					$ 3,554	$ 3,994	$ 4,472	$ 4,901	$ 5,282	$ 5,084	$ 5,192	$ 5,491	$ 5,665	$ 5,569	$ 5,610	$ 5,642	$ 5,705	$ 5,772	$ 5,839	$ 5,910	$ 5,985		6.0%	0.7%
		Annual growth (%)				n.a.	12.4%	12.0%	9.6%	7.8%	(3.8)%	2.1%	5.8%	3.2%	(1.7)%	0.7%	0.6%	1.1%	1.2%	1.2%	1.2%	1.3%
		Agent commissions				$ (1,395)	$ (1,589)	$ (1,823)	$ (2,106)	$ (2,258)	$ (2,156)	$ (2,074)	$ (2,164)	$ (2,236)	$ (2,345)	$ (2,410)	$ (2,514)	$ (2,645)	$ (2,786)	$ (2,933)	$ (3,087)	$ (3,248)
		Depreciation				(34)	(32)	(35)	(49)	(62)	(56)	(62)	(61)	(62)	(46)	(52)	(59)	(62)	(66)	(67)	(66)	(68)
		Amortisation				(45)	(48)	(69)	(75)	(82)	(98)	(114)	(132)	(184)	(202)	(213)	(235)	(263)	(309)	(342)	(359)	(370)
		Other cost of sales				(386)	(450)	(504)	(578)	(609)	(565)	(713)	(735)	(712)	(741)	(743)	(756)	(759)	(765)	(771)	(777)	(784)
	Gross profit					$ 1,694	$ 1,875	$ 2,041	$ 2,093	$ 2,272	$ 2,209	$ 2,229	$ 2,400	$ 2,471	$ 2,234	$ 2,191	$ 2,079	$ 1,976	$ 1,847	$ 1,727	$ 1,621	$ 1,515		4.8%	(5.9)%
		Gross margin (%)				47.7%	46.9%	45.6%	42.7%	43.0%	43.5%	42.9%	43.7%	43.6%	40.1%	39.1%	36.9%	34.6%	32.0%	29.6%	27.4%	25.3%
		Marketing and advertising				$ (576)	$ (270)	$ (290)	$ (295)	$ (285)	$ (240)	$ (210)	$ (225)	$ (235)	$ (245)	$ (247)	$ (248)	$ (251)	$ (254)	$ (257)	$ (260)	$ (263)
		Other SG&A				n.a.	(330)	(438)	(475)	(549)	(686)	(660)	(730)	(863)	(865)	(876)	(881)	(894)	(907)	(924)	(941)	(959)
	Normalised operating profit					$ 1,118	$ 1,275	$ 1,313	$ 1,323	$ 1,438	$ 1,283	$ 1,359	$ 1,445	$ 1,373	$ 1,124	$ 1,068	$ 950	$ 831	$ 686	$ 546	$ 420	$ 292		2.6%	(17.6)%
		Operating margin (%)				31.5%	31.9%	29.4%	27.0%	27.2%	25.2%	26.2%	26.3%	24.2%	20.2%	19.0%	16.8%	14.6%	11.9%	9.4%	7.1%	4.9%
		Finance income / (expense)				$ (14)	$ 75	$ 24	$ (100)	$ (116)	$ (151)	$ (155)	$ (110)	$ (162)	$ (161)	$ (157)	$ (148)	$ (139)	$ (128)	$ (115)	$ (101)	$ (88)
		Taxes				(347)	(417)	(421)	(365)	(320)	(283)	(235)	(109)	(143)	(144)	(137)	(120)	(104)	(84)	(65)	(48)	(31)
	Net income					$ 758	$ 933	$ 915	$ 858	$ 1,002	$ 849	$ 969	$ 1,225	$ 1,068	$ 819	$ 774	$ 682	$ 589	$ 474	$ 367	$ 271	$ 174		4.4%	(20.3)%
		Profit margin (%)				21.3%	23.4%	20.5%	17.5%	19.0%	16.7%	18.7%	22.3%	18.9%	14.7%	13.8%	12.1%	10.3%	8.2%	6.3%	4.6%	2.9%
($m; FYE Dec-31)																								CAGRs
Key FCF items						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A	2013E	2014E	2015E	2016E	2017E	2018E	2019E	2020E		2004-12A	2012-20E
		Normalised net income				$ 758	$ 933	$ 915	$ 858	$ 1,002	$ 849	$ 969	$ 1,225	$ 1,068	$ 819	$ 774	$ 682	$ 589	$ 474	$ 367	$ 271	$ 174		4.4%	(20.3)%
		Depreciation				34	32	35	49	62	56	62	61	62	46	52	59	62	66	67	66	68
		Amortisation				45	48	69	75	82	98	114	132	184	202	213	235	263	309	342	359	370
		Capex				(50)	(65)	(202)	(192)	(154)	(99)	(114)	(163)	(268)	(277)	(325)	(358)	(416)	(430)	(433)	(436)	(439)		23.5%	6.3%
		Change in OWC				76	25	91	122	191	215	68	(71)	(7)	5	(2)	(2)	(3)	(3)	(3)	(4)	(4)
		Subtract: post-tax net interest expense / (income)				9	(52)	(16)	70	88	113	124	101	142	136	134	126	118	109	97	86	75
		Add back: Post-tax restructuring / integration costs				0	0	0	0	(63)	0	(48)	(55)	(37)	(8)	(4)	(6)	(6)	(6)	(6)	(6)	(6)
	Unlevered FCF					$ 872	$ 921	$ 892	$ 982	$ 1,209	$ 1,233	$ 1,176	$ 1,231	$ 1,144	$ 924	$ 842	$ 735	$ 606	$ 517	$ 430	$ 336	$ 238		3.5%	(17.8)%

Appendix C: Summary financials (high case estimates)

($m; FYE Dec-31)																								CAGRs
Key P&L items						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A	2013E	2014E	2015E	2016E	2017E	2018E	2019E	2020E		2004-12A	2012-20E
		C2C Traditional Channels				$ 2,862	$ 3,280	$ 3,745	$ 4,093	$ 4,472	$ 4,301	$ 4,383	$ 4,518	$ 4,459	$ 4,263	$ 4,418	$ 4,579	$ 4,758	$ 4,945	$ 5,095	$ 5,202	$ 5,313		5.7%	2.2%
		C2C Electronic Channels				0	0	0	0	0	0	0	156	221	403	479	563	656	759	859	955	1,058		n.a.	21.6%
		C2B				576	600	637	720	720	692	611	616	604	588	576	564	553	542	530	520	509		0.6%	(2.1)%
		B2B				0	0	0	0	0	0	107	161	367	420	482	553	634	726	832	952	1,090		n.a.	14.6%
		Other				116	114	90	87	91	91	92	41	14	14	14	15	15	15	15	15	16		n.m.	1.4%
	Consolidated revenue					$ 3,554	$ 3,994	$ 4,472	$ 4,901	$ 5,282	$ 5,084	$ 5,192	$ 5,491	$ 5,665	$ 5,688	$ 5,969	$ 6,273	$ 6,615	$ 6,987	$ 7,331	$ 7,645	$ 7,986		6.0%	4.4%
		Annual growth (%)				n.a.	12.4%	12.0%	9.6%	7.8%	(3.8)%	2.1%	5.8%	3.2%	0.4%	5.0%	5.1%	5.5%	5.6%	4.9%	4.3%	4.5%
		Agent commissions				$ (1,395)	$ (1,589)	$ (1,823)	$ (2,106)	$ (2,258)	$ (2,156)	$ (2,074)	$ (2,164)	$ (2,236)	$ (2,281)	$ (2,327)	$ (2,422)	$ (2,523)	$ (2,626)	$ (2,706)	$ (2,758)	$ (2,808)
		Depreciation				(34)	(32)	(35)	(49)	(62)	(56)	(62)	(61)	(62)	(46)	(53)	(60)	(65)	(69)	(72)	(73)	(77)
		Amortisation				(45)	(48)	(69)	(75)	(82)	(98)	(114)	(132)	(184)	(202)	(212)	(231)	(247)	(281)	(306)	(318)	(339)
		Other cost of sales				(386)	(450)	(504)	(578)	(609)	(565)	(713)	(735)	(712)	(756)	(794)	(822)	(860)	(901)	(938)	(971)	(1,006)
	Gross profit					$ 1,694	$ 1,875	$ 2,041	$ 2,093	$ 2,272	$ 2,209	$ 2,229	$ 2,400	$ 2,471	$ 2,401	$ 2,583	$ 2,739	$ 2,921	$ 3,109	$ 3,310	$ 3,524	$ 3,755		4.8%	5.4%
		Gross margin (%)				47.7%	46.9%	45.6%	42.7%	43.0%	43.5%	42.9%	43.7%	43.6%	42.2%	43.3%	43.7%	44.2%	44.5%	45.1%	46.1%	47.0%
		Marketing and advertising				$ (576)	$ (270)	$ (290)	$ (295)	$ (285)	$ (240)	$ (210)	$ (225)	$ (235)	$ (239)	$ (251)	$ (257)	$ (265)	$ (273)	$ (279)	$ (283)	$ (287)
		Other SG&A				n.a.	(330)	(438)	(475)	(549)	(686)	(660)	(730)	(863)	(890)	(938)	(980)	(1,027)	(1,078)	(1,124)	(1,165)	(1,209)
	Normalised operating profit					$ 1,118	$ 1,275	$ 1,313	$ 1,323	$ 1,438	$ 1,283	$ 1,359	$ 1,445	$ 1,373	$ 1,272	$ 1,394	$ 1,501	$ 1,629	$ 1,759	$ 1,907	$ 2,077	$ 2,259		2.6%	6.4%
		Operating margin (%)				31.5%	31.9%	29.4%	27.0%	27.2%	25.2%	26.2%	26.3%	24.2%	22.4%	23.3%	23.9%	24.6%	25.2%	26.0%	27.2%	28.3%
		Finance income / (expense)				$ (14)	$ 75	$ 24	$ (100)	$ (116)	$ (151)	$ (155)	$ (110)	$ (162)	$ (178)	$ (194)	$ (212)	$ (228)	$ (248)	$ (268)	$ (290)	$ (314)
		Taxes				(347)	(417)	(421)	(365)	(320)	(283)	(235)	(109)	(143)	(164)	(180)	(193)	(210)	(227)	(246)	(268)	(292)
	Net income					$ 758	$ 933	$ 915	$ 858	$ 1,002	$ 849	$ 969	$ 1,225	$ 1,068	$ 930	$ 1,020	$ 1,096	$ 1,191	$ 1,284	$ 1,393	$ 1,519	$ 1,653		4.4%	5.6%
		Profit margin (%)				21.3%	23.4%	20.5%	17.5%	19.0%	16.7%	18.7%	22.3%	18.9%	16.4%	17.1%	17.5%	18.0%	18.4%	19.0%	19.9%	20.7%
($m; FYE Dec-31)																								CAGRs
Key FCF items						2004A	2005A	2006A	2007A	2008A	2009A	2010A	2011A	2012A	2013E	2014E	2015E	2016E	2017E	2018E	2019E	2020E		2004-12A	2012-20E
		Normalised net income				$ 758	$ 933	$ 915	$ 858	$ 1,002	$ 849	$ 969	$ 1,225	$ 1,068	$ 930	$ 1,020	$ 1,096	$ 1,191	$ 1,284	$ 1,393	$ 1,519	$ 1,653		4.4%	5.6%
		Depreciation				34	32	35	49	62	56	62	61	62	46	53	60	65	69	72	73	77
		Amortisation				45	48	69	75	82	98	114	132	184	202	212	231	247	281	306	318	339
		Capex				(50)	(65)	(202)	(192)	(154)	(99)	(114)	(163)	(268)	(276)	(324)	(355)	(378)	(403)	(427)	(449)	(470)		23.5%	7.3%
		Change in OWC				76	25	91	122	191	215	68	(71)	(7)	(1)	(14)	(15)	(17)	(19)	(17)	(16)	(17)
		Subtract: post-tax net interest expense / (income)				9	(52)	(16)	70	88	113	124	101	142	151	165	180	194	211	228	247	267
		Add back: Post-tax restructuring / integration costs				0	0	0	0	(63)	0	(48)	(55)	(37)	(8)	(4)	(4)	(4)	(4)	(4)	(4)	(4)
	Unlevered FCF					$ 872	$ 921	$ 892	$ 982	$ 1,209	$ 1,233	$ 1,176	$ 1,231	$ 1,144	$ 1,046	$ 1,108	$ 1,194	$ 1,297	$ 1,419	$ 1,550	$ 1,688	$ 1,845		3.5%	6.2%

Catalyst