Valuation:

(All numbers assume the Travelex Global Payment Business)

 

Mkt Cap: $16.50 * 632mm --> $10.4bn

Cash: $2.1bn

Non-Consolidated Subs: $0.1bnDebt: $3.6bn

TEV: $11.8bn

 

EBITDA '11 = $1,580mm (note that restructuring expenses not included but stock compensation is; as well, there should be additional cost savings going forward that were not fully realized in 2011)

EBIT = $1400mm

NOPAT = $1,120 (20% tax rate as they get large benefit from offshore profits; as well, their tax rate should go down over time as lower-rate profits are growing faster than U.S. profits)

D&A = $180mm while all-in capex is about $130mm
so, Unlevered FCF = $1,170mm (10.1x)

 

Interest = $175mm
EBT = $1,225mmAdj NI = $980mm ($1.55/shr --> cash earnings of about $1.65/shr due to D&A > Capex)

 

The Travelex business acquisition is certainly dilutive on an unlevered basis. Even giving credit for predicted synergies, WU is still paying $950mm for a business that adds post-synergy EBITDA of $100mm. However, they do predict high growth rates going forward. We do not have enough information to fully evaluate the acquired business, and it may alter valuation by +/- $200m, but it is not a determining factor in the valuation. It is certainly a business in line with WU's other businesses in terms of nature of business and margins, and WU management has done a good job selecting and integrating acquisitions in the past.

 

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Western Union is a well-known company that has been written up on VIC several years ago. I will not repeat the 10-K, but the features of the business are:
- 85% of revenue is derived from consumer-to-consumer cash transfers and the vast majority of this consumer-to-consumer business is cash-to-cash. In other words, the sender walks to a physical location with cash and the receiver walks from a physical location with cash. As well, the vast majority of this c-to-c business is cross-border remittances.
- 15% of revenue is business payments where un-banked consumers make payments to utilities, auto lenders, etc.
- In short, the business is established on two major realities: (1) workers migrate far from their immediate or extended families in order to find work and (2) large numbers of these migrant workers and lower/working class families are un- or under- banked in both their adopted and home locations. If you believe that both of these realities hold steady or continue to grow, WU is a great franchise trading at a very inexpensive multiple.
- Even most bears acknowledge that Western Unions's franchise as a cash-to-cash service for the un-banked is impregnable. Their network effect means more agents and so more customers and so more agents . . . WU processes 5x number of transactions of #2, Moneygram, yet they only process 20% of all migrant remittances. As well, regulation due to anti-terrorism programs only strengthens the position of the largest player.

 

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Why does market put such a low valuation on a franchise that has put up admirable numbers year after year and that most agree has an impregnable franchise in its core business?

 

OBSOLESCENCE

 

- The market continues to believe that new technologies and products will make cash-to-cash transfers obsolete. However, there have been no signs of obsolescence despite all the necessary technology and products. And due to increased regulation and consolidation, it is less likely now than ever.
When I first looked at WU after its spin-off from First Data in 2006, I was sure that existing and/or new banking products would make WU (and other un-banked services like check cashing) obsolete. However, with the benefit of further research and more data, the opposite has happened. My errors were manyfold:
 - Location is key. Many WU customers do not have easy transportation. For me, a bank branch two miles down the road is the same as across the street. But not for WU customers--both money sender and money receiver. The fact is that for WU customers, WU agents are more numerous and much closer. Banks are not eager to locate branches where WU customers are located. - The cost of many traditional banking products is not significantly lower. Account fees. ATM fees. FX fees. Etc. Cross-border wire fees. - Immigrants do not trust traditional banking. Opening accounts is somewhat complicated and requires them to disclose some information even though the U.S. government has made an effort to assure them opening an account will not be used against them. - But the main reason is that banks simply do not want these customers and so do not market helpful products to them. I am convinced that some fraction of Mexican and Central American immigrants to the United States who use WU (and other services) would be better off opening a traditional checking account and mailing the ATM card to their family and then depositing the cash they would otherwise wire via WU. And have their family take the money out at a local ATM. The total transfer cost would still be significant, but it would be meaningfully lower. 
However, banks have made little effort to get this business because it is not profitable. Having someone deposit $100 into a checking account each week and then having that $100 withdrawn the next day is simply not a profitable business for a bank:   - fixed fees per account (mailings, paying Fiserv per account, etc.)   - additional customer traffic and these customers would not use ATM   - need to have foreign language speakers, and    - (close your ears naive ones) better-off people do not want to walk into their bank and see the guy that just mowed their lawn. And remember, WU operates worldwide, where class distinctions can be quite stark.
Note that with the increased regulations of 9/11 and 2008 bailout, the banks are even less interested in this business.
For whatever reason, the empirical data clearly reveals that migrants worldwide have not taken up traditional banking solutions. And this has persisted for years. The most obvious competing solution is the ATM debit card solution I offer above and it has been around for years. Online solutions like Paypal fail because they require the sender and/or the receiver to be banked. But the vast majority of these transactions must begin with physical cash and must end with physical cash. 

 

GLOBAL ECONOMY

 

I am not writing this long recommendation because I am bullish with the S&P above 1200. I am not and frankly, I am quite confused as to how things are going to turn out. But I do think that WU will outperform the market in a a broad spectrum of economic outcomes.
In the event of a slow recovery (think 2010 and 2011), we can expect growth in the mid-single digits. For example, WU has seen constant-currency, organic revenue growth of 4-5% in 2011. I would expect the stock to increase 50-60% in this scenario (with increased upside due to adding some leverage). My sense is this is the scenario that U.S. indices have priced into them.
While not insulated from global economic conditions, WU is not hyper-sensitive to economic conditions. Migrant workers do tend to work in more cyclical industries like construction and they tend to hold more marginal jobs in their industry, the importance and stability of migrant workers is under-appreciated. In many countries, migrant workers are in semi-permanent positions, and many work in non-cyclical industries such as agriculture, restaurants/hospitality, and healthcare.
As an example, in 2009, global cross-border remittances fell by 5-6% and WU's constant-currency, organic revenue dropped 3%. Margins remained almost unchanged (the majority of the slippage was in business payment). The consumer business has very stable margins because much of the cost structure is paying agents a set percentage of the total commission. 
As well, due to its scale, WU will naturally pick up market share faster as remittances fall, as happened in 2009.
In WU, the market has priced in a high probability of a severe global slowdown and severe political pressure to force migrants to return home. 

 

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At this price, you are buying a terrific company with a deep moat at an unlevered 10x multiple that is poised for 5+% growth if the economy shows even weak growth. And if the global economy enters Japan post-1990 territory, you are buying a company with stable margins that will continue to produce a high cash flow.

Catalyst:

 

Stable economic situation even with anemic growth

 

Management has aggressively repurchased shares and paid dividends and will continue to do so even with the acquisition.

 

WU is an ideal private equity candidate. For what it is worth, every time buyouts reappear, it is on lists of buyout candidates, and WU is rumored to be in play.