Here's Why Western Union Is a Good Buy Right Now
Move over, paper checks and bank wires. A new way to send money from place to place is catching on in a big way.
Meet the online money transfer, a new product that will revolutionize the industry of sending cash from point to point. Three emerging services from three very different providers -- Western Union , MoneyGram , and Xoom -- offer a convenient, inexpensive way to send cash to any country you please.
Money at the speed of light
Once, Western Union was the only game in town -- you had to use its service to send instant cash around the world.
But Western Union became too comfortable in its market-leading position. It lost exclusive contracts with agents in Mexico and failed to cut prices to thwart competitors elsewhere around the world. Industry rivals Xoom and MoneyGram capitalized on that weakness, working on deals to steal key corridors by driving down prices.
Prices for money transfers to Mexico felt the biggest impact from these moves. Here's how the three players compete for business south of America's borders:
$7 for debit/credit
$7 for debit/credit
$12.99 debit/credit or $4.99 via bank account
1-3 day delayed transfer
$4 paid by bank account
$0 paid by bank account
$4.99 via bank account
In a commodity business like money transfer, customers choose a service based on price. Xoom's position as the lowest-cost instant transfer service has rewarded the firm with outsized revenue growth. In just the past year, fast-acting Xoom grew revenue by 59%, compared to Western Union's 33% online growth and MoneyGram's 15% growth.
Is this the end of Western Union?
Smart investors know competition drives down prices. It also drives down profits. Western Union reported that operating margin fell to 20% from 23% as it lowered prices to remain competitive.
This isn't the end of Western Union, however. Remember, this company survived the death of the telegraph, so disruptive technology is nothing new for it.
Western Union still has major competitive advantages. Its network includes 500,000 agents, compared to 300,000 for MoneyGram, and no offline sales network for Xoom. In addition, the company excels in two-way money transfers. Xoom can only offer transfers from the United States to foreign lands -- it doesn't offer money transfer between the states, or into the United States from abroad.
Why Western Union is a top pick
Fast-moving companies may steal the show, but as investors, we have to worry about the profits. Western Union's ability to turn revenue into cash is unmatched -- it turns $0.17 of every dollar in revenue into pure free cash flow. MoneyGram turns roughly 14% of revenue into free cash, while Xoom hasn't posted a dime in cash flow generation.
Western Union generated an average of $1 billion in free cash flow in each of the last five years. Upstart Xoom only recently recorded its first quarterly profit, and it trades at 75 times annualized earnings. MoneyGram trades for 17 times forward earnings on news that it is actively engaged in going private.
Western Union deserves a higher valuation. At 10 times earnings and free cash flow, and with a competitive advantage in offline money transfer, I believe it can continue to compete offline while growing its online business at a 30%+ annual clip.
Furthermore, Western Union is a two-for-one deal. You get a piece of the legacy assets (a leading offline money transfer business), and an online business growing at 33% per year. Investors are severely discounting its highly profitable offline business and pricing power going forward.
Western Union's missteps may have cost it a near-monopoly on money transfer into Mexico, but that doesn't mean it can't continue to lead elsewhere around the world. New pricing initiatives and the largest network of agents should help it maintain its competitive position. Western Union is a substantially better business trading at a fraction of the price of Xoom and MoneyGram, making it a compelling buy for value-oriented investors.
The article Here's Why Western Union Is a Good Buy Right Now originally appeared on Fool.com.Fool contributor Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Western Union. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.