Opportunities Still Abound for Western Union

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor. Today it's my great pleasure to welcome Brett Horn, who is an associate director of research here at Morningstar, to talk about Western Union. Brett, thanks for coming.

Brett Horn: No problem.

Kobayashi-Solomon: So, just recently, I wrote an option strategy article about Western Union. It's a bullish article. I know you like Western Union a lot, and I just want to ask you a little bit more about this company.

Horn: OK.

Kobayashi-Solomon: I see that you have Western Union as a wide moat. And of course, moat is something that we here at Morningstar talk about for a sustainable, competitive advantage. What makes Western Union's wide moat?

Horn: Well, there's a few factors. The biggest thing, really, is scale. This is an industry with a substantial portion of fixed costs. Western Union is four times bigger than their closest competitor. They just have a huge scale advantage. It shows up in their profitability. You're talking about operating margins from Western Union that are close to double their closest competitor.

Kobayashi-Solomon: Basically, what it is, is they've got a good kind of back-office that they can run a lot more things through.

Horn: Right. Basically, once you set up these systems, once you have these systems in place for money transfers, every incremental transaction--the incremental costs of that are very, very small.

Kobayashi-Solomon: I see.

Horn: So the more transactions you can run through your system, the bigger your...

Kobayashi-Solomon: Right. Pure profit, right?

Horn: Right.

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Kobayashi-Solomon: I see. When I first started looking at Western Union, I think a lot of people who are watching this video think of Western Union as "from the United States to Latin America to Mexico." It's really not only that story.

In fact, there's a bigger proportion of revenues that are happening between that corridor and Europe and Africa and South Asia. Can you talk a little bit about the corridors and what corridors they're particularly strong in?

Horn: If you want to think about it, U.S. to Mexico gets a lot of the headlines around Western Union. The headlines for the immigration debate and so on and so forth. But while that's a big market for Western Union, it's less than 10% of their sales. This is really, truly a global company. They operate in basically every country in the world.

Kobayashi-Solomon: Like 200 countries, something like that.

Horn: Basically, almost every country that they're legally allowed to operate in, [laughs] they're in. These corridors, it's a global phenomenon. It's not just U.S. to Mexico. It could be Saudi Arabia to India. It could be U.S. to China. The general rule is that you're going to see, the money flows from wealthy countries to poor countries.

Kobayashi-Solomon: So Brett, let's talk about that European corridor for a second. There's been a lot of talk recently in the news about the PIGS. This is Portugal, Italy, Greece, and Spain. Do you think that there is the possibility for a double-dip there in Europe? Do you think that some of the financial problems that they're having are going to have a knock-on effect to Western Union's business?

Horn: I think it's something you have to think about. To date, the money-transfer industry has been what I would consider fairly resilient. But generally, the dynamic that we've seen is that immigrants are still sending money; they're just sending a little bit less. The anecdotal evidence we're seeing is that they are dipping into their savings.

It's important to keep in mind that when they're sending money back to their relatives in their home country, this is not discretionary money; this is money so that their relatives can eat and buy necessary things. They're going to do everything they can to keep sending that money.

The concern would be, if you do go into that double-dip scenario in, say, Europe and/or the U.S., that sooner or later they just kind of run out of time and they run out of money. You could see a significant fall-off in money transfers.

Kobayashi-Solomon: I see. And that really affects the revenues, because the word that you just used, resilience, really struck me when I was looking at their financial statements. Even in the depths of this downturn, you see, still, operating margins are in the mid-20%. It's amazing, right?

Horn: I wouldn't be concerned about the company's financial health at all. Profit margins are still fat, and they're still going to stay. They might be a little lower, but they're still going to be a very profitable company. There's really only a modest amount leverage in the business, financial leverage. So it's not a concern on that end. It's really kind of more, if we do go in...

Kobayashi-Solomon: Revenue-growth kind of thing...

Horn: ... basically, from the near term, the performance of Western Union is basically going to depend on how strong is the job market in wealthy countries. So, if we get a recovery, I would expect to start to see the drivers of their historical growth come back and reassert themselves. But if things drag out or get worse, they're going to have a tougher time.

Kobayashi-Solomon: Sure. But these are kind of near-term things. Even a double-dip doesn't last forever, right?

Horn: Right, right.

Kobayashi-Solomon: So, since we're in a bullish position here, what do you think is the worst-case scenario, kind of an Armageddon scenario, for Western Union?

Horn: From a valuation perspective, I think the risk that really would significantly impact the value of the Western Union franchise is that somebody builds a better mousetrap, somebody figures out a better way to provide money transfers.

Kobayashi-Solomon: Like using cell phones or something like that...

Horn: Yes, that's the one thing that there's a lot of talk around. I think the cellphones probably represent the one partially plausible idea. Because the interesting thing to take into account is Western Union's customer base are really, primarily, un-banked or under-banked people.

Kobayashi-Solomon: Right, sure. Pretty sophisticated thing to have a cell phone that will send money for you.

Horn: Right. But if you look at the numbers, there's four billion of those people, roughly. They are actually the majority. I think it's hard for people in the U.S. or people who invest in the market to understand the lives of these people. There are way more cellphones in the world than there are bank accounts, so that maybe represents one threat.

But I think, one, that threat, if it happens, you really need kind of a real evolution in payment systems around the world. You'd need mobile phones to be payment devices all around the world not just in the U.S.--also in these poor countries where these people, where they're sending the money, so I think that's a ways away.

Kobayashi-Solomon: Sure. So not only payment systems in Japan and the U.S., but also in Kenya and Pakistan or something like that.

Horn: Right, exactly. Places like that. There's the potential for those poor countries to leapfrog, but really, you have to have that worldwide acceptance. I think a lot of poor countries you go to, you can hand somebody in a poor country a prepaid Visa card. They're not going to know what to do with them. They take it to their local merchant, they're not going to know what to do with it, either, so I think it's a ways away.

Kobayashi-Solomon: Let alone a cellphone.

Horn: So there are some long-term risks. I wouldn't completely discount that as a risk, but I think, in the same sense, there's as many opportunities for Western Union from a long-term perspective.

We talked about this a little before. This is a company that's very unique in that they provide a regulated financial service in almost every country in the world. Right now, they have this very wide network that they're funneling one product through. I think there are opportunities for them to monetize that network further. Things like, they recently bought a business that provides business-to-business payments internationally, so, things like that.

Kobayashi-Solomon: Right. I think they're starting to look at prepaid cards as well, right?

Horn: Yeah, they're running pilots and all these things. Things like prepaid cards worry me considerably less because I think that's a very easy thing to kind of staple onto their existing reach. I don't think that's a game-changer. I think there are some possibilities. So if I look into the long-term future, I see as many opportunities as I see risks.

Kobayashi-Solomon: Brett, thanks very much. It's a fascinating company.

Horn: Sure. Thank you.

Kobayashi-Solomon: Thank you for joining us. Please stop by the OptionInvestor website, where you'll find many more great option ideas based on Morningstar's fundamental research.