I don’t like Western Union. As of 03/08/2021 the valuation is as follows:
-P/E: 13.3x
-EV/EBIT: 11.1x (9.00%)
-FCF yield: 8.19%
-10-yr avg. ROIC: 38.5%
It’s cheap. That much is given. And for some lazy investors looking for a quality stock that is trading at a cheap to fair valuation then Western Union fits the bill. It’s earned its cheap valuation and I think the financial statements bear that point. Once upon a time Western Union may have been seen as a great stock to invest in as it was seen to have a competitive advantage with its money transferring services. You would have to go to either them or Moneygram or a bank to wire money to someone. I think that moat doesn’t exist anymore. Moats are supposed to disappear. Western Union is falling prey to greater competition in their industry. And that greater competition comes in the form of alternative money transferring services like Moneygram, Paypal, Facebook lets you send money, Snapchat allows you to send money, CashApp, Zelle, crypto, and I think the greater trend of consolidation in the bank industry are all signs that anybody can do Western Union’s job. As banks begin to merge in an effort to fight off their industry’s headaches, they begin to offer greater services to a larger depository base. Not all banks right now can afford to offer domestic or international money transferring services (because not everybody banks with the Big Four banks). As banks begin to merge, and as the population of people who are unbanked shrinks as a result, I believe you’ll see Western Union’s “moat” deteriorate at a faster pace. This is just one of their many problems.
Western Union has been playing some accounting games to mask deteriorating business conditions.
Between 2012 and 2021, net revenues have been falling. Over the past ten years they’ve contracted -1.40%. Despite all their acquisitions and divestitures they’ve been losing money trying to buy their growth. This doesn’t speak well of their economic prospects if buying growth doesn’t work to increase revenues. Operating profit has fallen even faster over the same time period at -3.91%. How much have they spent on buying their growth? Well it depends on how you understand capital expenditures. Over the past ten years they spent $715M in total. Reported cumulative depreciation and amortization over the same timeframe was $2.51B. Now I think one should account for acquisitions and divestitures in your understanding of capex. Why? I understand acquisitions to fall under growth capex. They’re trying to purchase their own growth because the organic revenue growth in the business has been negligible for ten years. If you add acquisitions into capex and subtract out cash made from divestitures to get your total capex number for a given year, and you do this for ten years, you will see that Western Union has spent $1.58B in capex. Depreciation still cost them $2.51B. They are rotting faster than they are growing. Imagine a sand castle being constantly hit by waves and a person trying to rescue it from being washed under the water. You can slow down the inevitable but you can’t stop it. With their accounting you have to adjust a few things and this is one of the usual adjustments I do with acquisitive companies that are in effect capitalizing their R&D. They also capitalize their contract costs which, to be honest, confused me at first as to how I adjust for such a thing. So I looked at Moneygram, their direct competitor, to see how they dealt with contract costs. Moneygram’s contract costs are expensed, not capitalized. Why did I look at Moneygram? Because if they are their direct rivals I would imagine their financial statements to try and reflect one another. If the way Western Union capitalizes contract costs is the best way to account for such things, why isn’t their direct competitor doing it too?
Because Western Union capitalizes their contract costs you have to take that amount out of intangible assets. Why did I look there? If I know that the definition of “capitalization” means taking an expense from the income statement and turning it into an asset then I know where to look. If I know that contracts of any kind represent an intangible asset, something you can’t touch or feel but that makes the company money, then I have a good shot of it being in the intangible assets section. For example, out of their most recent 10-K, they had $69.1M in capitalized contract costs in 2020. Intangible assets were $505.0M. I subtracted $69.1M from $505.0 to get an adjusted intangible asset amount of $435.9M. I took that $69.1M and subtracted it from operating income. Why? Because it was always supposed to be expensed on the income statement. You’re putting it back where it should’ve been in the first place. Reported operating income was $967.3M. $967.3M-$69.1 gets you $898.2M, an adjusted NOPAT of $709.578M, and will drop net income to $744.3M. Adjusted EPS would then be $1.63, not reported EPS of $1.79. On top of the net income adjustments I do one more tweak to the income statement at the gross profit line. I take gross profit and subtract advertising costs. Why? Because if that’s the cost of their getting you to walk in and use their money transferring services then I’m going to treat that as a direct cost of them getting their revenue. To be clear advertising under GAAP would be seen as an expense going against operating income, not against gross profits. But I think putting it against gross profits reflects what it actually costs to get people to use their services. For example, out of their most recent 10-K, gross profits was $2.008B. Advertising costs were $177M. Subtracting $177M from gross profits gets you adjusted gross profits of $1.83B and an adjusted gross margin of 37.88%. Reported gross margin is 41.54%. I would say the difference between adjusted and reported margins here is meaningful. I’ll include my spreadsheet at the bottom of this post where all of these adjustments are made. I did this for the years 2012-2021.
I think there’s larger reasons to be worried about their financial statements than what you may find in the number crunching you can do on the income statement. Ernst & Young is their auditor and after 2020 I almost immediately see it as an indicator that the company may have done some exotic accounting choices. Their current CEO came from GE Capital and they were notorious for playing aggressive financial games to make their earnings per share look good. On top of their exotic accounting decisions, the company still has to deal with how they’re going to create shareholder value in a dying industry. Western Union charges higher prices than other money transferring services. On pg. 6 of their recently filed 10-K they mention that their brand symbolizes trust and speed and convenience. I don’t doubt that. They have a large agent footprint all over the world that can send money to another person in minutes. But does that warrant premium prices for their services? With cryptocurrencies facilitating money transfers 24/7, Moneygram and Paypal and Snapchat and Facebook being able to facilitate money transfers, Walmart wanting to get into fintech, and banks being able to provide greater money transfer services as a result of consolidation in their industry, I don’t think they have the leeway to demand higher prices just for the brand. Well over 90% of their net revenues come from cross border foreign exchange transactions (think US-Mexico border transactions for example) and I don’t see them being a sticky customer base in terms of pricing power. Foreign exchange transactions in countries where they’re not the industry leader and where their business practices are being seen as anti-competitive. Once upon a time they would require agents to sign exclusivity agreements. That would create a moat for them. Moneygram broke that. Now you may see Western Union and Moneygram in the same locations as a growing number of agents refuse to sign exclusivity agreements. Because I think the cross border foreign exchange transactions demographic will always be there, as there will always be an unbanked/underbanked part of the population (and that population will more than likely not be using cryptocurrencies either), there will always be a market for money transferring services. However at that point it becomes a game of pricing. A battle of the pennies. Nobody wants to invest in a company that competes on the basis of pricing. At that point you’ve lost competitive advantages and shareholders don’t get great value for their investments. Their accounting games are a way of trying to suck their gut in and delay the inevitable.
Disclaimer: This is not investing advice. Do your own work.
Spreadsheet: https://docs.google.com/spreadsheets/d/e/2PACX-1vTBl7kmHddrnVcsta-5R4ruEoDfpAZm5f6XVCNA71sQ3uWM_f22frXTJDljg_7Y_tks0twJRGz-YlhD/pubhtml