Monday, 5 November 2012

Western Union - A Compelling Investment


Western Union (WU) is the largest money transfer company in the world. They are 5 times larger than their next competitor which is Moneygram (MGI). They have been operating since 1851, and been through many radical market innovations which they have to reinvent themselves in order to stay relevant. They used to be the largest telegraphy service company in the world last time, and had evolved totally into the money transfer business as the previous business had gone obsolete.

Competitive Advantage

A business with terrific economics comparable to See's Candy! They earned extremely high FCFs, due to the fact that they need only little for reinvestment while their business model allows them to constantly scale up. Average capex is only about 11% of operating cash flow, and despite their high payout ratio of almost 85% (shares repurchase & dividend), they can constantly grow their business and spend on acquisition.

The only ones that can compete with them are the big banks who are going into the money transfer business they are in. For example, wells fargo recently announced they are going into it also. However, the competitive advantage of Western Union is such that they provide money transfer service to the unbanked, underserved customers, esp in the emerging markets.

Not all customers have access to banking facilities, the way that many of us do. Hence, they have to rely on money transfer companies like Western Union for their remittance. Even the big banks now are partnering with Western Union, as their massive operation, economies of scale and reach do not make sense for the bank to come up with a service on their own.

Income Statement

2011 2010 2009 2008 2007
Rev 5491 5193 5084 5282 4900
Adj. OI 1432 1360 1354 1355 1322
Op Margin 26.1% 26.2% 26.6% 25.7% 27.0%

Adj. NI 1145.9 957.2 922.5 909.3 847.3
EPS  $1.81  $1.43  $1.32  $1.23  $1.10
Net Margin 20.9% 18.4% 18.1% 17.2% 17.3%

Taking a look at their past 5 years earnings, they have a slight decrease in operating margin from 27% to 26.1%. Even with this decrease, they managed to earn a respectable net margin of 20.9% in 2011, compared to a margin of 17.3% in 2007. Lets take a look further at their key indicators below:

2011 2010 2009 2008 2007
C2C 225.8 213.7 196.1 188.1 167.7
Growth 34.6%

Business 425 404.9 414.8 412.1 404.5
Growth 5.1%

Their transaction volume has increased 34.6% over the last 5 years for C2C, and 5.1% for business segment. Even though they did this by reducing fees, they still managed to maintain their margins and profitability. They only way they can do so is by driving down their own operating costs.

Competitor analysis

Competitor  Revenue  OI NI Op Margin Net Margin
1 Western Union 5491 1432 1146 26.1% 20.9%
2 Moneygram 1248 143 59 11.4% 4.8%

Take a look at the comparison of Moneygram, their closest competitor to Western Union. They are simply being crushed by Western Union as they cannot afford to fight the price war being the much smaller player.

An obvious metric to use would be their margins. WU has more than twice the operating margin of MGI, even though they are in the same busness, which shows their cost is substantilly lower.

Net margin is almost 4 times that of MGI, showing their leverage on their economies of scale.


Projecting Investment Return

1 Dividend 0.5

Yield 4.18%

Shares Repurchase (end 2013) 750

Yield 10.39%

Total Yield 14.57%

2 Operating CF 1129

Capex 125.1

FCFs 1004

FCFs Yield 13.9%

Capex/OCF 11.1%

Current management projection for 2012 EPS is $1.65, which translate to a p/e of only 7.24.
The lowest p/e they ever trade was during the subprime crisis which is at 7.93, still higher that the projected.
Average p/e over the years is about 15 at least.
Dividend yield is at 4.18% after the increase, and the dividend payout ratio is only at 30%.
Share repurchase of 10.39% outstanding shares till end of 2013, which will boost EPS by almost 11.1%.
Total yield calculated as per above would be at least 14.57%
If FCFs method is used, their yield would be about 13.9%.

We would expect them to at least trade at the pe of 15, which represents an upside of more than 100% to current share price. Competitors are trading at average of 15 - 22 p/e.

Shareholder Value

2011 2010 2009 2008 2007
Repurchase 804 581 400 1315 727
Total 3827

Dividend 0.31 0.25 0.06 0.04 0.04
Abs. 196 167 42 30 31
Div Payout  16.8% 18.4% 5.0% 3.2% 3.6%

Total Payout 1000 749 442 1344 758
ratio 85.8% 82.3% 52.1% 146.3% 88.4%

As the need for capital reinvestment is little compared to the tremendous cashflow they earning, management can constantly create shareholder value by repurchasing shares and increasing dividend payout.
Take a look at the table on shareholder value, in the past 5 years, they have repurchased a total of 3.8 billion worth of shares!
Payout ratio is on average 85%, and even with such high payout, they can constantly grow their business and spend on acquisition.
With the recent drastic drop in share price, we believe Western Union is a compelling buy for the long run. We have a market leader with a See's Candy like business economics, shareholder friendly management, and plenty of growth opportunities in the emerging markets.

What more does investor wants?

Tuesday, 7 August 2012

AIG, BAC Warrants - Bruce Berkowitz's Thoughts

We have just read Bruce Berkowitz's semi annual letter and was more than glad to see him discussing about the long-dated warrants that we have mentioned in previous posts.

Here is the snapshot of the returns that he is projecting for the different warrants:

Both AIG and BAC warrants are high up on the list, offering returns of 752% and 592% respectively.
We have used even more conservative growth rate than his suggested 10% growth in book value through the years. What is interesting here is that Hartford warrants have almost the similar returns as AIG warrants. We will probably do some work on it.

On investing in the warrants, we always have people asking us how come then with such returns, well known value managers are not putting their money in the warrants but instead in the common stocks?

The reason is they can't. There is simply not enough volume of warrants out there in the market for them to buy. Bruce himself already holds close to 25mil of the 75 mil outstanding AIG warrants. That is almost 1/3 of the entire float!

But for retail investors, that is a different case altogether. We can instead buy in to these warrants and hold on till expiry and chances are, you will be getting a huge paycheck at the end!