Shares of Western Union (WU 0.75%) have been on a tear since Barron's published a bullish article on the stock in May. The stock traded hands for less than $13 just last fall after management announced a price-cutting plan to regain lost market share in the Mexico corridor and other geographies in which competition had eroded the company's dominance. A debate over the company's long-term viability has ensued, but it is only a matter of time before we find out whether Western Union is here to stay or is the next victim of the Internet.
Great business, but is it durable?
Western Union was spun out of First Data Corporation in 2006 with two primary businesses: consumer-to-consumer transfers and global business payments.
Consumer-to-consumer accounts for the vast majority of revenue, and is the source of the company's competitive advantage. Western Union generates most of its business from migrant workers who send money from wealthy nations back to their families in their country of origin.
Western Union's earnings miss last fall led to speculation that online money- transfer businesses, like Xoom (XOOM.DL), had permanently impaired the company's earning power. But the evidence suggests that Xoom is a long way from posing a threat to the cash-transfer business.
Xoom is touted as being a revolutionary consumer-to-consumer global money- transferal service, and, having grown revenue at nearly 60% per year over the last few years, is expanding rapidly. The company's near-70% gross margin exceeds traditional money-transfer companies' margins by 30 percentage points, suggesting a lot of room for price competition.
However, while Xoom is justifying its high expectations by growing quickly, it is unlikely to unseat traditional money-transfer companies like Western Union and MoneyGram International (MGI) any time soon. According to Cornell University, 85% of retail transactions in all countries are in cash or check, including substantially all transactions in developing countries. Developing countries -- typically the recipients of traditional money transfers -- are not even close to becoming banked, so Xoom is of little use to citizens in these countries.
Instead, online transfer providers are likely to erode Western Union's global business payment's business -- about 20% of the company's revenue in 2012. The global business payments segment acts like a toll bridge; it charges a fee for a transfer from one end to the other. Even in developing counties, businesses that make global money transfers are more likely to have bank accounts rather than keep actual cash on hand. As a result, this portion of Western Union and MoneyGram's business is vulnerable to companies like Xoom (though Xoom currently only focuses on consumer-to-consumer transfers).
Will Western Union always be better than MoneyGram?
If you can accept that Xoom does not present a serious threat to Western Union's consumer-to-consumer segment, then the only other question to answer is if the company will continue to fend off competition from its primary rival, MoneyGram.
MoneyGram has made large market share gains in the all-important Mexico corridor, which is responsible for Western Union's latest price-cutting plan. However, MoneyGram is unlikely to ever pose more than a minor annoyance to the world's largest money-transfer provider.
With only 300,000 agents, compared to Western Unions' 500,000 agents, MoneyGram does not have the scale to effectively compete in most of its larger rivals' geographies. This is due to a network effect; agents -- which are sort of like franchisees -- are more likely to attract more business if they work for Western Union because the company has more connecting points than MoneyGram. As a result, Western Union can facilitate transfers to a much wider array of remote destinations that MoneyGram is unable to deliver to.
This gives Western Union a permanent advantage in agent attraction, which then enables the company to grow its customer base more quickly, which continues to feed the cycle.
Bottom line
Xoom will not encroach on traditional money-transfer businesses because the majority of the latter's business comes from un-banked migrants. Western Union and MoneyGram are recession-resistant businesses that benefit from economies of scale and regulatory barriers to entry. However, Western Union's significant advantage in the size of its agent network gives the company an unassailable lead in the business, relegating MoneyGram to little more than a minor annoyance.
As a result, investors should expect more of the same from Western Union going forward; at 11 times earnings, the company has room for a drop in earnings before investors stop earning an adequate return.
