Why I'm Dumping My Shares of Western Union

Western Union (WU -2.21%) just got another bump in the road. News broke on April 17 that Wal-Mart (WMT 0.57%) is now making a foray into the money-transfer business, directly threatening the operations of both Western Union and MoneyGram (MGI). Why is this such good news for Wal-Mart and pretty bad news for more traditional money transfer companies?

A brilliant move in true Wal-Mart fashion
Normally, I would not be too concerned over another competitor entering a market of one of my stocks, much less sell my holdings. However, Wal-Mart's new presence in the money transfer industry will be a game-changer, if Western Union and MoneyGram's large declines in stock price are any indicator. 

Wal-Mart has traditionally done well with an aspect of its business model in discounting or significantly undercuting competitors, and that strategy is continuing to be followed with Wal-Mart's new money transfer initiative. Wal-Mart's money transfer service will be, on average, a staggering eight times less than Western Union and MoneyGram's fees. There will be no competitive reason for customers to choose Western Union and MoneyGram when they have a much less expensive option right down the street at their local Wal-Mart.

For example, Wal-Mart customers will be able to transfer up to $50 for a fee of $4.50; this compares to fees of $4.75 and $5 at Western Union or MoneyGram. Transferring $900 will cost $9.50 at Wal-Mart, compared to $73 via MoneyGram.

This move isn't only bad for Western Union and MoneyGram, however; it is also a great marketing tactic on Wal-Mart's part. As Wal-Mart has suffered a decrease in regular shoppers, moving into money transfers will help drive customers to the store and drive up sales. By getting people into Wal-Mart's doors, people who will only be planning on doing a money transfer may also want to impulse buy that shiny new video game on display.

As Ben Jackson, a senior analyst at Mercator Advisory Group, stated:

This is an extension of Walmart's larger financial services strategy. It's adding one more service to form the full sweep of basic financial services offerings. If customers are able to make financial transactions in a Walmart store, then they're more likely to stay and buy something too...The big strategy is capturing people's wallets as soon as they are filled. If a customer's wallet is filled at a Walmart store, then it's likely the customer will do some incremental shopping there too. 

While the new revenue stream from this initiative may not be too large, the important factor that drove Wal-Mart to do it was the notion that launching money transfers will help bring customers to stores and thus increase revenues. 

Caution: Rough seas ahead
The news about Wal-Mart isn't the only concern I have about Western Union and MoneyGram. Western Union's normally stellar operating margins and free cash flow have declined in the wake of increasing compliance costs. The government has started to become more vigilant about cracking down on money fraud, so money transfer companies have naturally had to pony up to be in compliance with federal edicts.

Both Western Union and MoneyGram are highly reliant on the money transfer business, while Wal-Mart is highly diversified. According to Forbes: 

For Western Union in particular, consumer to consumer transactions, like money transfers, are a core business making up 80% of its annual revenue. MoneyGram says global money transfer and bill payment services are its primary revenue drivers as well, accounting for 95% of total fee and other revenue. 

MoneyGram's stock specifically seems to be overvalued in comparison to its growth prospects. The market correction on the company's stock seems to be an indicator of this. The Wal-Mart news is hitting MoneyGram particularly close to home, as MoneyGram is currently a service offered in Wal-Mart stores. If Wal-Mart decides to boot MoneyGram in favor of its own service, MoneyGram has just lost considerable market exposure.

Not all is doom and gloom with the news, however. Wal-Mart's move will only be rolled out in its United States physical locations, which is a small solace to both companies as they have large international and Internet presences. However, despite Wal-Mart's proposal only being in the United States, I believe that it is a significant enough measure to warrant caution for Western Union and MoneyGram shareholders. It's also a large enough bump in the road for me to part ways with my Western Union stock.