Late in 2013, money-transfer company Western Union (NYSE:WU) saw its shares tank on news that it would incur increased compliance costs in 2014. But that plunge isn't a sign of things to come in the year ahead.
There's plenty of friction involved in moving money around the world, and complying with a patchwork of regulations around the world is a significant hindrance. The difficult regulatory environment could actually be a good thing for Western Union, as it favors the largest company in the industry at the expense of smaller competitors like Xoom (UNKNOWN:XOOM.DL).
2014 will bring with it flat operating profit at best for Western Union, but the company could grow stronger relative to its competitors, even as the rise of digital currencies like Bitcoin threaten the industry.
A good investment for 2014
Western Union enjoys high profit margins because of its scale. The company is by far the largest money transfer company in the world, recording $5.6 billion in revenue in 2012. This year, Western Union will spend between 3.5% and 4.5% of its revenue on expenses related to regulatory compliance, or as much as $250 million.
Xoom, which had an IPO last year and saw its stock initially surge, has trailing 12 months revenue of less than half of Western Union's annual compliance costs. Money transfer is an expensive business to be in, and Western Union has been lowering its prices to snuff out the competition. This leaves Xoom little room for profit and an expensive path toward expansion.
Shares of Western Union haven't recovered much from their collapse toward the end of last year, presenting an opportunity to value investors. Trading at just about 10 times earnings, with a 2.9% dividend yield to boot, Western Union could be worth quite a bit more, especially if the company manages to return to revenue growth in 2014. Western Union is a stable business, and short-term problems have created a long-term opportunity.
Is Bitcoin a threat?
Digital cryptocurrencies like Bitcoin went mainstream in 2013, with the value of a single bitcoin rising from $13 to over $1,000 at its high. Much of the hoopla surrounding Bitcoin is the idea that it could be used to transfer money around the world with significantly less friction than traditional means. This would be very bad news for Western Union.
But the promise of Bitcoin is quite a bit overdone. There are currently very few businesses that accept Bitcoin as payment, meaning the digital coins would need to be converted into the local currency to be of any use at all. While the act of transferring bitcoins can't really be regulated, the act of converting into another currency can be. Last month, the cental bank of China did exactly that, banning financial institutions from handling Bitcoin transactions. Other countries, including the United States, could eventually take similar steps.
A majority of businesses would need to start accepting Bitcoin directly for the currency to have any staying power, and so far, there are very few. The most notable is Overstock.com (NASDAQ:OSTK), an online retailer that does about $1.2 billion in revenue each year. The decision to accept Bitcoin, which will take effect later this year, looks to be partly an attempt to get some free press coverage, and partly an attempt to give the digital currency a boost. It looks like a gimmick more than anything else, and a risky one at that, given Bitcoin's massive daily fluctuations.
While the number of bitcoins is capped, there are plenty of other digital currencies basically identical to Bitcoin from a technical standpoint. There's very little barrier to entry in creating a new digital currency, so the question arises: What makes Bitcoin so special?
This is the major reason why digital currencies may never be fully accepted. While the number of bitcoins is limited, the number of digital coins of any type is essentially unlimited, and there's no inherent reason to favor one over another, since they're all technically very similar. There's even a digital currency named after an Internet meme called Dogecoin with a market capitalization over $1 million. As the absurdity of that statement sets in, it's clear that Western Union has little to worry about on this front.
The bottom line
Although costs will rise for Western Union this year, the company will actually get stronger relative to its competition. Digital currencies like Bitcoin pose no threat to Western Union in the short term, and likely pose little threat in the long term. Western Union is a solid company with a defensible economic moat, and that won't be changing any time soon.
Timothy Green owns shares of Western Union. The Motley Fool recommends Western Union. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.