The fundamentals of Western Union (“the Company”, “WU”) are deteriorating and the Company has been losing agent exclusivity. Although Management has been resistant to any aggressive price cuts, we believe such cuts are imminent. The last time WU initiated large price cuts was in 2012, and following the announcement, the share price dropped 30%. We believe a repeat is likely.
We also have concerns over Western Union’s accounting. WU has only missed earnings estimates once since the beginning of 2012 (14 quarters). We find these consistent earnings beats questionable. The earnings of such a mature company facing secular decline shouldn’t be that hard for Wall Street’s finest to forecast. Based on the evidence and available information we have reviewed and analyzed, all of which we set out herein, we believe that WU is manipulating its EPS numbers through cost capitalizations in order to beat analyst estimates and directly influence its share price. Our analysis suggests that since the beginning of 2012, the Company’s largest quarterly share price declines have been followed by unusually large capitalization of contract costs. Because capitalized costs don’t flow through the income statement, we believe WU was able to report more favorable earnings results to the market, which in turn had the effect of either stemming the share price decline, or reversing it.
Western Union’s reported tax rates have also been declining over the years and are some of the lowest among our analysis of multinationals. There is growing discontent over tax minimization strategies, which have become a hot topic for countries the world over. In Europe, numerous governments are strapped for cash while in much of the rest of the world countries that relied on the commodities boom are seeing large holes in their budgets. Companies like WU, which are already viewed by many as preying on the poor,1 do business in all these countries, yet appear to pay little, if any taxes. From a public policy perspective, we take issue with WU’s low tax rates, and believe they face severe headline risk. If anything, the case of Valeant is a sobering reminder of the problems that can quickly spawn when corporate practices are seen as exploitive and unfair.
Western Union is a provider of money transfer services, operating through a network of approximately 500,000 agents globally.
Where once Western Union’s yellow signs were synonymous with money transfers, the industry is now crowded with countless convenient alternatives, ranging from electronic options such as Paypal, Xoom, and numerous start-ups, to more traditional brick-and-mortar options, such as Moneygram (“MGI”) and Ria. Recently, even Wal-Mart jumped into the arena with its own money transfer service.
While more traditional operators are making Western Union’s dominance in the legacy retail space a distant memory, the entire industry is being displaced by online and digital alternatives. WU’s near-monopoly in the global money transfer industry and its premium pricing is being eroded by these disrupters the same way the taxi industry is being dismantled by Uber.
With an industry ripe with fresh competition, any portfolio manager that owned the stock over the last five years should have been fired, because the stock has gone nowhere while the market is up ~70%.
Aggressive Price Cuts Imminent
There is perhaps no better indication of WU’s deteriorating fundamentals than its agent locations count. Western Union’s agent count peaked in Q2 2013 at 520,000 locations. In Q3 2013, the Company disclosed its agent count at 515,000. 5 The latter disclosure was notable because it marked the first agent decline in the Company’s history, and it was also the last time the Company would disclose this number.
Today, the only disclosure Western Union provides concerning its agent count is a vague statement noting that the Company has “a combined network of over 500,000 agent locations…” For a company that once took pride in its vast network of agent locations, and paraded them as a clear advantage over competitors, Management’s recent lack of disclosure on the subject is telling.
Western Union had envisioned having 1 million touch points as recently as 2012. But that seems like a distant memory now. In the meantime, competitors have been ramping up their own agent locations and choking WU of any effective monopoly it may have held in the past. For example, MGI has increased its agent locations by 50% from 233,000 to 353,000 since the beginning of 2011.
Likewise, Ria has been on its own agent acquisition spree, increasing its location count by 150% from 107,700 to 272,000 in the same time period.
Along with agent locations, Western Union’s revenue also peaked, reaching US$5.6 billion in 2012. Since then, revenue has declined as growth rates have turned negative:
Part of the issue is pricing. Western Union believes its brand carries a “trust factor” which allows it to charge premium prices.10 Globally, WU charges 15% to 20% more than its competitors.
We believe Management’s notion of charging a 20% trust premium is antiquated. WU is no longer the only visible player in global remittance, and as more competitors become established and take mindshare, Western Union will be left with two options: keep its premium pricing and lose market share, or cut prices and lose on margins. Both scenarios are unenviable.
For all the talk of premium pricing, this rhetoric was put to the test in 2012 as competition ate away at Western Union’s market share. In response, WU was forced to announce an “accelerating pricing investment” strategy12 – which is just a really obnoxious way of saying “aggressive price cuts”. Following the announcement, the share price responded with a 30% drop:
WU’s aggressive price cuts led to some short-term, albeit fleeting market share gains as C2C transaction activity rebounded sharply in 2013, and was followed by nominal revenue growth in 2014:
Credit where its due, this play-out is consistent with Management commentary regarding price cuts at the time:
“I know it’s about 12 to 18 months. It may — in most of the time, within the 12 months, the revenues are coming back. And the first 2 months, you will immediately see the transaction increase market share’s gain, and we have done that, and we will be active on the market to gain market share.” – CEO Hikmet Ersek, Q3 2012 conference call
However, any lasting benefits from the 2012 price cuts are elusive. While transactions did rebound immediately following the price cuts, those same growth rates have dropped dramatically in the last three quarters. Moreover, the revenue growth Management was hoping for seems muted. C2C revenue only grew for a portion of 2014 – barely – only to once again return to negative territory.
When Western Union announced the aggressive price cuts back in 2012, revenue growth, transaction growth, and principal per transaction in the C2C segment (representing 80% of revenue)13 were deteriorating materially in the four quarters prior to the announcement:
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