Shares of The Western Union Company (NYSE:WU) 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?
The Western Union Company (NYSE:WU) 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. The Western Union Company (NYSE:WU) generates most of its business from migrant workers who send money from wealthy nations back to their families in their country of origin.
The Western Union Company (NYSE:WU)’s earnings miss last fall led to speculation that online money- transfer businesses, like Xoom Corp (NASDAQ:XOOM), 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 Corp (NASDAQ: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 Corp (NASDAQ:XOOM) is justifying its high expectations by growing quickly, it is unlikely to unseat traditional money-transfer companies like The Western Union Company (NYSE:WU) and MoneyGram International Inc (NASDAQ: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 The Western Union Company (NYSE:WU)’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 International Inc (NYSE:MGI)’s business is vulnerable to companies like Xoom Corp (NASDAQ: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 Corp (NASDAQ:XOOM) does not present a serious threat to The Western Union Company (NYSE:WU)’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 International Inc (NYSE:MGI).
MoneyGram has made large market share gains in the all-important Mexico corridor, which is responsible for The Western Union Company (NYSE:WU)’s latest price-cutting plan. However, Moneygram International Inc (NYSE:MGI) 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 The Western Union Company (NYSE:WU)’ 500,000 agents, Moneygram International Inc (NYSE:MGI) 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 The Western Union Company (NYSE:WU) 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 Corp (NASDAQ:XOOM) will not encroach on traditional money-transfer businesses because the majority of the latter’s business comes from un-banked migrants. The Western Union Company (NYSE:WU) and Moneygram International Inc (NYSE:MGI) 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 The Western Union Company (NYSE:WU) going forward; at 11 times earnings, the company has room for a drop in earnings before investors stop earning an adequate return.
The article This Stock Will Continue to Dominate Its Market originally appeared on Fool.com.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Western Union.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
