Keep Your Cash Out of Western Union

 | Nov 06, 2012 | 11:30 AM EST
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One of the biggest earnings disappointments last week came from Western Union (WU). The quarter itself was better than expected, with earnings of $0.46 per share vs. the $0.45 consensus. Revenue was a bit lighter at $1.422 billion, but this is hardly unusual this quarter, since most of the Fortune 1000 firms have been reporting slightly below-par revenue growth for the period. General investor expectations had called for a routine quarter of growth in the low-to-mid-single digits

However, after management's outlook and commentary, things turned sour. The stock sold off by a whopping 33%, and it's currently selling at approximately 8.7x 2013 earnings, with a 4.1% dividend yield.

At these levels, Western Union shares look statistically cheap. So, should you consider buying? We don't think so.

Despite the prior slow-but-steady earnings growth, management dropped a bombshell on investors this quarter by reducing fourth-quarter earnings guidance by $0.10 per share due to increased price competition in key transaction corridors. In many routes, Western Union has a 10%-to-50% pricing premium that needs to be reset in order for the company to regain market share and volume growth.

Reflecting this reality, management guided to a decline in 2013 earnings of between 10% and 15%. Furthermore, the team wouldn't commit to how long this debilitating price war would last. But, as a result of this guidance, many of the leading analysts cut Western Union's annual earnings estimates by $0.30 to $0.40 for 2013, and now anticipate a range of $1.35 to $1.45. This reduced earnings expectation was the primary reason for the recent share price collapse.

We fear this price war could last longer and be more destructive than what is currently anticipated.

Another unfortunate part of the earnings announcement came against the backdrop of an already-perpetual black cloud over the company: Some have feared the emergence of competitive technologies -- specifically, an "electronic wallet" -- will eat into Western Union's volumes and market share. To investors' dismay, however, the company's recent travails have been coming not from future threats -- which we fear still exist -- but from historical competitors that focused on lower prices to gain volumes and market share.

Management was apologetic to investors during the call, promising to take all the necessary actions to right-size the situation in the upcoming year. In order to help alleviate shareholder pain, the board of directors announced a 25% increase in the dividend to $0.50 per share for a 4.1% yield on the current stock price of $12.22. The board also announced a further share-repurchase authorization of 10% of the outstanding shares.

While these steps show that management is focused on enhancing shareholder value, we think the company is facing an uphill battle and believe that the shares will in all likelihood be a value trap for investors in 2013. After all, there will now be nagging questions hanging over the short- and long-term prospects of the Western Union business model.

It is likely to be quite some time before new company pricing and promotion initiatives begin to regain market share. In addition, we think there is meaningful uncertainty about the long-term competitive landscape from new technologies and/or much-lower-cost solutions.

The upshot is that prospective new investors are likely to wait for confirmation that the company has successfully addressed its threats from traditional competitors before they'll move in. They are likely to be waiting a long time. Even worse, by the time Western Union has addressed these profitability challenges, it might be struggling with more serious ones from new technologies.

So, attractive valuation metrics notwithstanding, this company's recent disappointments raises real questions about its business model, both in the short term and in the long run. We would stay away.

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