Sunday, October 22, 2006

Quick Valuation - Western Union (WU)

Over the weekend I skimmed over the Western Union spinoff information kit with unaudited pro forma financial statements. While looking at the previous 5 years worth of historical cash flow, I noticed that the growth rate in free cash flow (net cash - capex) diverged significantly from the growth rates that I am seeing used in DCF calculations by other bloggers like Mike. Interpolated from these numbers, free cash flow has grown at about 18% over the last 5 years. Since others already consider it cheap at 10% fcf growth rate, this makes WU an interesting investment opportunity. Greenblatt always said to investigate spinoffs as they usually present good investment opportunities.

My current estimate of the intrinsic value of the WU is $30. I used a 2-stage DCF model with growth rates of 10% for the next 10 years and 5% terminal growth. I used a 11% discount rate, justified by the company's enduring brand and global presence. In the worst-case, I can't imagine this company having lower growth rates than 7% for next 5 years, 5% for the following 5 years, and 3% in perpetuity. The intrinsic value in this highly unlikely worst-case configuration of growth rates is $19. Any purchase under $19.50 has a 35% margin of safety from my $30 IV estimate and is fairly valued in the worst-case. Sounds like my kind of odds!

In a future post, I will discuss the merits of the Western Union business. I will discuss why we need not worry about immigration legislation and why we don't have a buggy whip business on our hands.

Full Disclosure: I have a 2/3 full position in this stock. My original shares were spunoff from First Data Corporation (FDC). I have also recently made purchases at $19.40 and at $18.50.

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