As a long-term investor, you should spend a lot of time thinking about what has happened to Garmin’s core business over the past decade. Way back in the early 2000s, the stock skyrocketed from $14 in 2004 to $125 in 2007 as it rolled out its consumer GPS navigational systems that made it possible to get on-the-go driving directions. If you relied on traditional metrics to make your investing decision, you would have thought that the stock seemed fairly priced. After all, the absolute highest valuation for the stock was 31.5x earnings in 2007. Other than that, the stock generally traded in the 20-29x earnings range which is quite attractive for a non-cyclical business that was doubling its profits every two years.
By 2008, we know what happened. Apple and Google rolled out their own GPS navigational systems that were free and convenient on smartphones, and the price of the stock tumbled as it got hit with the effects of a rapidly declining market share amidst a bear market. By the spring of 2009, Garmin stock fell from its 2007 high of $125 all the way down to $14 per share.
And it’s not even a bad management thing, either. The Garmin team has done a commendable of trying to expand into exercise GPS devices and adding automatic features to entice customers to purchase the obsolete-ish navigational equipment. Their balance sheet is exceptionally strong, with no debt and a billion dollars in cash. And the firm is still profitable with $400-$500 million in net profits per year.
The problem, rather, is that everything is a struggle. Profits at Garmin have not broken out of the $400-$500 million range since 2010, and sales are only growing at 1%. If there is any growth over the coming years, it will surely come in a scrappy fashion. Profit growth will not be easy, certain, or guaranteed.
The lesson I take it from Garmin comes largely from the 2007 experience. Those investors who paid $125 per share are never going to recoup their losses. It’s doubtful that Garmin will even clear $60 per share within within the next five to ten years because the earnings growth are stagnating and carry the risk of further erosion.
The Garmin experience should be on your mind when you study a company like Western Union. On a P/E basis, a company like Western Union looks decently cheap because it is only trading at around 13x earnings. The dividend yield is around 3%, and the operating margins are an extremely attractive 25%. The math side of the analysis makes this stock look like an attractive investment candidate for consideration.
But the qualitative side is much more difficult to figure out. The point of using Western Union is that you want to transfer money long distances–usually between countries. Transaction fees account for over 74% of revenues.
The current status quo with 25% profit margins is not sustainable. As a new generation of workers create the habit of using firms like PayPal to execute internet cash transfers, and firms like Google and Facebook begin to experiment with their own money transferring services, it is not difficult to imagine a scenario in which Western Union loses a lot of market share very quickly.
I could even see it becoming a crusade with moral overtones. It is foreseeable that, within the next two or three years, Facebook might launch a promotion discussing the unfairness of the working class having to pay exorbitant fees to ship money to their loved ones along with an announcement that it will launch a Facebook money transfer service that is free for the first year and then only costs $1 thereafter. If not Facebook, I could imagine Google launching a similar offer.
A lot of brokerages like Shearson Lehman earned exorbitant profits in the 1960s through 1990s and then saw them disappear quickly with the rise of Schwab and the discount brokerage as technological advancements facilitated lower cost capital transfers. With the loss of hefty commissions, these firms shifted towards trading and leverage to offset the market share and profit losses from the rise of their discount rivals.
The remaining frontier is inter-country transfers of cash. Even though things like nice for Western Union right now, those 25% profit margins aren’t here to stay. Just as no one used Shearson Lehman to house their investments because they were infatuated with the brokerage brand, no one transfers money through Western Union out of customer loyalty. It’s just the most straightforward way to meet a need.
But technological changes are on the precipice of altering the business model. My guess is that Facebook will heavily advertise inter-country cash transfers sometime in the coming years, and it will begin to take a bite out of Western Union’s market share. A best-case scenario for Western Union shareholders is that it merely has to lower its price to keep its customers. A worst-case scenario is that Facebook begins to take on bank-like functions that lead to dramatic market share shifts seemingly overnight.
I would stay away from a stock like Western Union entirely because valuing future cash flows are too speculative. It’s like owning Lehman stock in the 1990s or Garmin stock in 2007. You can sense a permanent disruption to the business model in the offing, rendering any analysis that relies on P/E ratios or other traditional metrics nearly meaningless.
Originally posted 2016-09-03 19:00:31.