Could a Western Union–MoneyGram deal help two giants fend off fintech disrupters?

The news last week that Western Union is considering an acquisition of rival MoneyGram would not have been a huge surprise to those following the remittance space in recent years. 

Despite their status as the two largest legacy players in the realm of money transfers, the companies have been on divergent paths as of late. Western Union remains the dominant name in its industry. With more than 550,000 retail locations in more than 200 countries around the world, the 169-year-old firm generated $5.3 billion in revenue last year and carries a market capitalization exceeding $10 billion.

MoneyGram, by contrast, has struggled mightily. Since U.S. regulators blocked a proposed $1.2 billion acquisition by the Alibaba-owned Ant Financial in early 2018, the 80-year-old company has been beset by declining revenues and annual losses. MoneyGram generated less than $1.3 billion in revenues last year (down 11% from the previous year) while its stock has also underwhelmed. Today, its market cap stands at less than $240 million.

For years, analysts and market observers have floated a Western Union acquisition of MoneyGram that would further cement the former’s position in its industry. With MoneyGram floundering more than ever, the circumstances would appear ripe for such a transaction.

“You’ve heard rumors about [a deal] pop up over the years, because it does make so much sense,” according to Morningstar equity research analyst Brett Horn. “Money transfers, like any payment processing business, is highly scalable. If you put two of the leading players together, you end up with more scale, and that’s the benefit.”

Representatives for Western Union did not return requests for comment, while a spokesperson for MoneyGram said the company does not comment “on market rumors or speculation.”

Doubling down against digital disruption

Should a deal transpire, the added scale would help insulate Western Union against the threat posed by a new generation of tech-enabled remittance startups pining for a piece of its enviable market share. Though they lack Western Union’s global network of retail agents and its vast compliance infrastructure, upstart fintech competitors like TransferWise, Remitly, and the PayPal-backed Xoom are focusing their efforts on a limited number of high-traffic money transfer “corridors,” such as the U.S.-to-Philippines and the U.K.-to-Pakistan. They’re also betting that their online-oriented platforms will prove ever more viable in an increasingly cashless world—not to mention economical and more efficient to operate.

“It’s going to become cheaper and cheaper every year to move money around,” says TransferWise CTO Harsh Sinha. “It reminds me of what happened in international texting 10 years ago when WhatsApp came around. You used to get charged $15 per month for a texting plan. That business wasn’t costly for [mobile carriers], but they could charge that because nobody else could bring their prices down.”

In response, both Western Union and MoneyGram have sought to accelerate the digital transformation of their own businesses. Western Union has pointed to steadily growing digital revenues, and the expansion of its online platform to more than 75 countries, as evidence that it’s looking to stay ahead of tech-fueled disruption. As the coronavirus pandemic forced brick-and-mortar retailers around the world to shut their doors, the company responded by promptly rolling out new digital services for its customers.

MoneyGram is also in the midst of its own “digital transformation,” company COO Kamila Chytil told Fortune earlier this year. That has involved a new mobile app and a shift away from legacy services like call centers, as well as a partnership with blockchain firm Ripple (which itself trialed an ill-fated pilot program with Western Union). Chytil compared the process of developing and implementing new digital capabilities at a legacy firm like MoneyGram to “changing an engine on an airplane that’s flying.” 

Despite their efforts, both firms’ digital operations remain a limited piece of their overall business. Western Union’s digital money transfer revenues represented 14% of its $4.4 billion consumer-to-consumer business in 2019, while digital transactions made up 20% of MoneyGram’s overall business last year. (Naturally, both companies have reported a significant increase in digital transactions since the onset of the coronavirus pandemic.) 

But an acquisition of MoneyGram would see Western Union double down on its core business and further expand its already formidable, global brick-and-mortar retail network. MoneyGram has 350,000 retail agent locations of its own around the world, and these outposts remain preferred by both companies’ core customer base: migrant workers from across the globe, many of whom are underserved by banks and financial institutions but still need a way to send money to their families back home.

As Morningstar’s Horn notes, the countries on the “receive” side of Western Union’s money transfers are “often developing markets” that remain “very cash-based.”

“The shift to digital [money transfers] is happening, and it’s likely to be accelerated by the coronavirus, but there will continue to be demand for cash transfers,” Horn says. A merger between the two largest players in the remittance space, he adds, would “create a bigger organization with more volume that, down the road, would have the ability to invest in that shift toward digital.”

A checkered acquisition track record

Western Union, however, has a checkered recent history when it comes to ambitious acquisitions meant to bolster its business—as seen with its attempts to grow its Western Union Business Services segment. The company spent $370 million to acquire Canadian business-to-business payments provider Custom House in 2009, and nearly $1 billion to buy British foreign exchange provider Travelex’s business payments division, in 2011. 

Both purchases were characterized by a failure to effectively integrate the businesses into Western Union’s own operations, according to analysts and market observers. Today the company remains hugely reliant on its consumer-to-consumer operations, which makes up 85% of its total revenues in the first quarter of this year, while Western Union Business Solutions represented only 8% of revenues.

A MoneyGram acquisition would be more straightforward than Western Union’s attempts to expand business-to-business services, given the synergies inherent to both companies’ business models. “They were trying to build a new business, and it didn’t pan out,” Horn says of the Custom House and Travelex deals. “This time, you’d be merging like-for-like.”

It would also provide a pathway to growth for a company that, even before the pandemic, was “struggling to break out of low-single-digit revenue growth” and “kept trying to cut costs to drive any semblance of margin improvement,” according to Bank of America Merrill Lynch equity research analyst Jason Kupferberg. (In September, Western Union unveiled a strategy that earmarked $150 million in annual savings by 2022, in an attempt to improve operating margins and return up to $3 billion to shareholders by 2022.) Those challenges have been exacerbated by the pandemic, which the World Bank projects will lead to a 20% decline in global remittance volume this year. 

Of course, there is the matter of making the financials work. While it’s unclear what Western Union is prepared to offer for its rival, it would likely have to assume the nearly $878 million in debt that was on MoneyGram’s books at the end of the first quarter. And the prospect of a Western Union–MoneyGram merger has always raised the specter of antitrust issues that may have to be negotiated.

In a Bank of America research note on Wednesday, Kupferberg downgraded Western Union to “neutral” and expressed a more skeptical outlook on an acquisition.

“[MoneyGram] would add scale and create cost synergies, but both companies face very similar, potential longer-term structural headwinds related to industry competition and technology disruption,” he wrote. Kupferberg added that the deal “would be a large transaction by [Western Union]’s historical standards”—one that would come with “regulatory review risk” and force the company to take on leverage that would hurt shareholder returns.

But with MoneyGram’s stock trading at under $3 per share before the news broke of the potential acquisition, the timing and circumstances may finally lend themselves to a merger.

“If there’s a catalyst for this deal, it’s probably MoneyGram’s issues,” Horn notes. “I think Western Union can pay a good premium on the stock price, and have it be a good, value-creating deal.”

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