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Western Union Spin Off May Do Little for First Data

Last week’s news that First Data Corp. will spin off its Western Union operations to First Data shareholders and create a company worth an estimated $20 billion is probably good news for Western Union. Noting that the parent company will be keeping its card processing, card services, and international business lines, observers were asking what had otherwise changed.

The answer: Nothing. “The bottom line for me is that this doesn’t change the realities, which are that even though they’re going to reconstitute what First Data will be, it doesn’t change the facts that Western Union, while it’s a good business, is facing increasing competition around the world, that the card business is struggling mightily, and that merchant processing is a commoditized business,” says Scott Kessler, who follows First Data for Standard & Poor’s.

“I think it’s interesting that the company is selling its best business, and retaining two lesser businesses, and it’s pretty obvious that the two remaining businesses are challenged, and in some cases, I’d say challenged at best,” adds Kessler, who has a “sell” rating on First Data’s stock.

Wall Street, not known for its sympathy toward struggling companies, seemed to have been largely unmoved by First Data’s announcement. Though it opened on January 26, the day of its announcement, at $46.30—$3.58 above its January 25 close—it closed that same day at $45.30, and the following day at $45.  Over the same two days, the Dow Jones Industrial Average rose 139.04 points.

To be fair to the company, it was forced to take these steps by Wall Street; it’s unlikely Chairman Ric Duques would have spun off his most profitable unit if he hadn’t been under pressure. That pressure produced some remarkable tactics. At the early morning conference call, Duques and his new team admitted mistakes had been made and a tough job lay ahead: It was a remarkably honest mea culpa in an era in which corporations routinely spin everything as part of some Olympian plan.

Unmentioned, though, was the news that whichever direction First Data takes, it will sooner or later have to do without chairman Duques. Duques, who came out of retirement to re-structure his old company after the sudden departure last November of Charles Fote, was named “non-executive” chairman of Unisys on Jan. 24.

The new First Data has some real problems over and above Kessler’s objections and the eventual departure of its chairman. Observers point to the fact that aside from its international operations, which, growing from a relatively small base, are projected to grow 45 percent this year—25 percent without the impact of acquisitions, according to the company—2006 earnings for the rest of the company are anemic, at best. The company estimates 2006 growth for its processing and card services units to be mid-teens and zero, respectively. And the company is saddled with numerous negatives, including its business model, changes in the marketplace, and its computer platform. 

First Data’s business model is geared for servicing big banks with big credit card businesses—companies that handled their own customer service and other support operations. But in the past year, all the monoline banks except First Capital and Advanta were bought, mainly by First Data customers, while many other credit card processing operations, like those of the former Juniper Bank, have been brought in-house.

As a result, many of First Data’s main or potential customers just don’t need it anymore, considerably trimming the company’s future customer list. And with most of the big fish out of the pond, First Data will need to load up on smaller fish, which First Data traditionally didn’t handle, because it didn’t want them and because they need many services that First Data didn’t supply—like customer service. Whether First Data can re-invent itself to include those business lines, when it said at the conference call that it would be selling off businesses, is a matter of some speculation.

Also unclear is the future of the last remaining big business relationship on First Data’s books, Chase Paymentech Solutions LLC. Chase Paymentech is a joint venture between JP Morgan Chase & Co.’s Chase Card Services unit and First Data. But the deal has only five years to run, and Morgan Chase has been streamlining its operations ever since chief executive officer Jamie Dimon came on board with the 2004 acquisition of Bank One. Should Chase buy out First Data’s interest in the unit it would be a fat one-time gain, but a long-term revenue loss for the company.

On the computer platform side, First Data has the same problem that many other large financial institutions have, entrenched, last-generation legacy systems, while its main rival, TSYS, is newer and generally considered to have had a technology edge over First Data before the announcement. Replacing First Data’s computer systems won’t be cheap; it should cost at least $100 million, say consultants.

TSYS has its own problems; it lost one of its biggest customers last year when Bank of America bought MBNA Corp., and has to replace that revenue. But TSYS is also able to serve those smaller banks. Plus, it’s 81 percent owned by $27 billion Synovus (those assets include TSYS). Synovus had $3.2 billion in revenues between December 2004 and October 2005; its revenues grew 29 percent, year over year, in the quarter ended September 30. In the last four years, First Data’s revenues grew 6 percent. And First Data, which reported $10.5 billion in revenue in 2005, will be losing Western Union’s $4 billion in 2005 revenues.

That $4 billion will probably be put to good use by Western Union, though. Despite serious competitive issues growing from some newer technologies, it still has a powerful brand and the largest such dealer network in the world—some 271,000 locations in more than 200 countries and territories. The money, the network, and the brand, combined with the fact that an independent Western Union won’t have to contribute its earnings to its former parent, are likely to at least give it a running start following the spinoff later this year, say analysts.

“It will probably give more flexibility to Western Union, and give it more room to makes its own decisions,” says Gwenn Bezard, a partner in Aite Group. “Being part of First Data gave it some challenges in terms of things like resource allocation, and by being independent, it will be easier for management to move ahead with their own ideas and strategies and budget.”

The challenge for an independent Western Union, says Bezard, will be to continue to innovate and stay ahead of competitors like MoneyGram,Inc., which, while much smaller than Western Union and its $1.12 billion in 2005 operating profits, produced 35 percent in profit growth—$29.6million—in the same period.

But he suspects that it may not be much of a problem for the new company. Bezard points out that aside from being able to use its financial muscle to buy companies with new technology, Western Union’s enormous distribution network can help transform its business by giving it a base for moving into other financial products. He can, for example, imagine the company going to the large overseas financial institutions it does business with now, and selling them products like bill payment and processing. Products that would represent real innovations in countries like China and Russia, and at the same time create entirely new revenue streams for Western Union.

The same goes for First Data, thinks Dan Schatt, a Celent Communications analyst. “First Data may do better without a Western Union business in the middle of it,” he says. “The reality is that from a business strategy and operational point of view, the businesses weren’t aligned, and actually came to odds with each other.”

Schatt thinks that being able to lean on Western Union actually worsened First Data’s structural problems as much as First Data prevented Western Union from solving its own problems for itself: Western Union’s cash flows allowed First Data management the illusion they had plenty of time to find an ideal solution, while all the while the sand was running out of the glass. “With Western Union gone, they can hone in on the dirty work, which is to grow their position internationally and open up their business,” he says.

One possibility, he thinks, would be for First Data to work with large retailers who may be mulling creating their own payments platform. First Data could take a retailer’s loyalty card, he suggests, and turn it into a payments vehicle, linking it via its ACH lines to a customer’s checking account, and saving the retailer interchange fees.

“They’re really saying they’re not going to use Western Union as a crutch anymore, that there are opportunities out there, and that if they’re freed from the safety net of Western Union, they can focus on them. But can means have to,” and if First Data doesn’t use this opportunity to let go of its old company culture and re-invent itself—a hard job in the best of times—Schatt thinks First Data’s future is doubtful.

Charles Fote apparently agrees. On January 27—the day after the company announcement—First Data’s former chairman exercised 2.37 million stock options and then sold them for $106 million, making a $50.8 million profit. On Monday, January 30, he sold another 262,000 shares, worth $11.8 million. (Contact: First Data Corp., 303-967-6553; Standard & Poor’s, Scott Kessler,212-4328-2000; Gwenn Bezard, Aite Group,646-485-1193; Celent Communications, Dan Schatt, 650-627-8897)