Shares of First Data (FDC) - Get First Data Corporation Class A Report have been sinking since Jan. 26, the day the payment-transaction processor said it would spin off Western Union, its largest and fastest-growing division.
While the move was part of management's strategy to unlock shareholder value, First Data shares are down 8.1% since then, closing Tuesday at $41.65
At current levels, First Data is trading at 17.8 times expected full-year earnings of $2.33 a share. This is a discount to the company's average historical valuation, and also 17% below its peer group, according to Capital IQ.
With Western Union now gone from First Data, I'm here to answer investors' questions: Should I do it? Are the remaining businesses of First Data worth investing in, or should readers look elsewhere?
First Data held an analyst meeting Sept. 20, projecting 8% to 10% annual revenue and earnings growth at its core credit card and ATM transaction-processing businesses. The company's international business (8.2% of 2005 total sales) is also expected by management to grow by at least 20% a year.
The company is also on track to generate $1.4 billion of free cash flow this year. In addition to investing in its business and making acquisitions, First Data will also put this cash toward its $1.2 billion share-repurchase program and eventually boost its 6-cent quarterly dividend (0.6% yield). Management has not set a time frame on raising the dividend, but I expect it to double over the next year.
Suntrust Robinson Humphrey analyst Andrew Jeffrey, for one, believes Western Union will be the better stock to own going forward. Jeffery downgraded First Data shares to neutral from buy Monday, citing valuation, which I would disagree with. (First Data acquired Western Union in 1995 and last year it made up 38% of First Data's operating income.)
While Western Union has the lion's share of the money-transfer market, lower growth at the division led to First Data's second-quarter earnings shortfall reported July 21, when the stock fell 5%.
Western Union is also being investigated by Arizona Attorney General Terry Goddard, because of payments allegedly sent to Mexico by smugglers and illegal immigrants. About 70% of Western Union's transactions are sent across country borders.
When Western Union gave guidance at its road show Sept. 18, management said it expected 6% to 9% annual operating income growth and 10% to 12% revenue improvement in 2007. When profits grow more slowly than revenue, that means margins are contracting, relative to First Data, where margins are expected to expand next year.
At the end of the day, I expect the Western Union spinoff to benefit First Data investors, whether or not they hold onto the WU shares. The remaining First Data businesses may not be growing as quickly, but they generate significant cash flow, which management is using to grow the business and support the stock with buybacks and a dividend. At current levels, I believe First Data investors could realize a 10% to 15% return over the next year, with limited downside potential.
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David Peltier is a research associate at TheStreet.com In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier appreciates your feedback;
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