In September 2006, First Data Corporation (FDC) spun off Western Union. Then a few weeks ago, FDC announced that it was being bought out by KKR. Now I am moving FDC to the "gone (private), but not forgotten (or public yet - again)" category.
I have studied FDC since the Great Tech Bubble. As we saw the use of more plastic and less cash, a colleague of mine asked, "who makes money on that?" I found out that FDC did - in a big way.
FDC dominates merchant-processing, processing over 50% of the U.S. Visa and Mastercard transactions. FDC's market share in a high fixed cost business gives FDC an enormous competitive advantage. On top of that, FDC is in the best business in Texas (besides Dallas and Houston tollways): helping Mexicans send U.S. earned money back to Mexico. FDC's Western Union dominates this business.
Unfortunately, I never became an owner of FDC stock. My ailment might be considered psychosomatic: I get nosebleeds at p/e ratios over 20. With FDC's average p/e ratio hovering above 25, "bargain" opportunities arose when the p/e dropped all the way to 19 - twice in six years. Nevertheless some investors dove in where I feared treading. One of my cachamim was among them: David Swensen.
Most people had not heard of Mr. Swensen until a recent NYT article featured him. The article told how Yale's endowment had generated an investment return of 16.3% per year under Mr. Swensen's leadership. Such an investment record would send lesser individuals into managing a hedge fund with at least a "2 and 20" fee. Rather than working for Yale for a little over $1 million, he could get paid tens or hundreds of millions of dollars.
But that's not Mr. Swensen. He has explained that his motivation is a "mission" to "make money for financial aid for students." Last year, Yale University's president analyzed their top donors and put Mr. Swensen at the top with a "donation" of $7.8 billion. That sum is the amount of outperformance he has generated relative to his peers at Harvard et al.
His sense of mission translates to what he expects of others. When evaluating a money manager, Steve Cohen, who received a 50% performance fee, he commented "the fees alone are enough to say that I don't want a meeting and there are enough people who put together fair deals." Further, he doesn't go for the "trust me" method of "black box" investing, such as ESL Investments.
The article also describes Mr. Swensen as "not afraid to go where other people don't" which is exactly what I found with his investment in FDC.
Equipped with perfect knowledge of what happened, I went back to my research and reevaluated my calculations. For 2007, Western Union still looks like it's worth $24. The rest of FDC still looks like it's worth $28. Together, they're worth $52. 75% of $52 is $39 - a p/e ratio of 15 - something it never got close to. Maybe it will next time around or maybe, by then, I'll better understand why Mr. Swensen thought he could pay a higher price.
Your flaw is to rely only on a relative valuation ratio such as P/E although it is very useful in projecting valuations, you cannot treat 'high pe's and low pe's' as the same in valuaing a company's revenue sreams.
ReplyDeleteWhere you have went wrong, and David went right in this hindsight valuation IMO is this reliance on P/E.
Some businesses like deserve higher P/Es as they are pretty inflation proof in thier revenue streams - and have little tangable capital base which sucks free cash flow (which would otherwise go for the e in pe) when such capital investment needs upgrading at higher prices, thats why sweets companies with high intangable assets and low asset bases like HSY have such 'nosebleed' p/es.
I dare say that David worked out a higher relative PE based on these factors and on the possibility of a higher ROE as the business expands with economic activity
After all 1/pe is just current yield, not an fair indication of compounding returns.
I'm grateful for your comments and agree that I "went wrong" while David "went right." However, I did not "rely only on a relative valuation." I tried to value the components of FDC based on an understanding of other processors and AXP in particular. For this written blog, I simply "short-handed" my analysis with a P/E description. But it does appear that I went wrong in my excessive conservativism at an estimate of FDC's sustainable growth rates. I am seeing this same issue working against me in my underestimating Mastercard's growth rates. By the way, I completely subscribe to your appreciation of those companies which are not "capital pigs." Again, thanks for sharing your insights.
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