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Posted by: P.I.A. (IP Logged)
Date: August 20, 2013 11:24AM
Introduction: If you have been watching one company after the next stumble in the tech industry we may have something in common. Some would like for things to be as they were in past decades, when "Wintel" stocks offered domestic economic status. Meanwhile, with the decline of the desktop computer and rise of mobile device usage as a backdrop, other names with Internet presences leverage future potential to become winners. As payment technology appears to be a here-and-now line of business, a new entrant, Xoom (XOOM), may prove to be among equities that continue to obtain the highest of valuations. Its explosive growth is ongoing, and an entry point for investors may be at hand.
For the company's continued success, it seeks to disrupt traditional, "cash-to-cash" exchange methods used by Western Union (WU), among others. Xoom has only traded publicly since Feb. 15, 2013, when set to IPO at $16 per share. It is an online, international money transfer service, allowing personal placements of funds between friends and family members. Recipients, including the 60% located in the Philippines and India, do not need a bank account or Internet connection.
I have been cautious regarding paper-money printing businesses, such as De La Rue PLC (DELRF.PK), but have seen nothing convincing enough to justify betting against them. By contrast, anyone who has followed Visa (V), MasterCard (MA), American Express (AXP) or Discover (DFS) is aware of their prowess. In fact, referencing the following chart, all except Visa have handily outperformed the S&P 500 this year.
Though business models differ, payment technology-oriented firms' contemporary success is difficult to deny. Further, MasterCard and Visa each have recently announced strong results. Anyone following the former closely is probably aware of a steep intra-day sell-off, immediately following its July 31, second quarter report in which it beat on top and bottom lines even more soundly than the latter corporation. MA has charged higher, resulting in profits for intrepid traders; however, V has not, which remains visible above.
An underlying issue is U.S. District Court Judge Richard Leon's ruling against a Federal Reserve interpretation of the Durbin Amendment to 2010 Dodd-Frank legislation that caps the amount that can be charged on debit card transactions at $0.21. If Leon has his way, the new limit will be $0.06 to $0.03. Also, the judge not only thinks merchant customers should pay less, but could be entitled to reimbursement. Though the matter is far from settled, it is a lingering issue for debit card businesses. The Wall Street Journal reports that card issuers received $15.4 billion in debit interchange revenue during 2012.
The situation could be incrementally beneficial to Xoom, and help sentiment. As disclosed in the prospectus, over 90% of Xoom's customers fund their transactions using the Automated Clearinghouse system, which is less expensive because it does not include the varied fees of debit or credit. Regarding the remainder of users, per the same document, it has:
Quote:What if the fees are cut 81%, actually?
Meanwhile, there appears to be genuine innovation at work within Xoom, and the market recognizes it. The company's 52-week high, reached at the end of July, of $36.46 is more than twice its IPO value. The firm uses its technology to minimize fraud, and can charge lower fees than traditional money senders that pay commissions to enormous networks of agents, and have significant infrastructure, such as Western Union and MoneyGram International Inc. (MGI).
Illicit transactions are a serious problem for payment processing firms. In fact, SmartMetric's (SMME.OB) CEO Chaya Hendrick has stated that card companies lose nearly $4 billion a year in unlawful activities, not including ATM transactions. However, security is a strength for Xoom. Though 90% of its payments tend to fall under higher risk, card-not-present transactions, losses have been 35 basis points or lower per year since 2010, and it reports $7.7 million, or 0.24% of gross sending volume, in 2012. Remarkably, Xoom's small transaction loss ratio has not increased, while Gross Sending Volume (GSV) is up 74%, to $2.662 billion, in six months.
There are several reasons that a case can be made in comparison to firms that do not directly compete with Xoom and make their money through transactions, such MasterCard or Visa. Though Xoom is newer, it might outperform them. Revenues are generated through fees charged to consumers, whose numbers are increasing; and foreign exchange spreads, which are typically 1% to 3%. Risk of Fx loss should be limited because funds are disbursed within six business days.
Increasing portable device use is another driver for growth. The company has had a mobile strategy since November 2011. In the three months ended Dec. 31, 2012, prior to going public, 25% of transactions used portable devices. As of the second quarter, mobile usage is up 200% from a year ago, to a $467 million value. Per a July 29 press release, there is a new relationship with Sprint (S) enhancing Xoom service for the carrier's subscribers.
A new program allows a user to send money within seconds using a tap or swipe. iOS and Android apps are being expanded. The company recognizes that mobile usage is important, and is hiring aggressively to bolster its engineering team.
Fiscal State & Risks
For the purposes of evaluating Xoom's financial statements, it is important to note that cash balances are significantly affected by the day of the week. Thus, quarterly and annual comparisons may be unreliable. Also, it is an emerging growth company under federal securities laws and is subject to reduced reporting requirements. Management is able to provide guidance, however, and relies upon marketing costs, new customers, and margins to do so.
Marketing is the largest line item, currently 21% of revenue, and direct marketing (online ads and television buys) the biggest component. The company's marketing expenditures are predominantly for television, online; and promotions, such as "Refer a friend," and a new partnership with Walmart (WMT). The number of customers acquired and the cost per acquisition (CPA) are key metrics. For the second quarter, 135,000 new clients cost $40 to $50 each in direct marketing expense. CPA costs are expected to stay in range for rest of year. Gross margins at a healthy 70% reflect the lack of agents and infrastructure.
Competition is a consideration. MoneyGram currently offers online transfers from the U.S. to agents only, but is making investments in mobile technologies. However, there appears to be no imminent threat from it or Western Union. During the second quarter conference call recording, an analyst with Needham & Company asks about Western Union's announcement of a new India online money transfer business. President and CEO John Kunze replies:
Quote:It appears that Xoom is poised to continue disrupting their business models. Clients are staying aboard and a growing, new customer base pays off.
Apt Peer Comparisons?
The Thompson/First Call consensus median target price (available at Yahoo Finance) is $33.50. Only $0.17 is forecast in 2014 EPS, so the market is pricing Xoom for the distant future, as a growth company. EPS may be substantially higher, which is discussed at greater depth later. Comparison to other richly-valued stocks such as Netflix (NFLX), Facebook (FB), LinkedIn (LNKD) or Amazon.com (AMZN) that offer innovation and potential is appropriate. Here is a table comparing relevant metrics of companies that may be priced for tomorrow's success:
All of the corporations have remarkably healthy debt figures, and Xoom's Market Cap / Total Enterprise Value of 1.02 is the median value. (The company had $49 million in debt outstanding on June 30, 2013; $25 million needs to be paid back on a weekly basis.) However, with a TEV under $1 billion, Xoom is probably the only one that would be a feasible acquisition target. Netflix may be a possibility for a deep-pocketed entity, as its TEV is just over $14 billion.
To make an argument for an investment in Xoom, one can cite the 42% EPS growth forecast over the next year, from $0.12 to $0.17. This is the same percentage gain predicted for LinkedIn. However, with a share price approximately one-tenth as much, the growth is cheaper: 0.66x in comparison to 5.4x. Indeed, it is cheaper than all the others. Analyst forecasts are supported by Xoom management's claims that it has under 10% of an $80 billion total addressable market share of money flowing out of the U.S. to the 30 countries served.
A key to assessing these stocks may be P/One Year Estimated Earnings Growth. While long-term prospects have considerable bearing, an increasing number of unpredictable things can occur over a longer span, i.e. five years. Projections into 2014 allow for forward-looking markets and more realistic consideration of uncertainties. Referencing the table above, the better-established and more widely followed AMZN and NFLX trade at the highest one-year projected growth multiples and lowest price/sales ratios. In light of relatively cheap growth, Xoom's price may grow through another several quarters of earnings history.
Currently, P/S data is pertinent for this healthy, young business. However, similar stocks discussed have one year of past information and Xoom does not. YCharts has each stock's multiple contracting, and Xoom is maintaining a median value in light of future projections.
While there are prospects, EPS comparisons cause hesitation. Using P/2014E EPS as a metric, Xoom is far more expensive than the others. Despite having a limited history in public markets, it would require over 100 years for a new acquirer to gets his or her money back, versus 77 or more for NFLX! While gains cannot be ruled out for new investors at current prices, I would like the stock better if either the price continues to come down, or consensus 2014 earnings figures increase so that the future multiple is no higher than 100x. The concern is mitigated by a huge untapped market; and also partially by management's ability to under promise and over deliver.
Xoom's second quarter results soundly beat estimates and guidance on top and bottom lines, similar to the first quarter. In fact, all analysts offer their congratulations during the recording of the second conference call. Management is exhibiting a tendency to guide lightly, though there is little operating history as a public company to go on. Meanwhile, revenue is up 59%, gross sending volume 82% and active customers 40%, since the second quarter 2012.
The company's results and prospects are real, and another issue is becoming a thing of the past, so an entry point may be at hand. The company's 21 million share lockup agreement expired Aug. 13, when the share price was over $31, so there could be a clear bottom with a concluding sell-off. There are roughly 33 million shares outstanding, some of which seem to have been recently liquidated. Available data shows high insider ownership: Executive officers, directors and affiliated entities control 38.2% of the corporation as of the second quarter. However, it has closed lower each day since expiration.
Q3 and the Rupee (₹)
For the third quarter, consensus is a $0.03 loss; guidance is for a $0.07 to $0.02 loss, and $27 million to $28 million in revenue, with seasonality and the rupee important considerations. Per CFO Ryno Blignaut, devaluation of the Indian currency could provide upside. The rupee has dropped to its one-year low pursuant to reporting on July 24. Further, one-third of Indian active customers are motivated by exchange rates and time transactions to achieve maximum rupees for dollars. Thus, there is reason for GSV optimism, despite seasonality, as a lot of rupees are sent to recipients.
The unconfirmed date for the third quarter earnings announcement is Oct. 21.
Some stocks are highly valued by the market. Within the technology sector, payment-oriented equities have been outperforming and reporting robust results. These things appear to be positives that combine well for Xoom, which has an untapped customer base before it and no sign of adroit competition. Nearly all figures underscore results, and continued acceleration.
There are considerations. On a price to 2014E earnings measure, Xoom is not compelling. Further, indication is needed that the post-lockup selloff has concluded.
Xoom is establishing itself to be one of the market's premier growth stocks, and at Western Union's expense, before and after it reports in October. Anyone who accurately calls its near-term bottom may witness it bolt past MasterCard and Visa.
Stocks Discussed: XOOM, V, MA, WU, DFS, AXP, MGI, S, WMT, NFLX, FB, AMZN, LNKD,