Description

Background:

As a foreigner in the UK with ties to a number of countries, the problem of international money transfers has always been very real and the search for better cost alternatives never ending.

The global average cost of sending remittances was 6.09% in Q122, according to the World Bank’s Remittance Prices Worldwide report from June 2022. While materially lower than the 9.67% recorded in 1Q09, the figure is still double the Sustainable Development Goal target of 3% by 2030. Banks are the most expensive channels to send money abroad, followed by post offices, Money Transfer Operators (MTOs) and Mobile Operators.

I don’t send remittances but the occasional gift to a niece or nephew back home has typically resulted in a 4 to 5% charge via Paypal, and spending money while on holiday carries a 2 to 4% penalty from Barclays and AMEX FX fees and extras. Over the years, I have found two solutions for currency transfers: for smaller amounts, Revolut’s account and card have worked well; for the larger amount, TransferWise (now Wise) has been phenomenal.

Following Wise’s IPO, I’ve become an avid user of their products (sorry Revolut!) and have been delighted to recommend them to anyone with a need to send money internationally or spend abroad (their debit card is AMAZING!)

Thanks to the 55% drop in share price since going public, investors can buy into Wise at a better valuation than VC investors got between 2017 and 2020 for a business with greater scale, highly profitable and cash generative and with the possibility of gaining share in a very large (and growing) market for years to come. I am recommending a long position on Wise shares at £3.8/share today.

Summary of investment case:

Wise is a mission driven business: to create money without borders: instant, convenient, transparent and eventually free. It is the largest non-bank operator in the ca. £20 trillion currency transfer market. With the exception of enterprise and large businesses, the typical channels to transfer currency for individuals and SMBs around the world are still opaque, expensive and slow. Wise is going after the £200bn of annual revenues that fees charged on these volume generate.

Wise has built an internal culture that revolves around its mission: autonomous teams are given freedom to organize themselves and compete for funding to develop ideas that can help the business achieve lower and more transparent pricing for customers, easier transaction journeys and faster completions. Today, 50% of transfers are completed in less than 20 seconds and almost 90% in less than a day, in an industry where transaction times are still typically quoted in days.

Wise’s mission obsession has helped define two key organizational characteristics: its cost efficiency (aiming for zero fee transfers without an efficient cost structure won’t work!) and its extreme cost allocation granularity, which flows from the principle that all businesses lines and currency corridors should be sustainable. Wise aims to set prices such that margins are very similar across its business, and to do so obviously requires a clear understanding of the unit costs of all of its services.

On top of these, I believe the mission has helped Wise maintain/reinforce its singular focus on international payments, which when combined with their scale has resulted in very few, easy to use, very good products (more effective product iteration, large scale A/B testing)

The importance of the mission and commitment to it transpires in conversations with former and current employees, reading interviews with experts, and quarterly updates provided by the founder and CEO Kristo Kaarman (which go far back in time to when the company was still private), as well as in their recruitment website and Glassdoor employee reviews.

The current set up can potentially create attractive feedback loops: lower prices >> more volumes >> lower unit costs >> further savings passed on to customers >> greater volumes >>

The evidence shows the loop is working: from a cold start in 2011, Wise has grown monthly transfer volumes to £8bn, has 13 million customers and operates in 12 countries (in its letter to shareholders in the IPO prospectus, Kristo Kaarmann envisions the day when Wise serves 100 million customers!). Customers keep close to £5bn of balances in their Wise accounts (as of Sep 2021). More importantly, customers are saving ~£1bn/year using them rather than competitors.

It remains a high quality business, with good unit economics (a ca. 25% FCF margin), a strong culture and a long growth runway. It also trades at a highly attractive price.

Private round valuations valued Wise at close to 8% of annualized transferred volumes and customers around £420 each. At IPO, they were valued at 13% annualized volumes and customers at £970 each. At current EV and my estimate of annual volumes as of FY22 (March YE), Wise is trading at 4% of volumes and around £220/customer. The business today trades at a ~4% FY21 FCF Yield, and 6% FY23E FCF yield. Highly attractive for a business that was growing revenues at over 50% pre-COVID, ~30% during COVID, and appears to be reaccelerating.

On top of this, the company is presenting its first full year results on the 28^th June. I expect the company to deliver financial performance materially ahead of analyst consensus, who are underestimating the extent to which Wise will benefit from COVID reopening, the positive impact of higher interest rates and the increased take rate from higher “other revenues”. This is backed by data on debit card issuance, card transactions and FX transfers. App and recruiting data also paint a picture of an accelerating business, quite opposite to what the share price chart would convey.

Business

Wise is the world's largest non-bank operator of currency transfers (by volume transferred) - at current run-rates it is over 20% larger than Western Union. Founded in 2011 by two Estonians to solve their own frustrations with slow and expensive currency transfers, the business has grown rapidly throughout its history, became profitable in 2017, and IPOd via direct listing in London in 2021. It rebranded as "Wise" (from "Transferwise") in early 2021 to reflect the broadening of its proposition away from just FX transfers.

Since 2011, however, Wise’s vision has expanded beyond their original FX transfer market focus. In 2016 the company launched a dedicated business-facing product. In 2017 the company launched multi-currency accounts - allowing customers to deposit money in multiple currencies and obtain bank details in multiple currencies for instance ("get paid like a local"). In 2018 it launched its "borderless debit card" with fee free payments in many currencies (customers are simply charged Wise's standard fees for currency transfer). And in 2021 Wise launched the first iteration of its investment product in the UK. Business services have broadened to include overseas expenses management and payroll etc. Customers increasingly use Wise accounts as a replacement for their bank account.

Additionally, Wise has opened their technology to partners wanting to offer currency conversion to customers but not willing to invest in the infrastructure needed to offer a best-in-class service and price. Neo-banks like Monzo and N26 are partners.

Market opportunity

The market for cross-border transfers is large, estimated at ca. £20 trillion. According to industry consultant EDC, ~£9 trillion (50%) are transfers made by Enterprise customers, who pay ~£9bn (10bps) to send and receive international transfers; ~£7 trillion (39%) are SMBs paying ~£118bn (1.7%) for transfers; ~£2 trillion are sent annually by individuals, who pay close to £63bn (3.1%) for the service. The market is expected to grow at mid-single digits over the next few years.

As of 2020, banks account for two thirds of personal transfer volume and ca. 95% of SMB volume.

Additionally:

-         Western Union estimates there are close to 200 million migrant workers sending between $600 to $700bn in remittances back home each year.

-         In their book The Payoff, Natasha de Teran and Gottfried Leibbrandt estimate there are over 5 million international students around the world paying for their tuition and living expenses

-         Lloyds Bank, in 2019, generated around £450 million of travel related revenues from customers using their debit and credit cards abroad. Assuming a 3% non-sterling charge and a 1% FX spread, this implies Lloyds’ UK customers transacted ~£11bn while on holiday. HSBC’s estimate of this market’ size in the UK is ~£65bn.

-         Visa, when announcing their acquisition of CurrencyCloud in July 2021 mentioned that 43% of all small businesses conducted international trade in 2020. In one of their recent earnings calls, they estimated a merchant target market of over 100 million businesses.

Wise’s main opportunity is to gain share of the market, from both banks and non-banks.

Also, as highlighted by the World Bank’s Remittance Prices Worldwide report, the cost of sending small amounts globally has declined by almost 40% since 2009. A similar and further drop in non-remittance prices would surely unlock additional volume. Wise can and should capture a portion of this.

Why do charges remain high?

Some thoughts (highly recommended reading: Marc Rubinstein’s Net Interest pieces on Western Union and Wise from summer 2021)

The cost of sending money has been high throughout history. A Google search for old money orders shows that sending $300 across the US in 1873 via Western Union money order cost $9.34, or around 3%; in 1974, sending $175 to Mexico from the US cost $8.25, or 4.7%. As mentioned above, sending money today, by bank, money order or using a specialized app like PayPal doesn’t cost much less, and in fact, can even be more expensive.

Another remarkable fact is that only around 4% of customers fully understand how much and where they are being charged. To date, it’s common to see financial intermediaries advertising “free” or “no fee” transfers while taking a 3-5% cut in the exchange rate. A charge of this kind led Kristo Kaarman and Taavet Hinrikus to launch Transferwise in 2011.

Up until recently, consumers doing sporadic transaction would trust their primary financial service provider (their bank) without bothering to look for alternatives. It would have been unlikely to receive feedback from a receiving party about the final amount received, which could have provided relevant information as to the real cost of it. Still, if you only had to do this once, why bother?

There’s also the lack of leverage: as an individual sending small amounts, what real choices do you have? Your bank knows this. Money Transfer Operators (MTOs like Western Union) are no better, they use the corresponding bank system themselves, using their aggregation advantage to get better rates, but there are several steps and charges in the chain.

SMBs get better treatment as their volumes become larger, but traditional channels confine them to the corresponding bank system.  If you’re transferring money to a supplier, but your local bank does not have a relationship with your supplier’s bank in a foreign country, your bank will need a correspondent bank that will in turn need a correspondent bank in that country who will have a relationship with the supplier’s bank. There are on average five nodes in this journey depending on how big your local and the supplier’s banks are and with whom they maintain accounts. Each step of the journey takes time, adds complexity (prone to error) and costs money (everyone wants a cut for facilitating the payment). Fewer steps in the chain and a bit of leverage reduce the cost dramatically. This is mostly the case for enterprise customers.

For larger banks, international money transfers represent less than 2% of their total revenues. A 2017 Santander internal presentation that was leaked to the press showed the bank had made €585 million in revenues from International Money transfers that year, or ~1.5% of the bank’s total revenue. For Wells Fargo, which has the largest wire transfer and remittance business of the US Big 4, it represents 0.5% of total revenues in 2020 at around $264 million.

Wise is currently doing around £8bn of monthly volume (May2022). They have been a digital only business from the start, focused on improving the cost for personal and SMB customers, initially in developed markets and focusing on the largest transfer currencies, USD/GBP/EUR. The range of markets and currencies they operate in has broadened over time and include several emerging market currencies today. They’re not directly competing in the ~$700bn remittance market, which remains largely cash-driven, where customer preferences still need to evolve and where average transfer values are relatively low.

Wise has been disruptive because it is easy to use, charges cheap and transparent fees and completes currency transfers much faster than traditional methods. It is 2x cheaper than digital competitors and 5-10x cheaper than traditional competitors, and 50% of Wise’s transfers are completed in less than 20 seconds, with almost 90% completed in less than 24 hours, compared to transactions traditionally being measured in days.

Why Wise is winning

Wise is still ran by co-founder Kristo Kaarmann who owns almost 20% of the company and who sold none of his stock into the 2021 IPO. He and the company more broadly give the impression of being genuinely passionate about the mission of money without borders - eventually achieving costless transfers between currencies. As noted on the website,

"We obsess about our mission in a way other companies don't. And we stay on track by following 3 unorthodox principles:

-          Be radically transparent

o   Most companies aren't always 100% honest about their fees and profits. We believe in having nothing to hide.

-          Charge as little as possible

o   Most companies charge as much as they can get away with. We believe in pricing for you, not us.

-          Make premium the new normal

o   Most companies have select products for select people. We believe in the best for everyone."

The commitment to the mission is illustrated by Wise's history of reducing prices over time, by the quarterly "mission updates" that are published on the corporate blog, and shines off the page when looking at the recruitment website and on Glassdoor employee reviews.

I believe this mission obsession has partly led to two of Wise's defining organisational characteristics: its cost efficiency and its extreme cost allocation granularity, which flows from the principle that all businesses lines and currency corridors should be sustainable. Wise aims to set prices such that margins are very similar across its business, and to do so obviously requires a clear understanding of the unit costs of all of its services.

 I believe that Wise's ease of use derives mainly from its singular focus on international payments and its scale (which allows for more effective product iteration / higher scale A-B testing).

The transfer speed is a product of the company's infrastructure, which includes being directly connected to payments networks (i.e. rather than being connected to central bank networks via a bank) in the UK, Euro area, Hungary, Singapore, Australia, Brazil. Next in line are US (FedNow) and possibly India.  

The low price is feasible as a result of an efficient cost structure, which in turn results from scale (amortising fixed costs of regulatory licences, technology infrastructure such as automated compliance and payment network integrations), the beneficial impact of the superior infrastructure (when payments are instantaneous Wise can offer a guaranteed price to the customer whilst taking next to no FX risk. A competitor with a slower infrastructure will have to compromise on one of these), and the self-reinforcing benefit of low prices driving low cost customer acquisition - a classic scale-economies shared flywheel.

To take one example of relative cost efficiency - remittance-focused digital peer Remitly has also grown very fast in recent years. However its economics are inferior to Wise's, principally reflecting much less efficient marketing spend. Wise's growth is around 4-5x as fast as Remitly's per unit of marketing expense. Hence Wise generates FCF of c. 25% of its revenue, whilst Remitly's cash burn is >10% of revenue. Both companies are likely to grow the top line at similar rates in 2022.

Speaking of marketing, Wise’s approach to NPS has delivered phenomenal growth for the business. Above 6 in the NPS scale is a promoter, below a detractor. Turning detractors into promoters is hard. It takes a product at least an order of magnitude better than what’s already available. Wise found out that a person going from 6 to 7 in the scale would tell a couple of friends about Wise, with each incremental point doubling the number of referrals someone would make.

Having happy customers potentially telling 16 of their friends about a product like this is powerful. A new financial product is typically associated with risk. With no reputation to go by, testing it out is not appealing to most customers. That high barrier comes down when someone you know - and trust – recommends it. For Wise, paying attention to detractors and working to turn future customers into promoters by fixing whatever issues detractors had had was a much higher ROI proposition than increasing the amount spent on marketing dollars in order to increase conversion rates. To this day, Wise gets two thirds of new customers form referrals.

Over time, Wise will increasingly benefit from incumbency dynamics also. Customers are somewhat sticky and will be hard to prise away from Wise given its strategy and scale, which will make it difficult for competitors to offer a low enough price to tempt customers to switch.

Competition / Threats

There are more than 20,000 banks around the world. They accounted for two thirds of personal transfer volume and ca. 95% of SMB volume in 2020. Regulatory trends globally are pushing them to get up to speed in payments. For example, the G20 has made the enhancement of cross-border payments a priority.

Historically, Wise have made banks their nemesis. They feature heavily in their marketing and advertising campaigns. Against banks, their product is somewhere between 3x and 10x cheaper

Some large banks, partnering with infrastructure providers such as SWIFT, EBA Clearing and The Clearing House, have recently trialed real-time cross border payment messages involving different settlement systems and one of the most active currency corridors (EUR-USD) to demonstrate the possibility of improving upon current processes and potentially enabling faster and cheaper payments on other corridors. While promising, the challenges banks face to effectively compete with Wise are significant.

The most obvious one is the complexity inherent in the current system. There are different messaging systems: SWIFT, CHAPS, etc. The incentives to mitigate complexity will differ for each member of these networks.

Beyond this, banks have a lot to lose. As a thought exercise, at Wise’s average take rate of 70bps, banks would lose ca. £125bn in revenues from the $9 trillion Business and Personal cross-border payment volumes the intermediate today at an average fee of 2.1%. Banks love these revenues, they’re RWA light and surely high margin. Large banks like Bank of America and Lloyds have operating margins well above 20%, but assuming a 15% operating margin (conservative) in cross-border transfers, banks would need to accept a reduction of ~£17.5bn in profits. At 10x, the market capitalization sacrifice would be almost £180bn, which seems like a big ask, but may become more palatable with higher interest resulting from higher rates.

Over the summer, we’ll get a chance to test this exercise, however, as HSBC recently announced their very own “Global Money” product for UK clients, which attempts to replicate Wise’s ease of moving money around. By helping customers save £1bn a year using Wise, the company is already eating into the banks’ lunch.

On top of these >20,000 banks, there are plenty of newcomers to the space.

Since 2015, over $250bn of VC money has been invested in payments and payment-related fintech companies.

By making the WisePlatform APIs available for partners, they are and will turn some of these potential competitors into allies helping with customer and volume growth, but not all.

Revolut (and others) has a broader product range and could cross-subsidize FX, for example. However, the business remains unprofitable.

Other competing products include Central banks creating digital currencies, which may make cross-border transfers much cheaper once they do. Crypto could end up being cheaper for cross-border?

What the data is saying

I have collected data on Wise’s debit card issuance, card transactions and FX transfers.  Here are some of my findings on a number of points

1.      Volume growth:

Wise’s daily FX transfers have roughly doubled since October last year, and currently run at ca. 650k. The average transaction size has been declining, probably as a result of new market launches, more frequent use of the service, growing numbers of super users. Still, assuming a decline of ~10% vs FY21 estimates of £450/transaction, the total annual volumes for FY22 should approach £77bn. Consensus expects £74bn. My expectation of volumes triangulates quite well with disclosures in a May 17th press release regarding the return to work of the CFO where they mentioned a monthly run rate of £8bn processed in the “About Wise” section. In fact, a trail of this section in various press releases confirms an acceleration in volume growth and customer numbers.

-          17 May 2022: "13 million people and businesses use Wise, which processes over £8 billion in cross-border transactions every month"

-          6 May 2022: "12 million people and businesses use Wise, which processes over £6 billion in cross-border transactions every month"

-          9 Dec 2021: "Over 11 million people and businesses have used Wise since it was founded. Today we process over £6 billion in cross-border transactions every month"

-          30 Nov 2021: "Over 11 million people and businesses have used Wise since it was founded. Today we process over £5.5 billion in cross-border transactions every month"

-          21 Oct 2021: "11 million people and businesses use Wise, which processes over £5.5 billion in cross-border transactions every month"

-          7 Sep 2021: "10 million people and businesses use Wise, which processes over £5 billion in cross-border transactions every month"

Also they disclosed that £8.75bn were received (and processed) in Wise Accounts in their most recent quarterly mission update. In previous quarters this figure represented close to 39% of quarterly volumes. In summary, their 4Q21 was likely a £22bn quarter, representing over 42% YoY growth and accelerating from previous quarters.

2.       Interest Income

Wise like to say they’re not a bank and cannot call themselves a bank but can’t help customers calling them or treating them as a bank. In fact, many appear to do so, using them as a relevant account for their needs, and leaving significant cash balances in their accounts.

Wise cannot do anything with these, other than safeguard them in different bank accounts and invest a portion in money market securities.

As of September 2021, customer balances were approaching £5bn, up from £3.7bn at IPO and just £147 million three years prior. Wise’s own corporate cash had increased to almost £400 million at the time.

In a July 2021 blog post Kristo Kaarmann disclosed the custody mix of the deposit balances. About half was invested at that time in US and UK (short term) government bonds, with the remainder placed in various large banks (JPM, Natwest, Barclays) Holding these assets cost them around £2 million in FY21, ca. 30bps.

Interest rates are rising, however, surpassing 1% already in the US and UK for T-bills, and expected to get to 0% in Europe soon. Using current rate expectations and based on the above-mentioned asset safeguarding blog comment, the run-rate interest income is probably around £50 million today on about £8bn of balances. Consensus has £5 million of interest income for each of FY22, 23 and 24, a material underestimation of the revenue opportunity embedded in their balance sheet. Also, there’s no long term debt to offset this income.

3.       Incremental margins

As mentioned before, Wise’s volume growth provides significant scale advantages. In certain major currency routes they’re number one in volumes already. This brings down their cost of sales, as does the focus on speed and accuracy of transactions, which reduce liquidity needs and FX costs. There’s a positive impact on gross margins every time they reduce these costs.

Wise generates two types of revenue (for now at least): one is the FX fees (fixed and variable) charged on sending money abroad; the other comes from various types of fees, the majority of which arise from customers using their debit cards (such as interchange fees) which are linked to their multi-currency account.

Wise multi-currency account holders transfer two times the volume of a non-account customer, for example. A fifth of individual customers and half of business customers have an account. On top of this, as judging from the data collected, account holders are using their debit cards more frequently: almost 8x per month as of 4Q22, compared to 2.5x as 4Q21 (remember Wise’s March year end).

The adoption of Wise cards has been spectacular: in July 2020, they had 1 million in the hands of customers. As of mid-June, the number is closer to 3 million. The volume of debit card transactions per day has increased by over 6x since Q4 of calendar 2019, and has more than doubled since the H1 FY22 financial period ending Sep 2021.

Finally, in September 2021, they were issuing close to 3k cards per day, 5k in March and April this year and close to 7k cards per day in late May.

The debit card naturally has a foreign-travel driven use case (but not only). Which makes Wise an underappreciated beneficiary of the post-Covid reopening of travel.

Interchange fees are incentive fees paid by the merchant to the card issuer. There are costs: anti-fraud, verification, etc. but margins are high. These revenues have been growing at higher rates than the total, and should become more important as adoption of cards accelerates further. Other fees have increased from 7, 8, 9 to 13bps of total volumes between 3Q21 and 2Q22.  

4.       Take Rate 

Directly related to the points mentioned above.

Wise’s mission is to lower their FX costs for customers sending money. They’re working hard on this. Consensus implied take rate is declining over the next few years. However, this ignores the interchange revenue opportunity discussed above, which management has alluded to a couple of times in recent calls.

I expect take rates to increase in coming years, despite the price of FX to customers following a downward trajectory. It was 74bps as of September 2021. 

With an upward volume growth trend, the total revenue opportunity for Wise looks very attractive.

5. Other data

App data: App Annie data shows an acceleration of app downloads since the beginning of the year.

Recruiting data: as of last week, there were close to 415 open roles in Wise’s careers site. There is a periodic historic record of the number of open positions over the last couple of years as the CEO has occasionally used Twitter to link to the recruiting page with a note of the number of open positions. The current figure is almost 50% higher than that of Jan 2022.

This counter-cyclical component of Wise's operating performance means it is aggressively hiring at the same time many tech companies with whom it would normally compete for talent have implemented hiring freezes or are conducting significant lay-offs. Wise may be in a position to have the pick of the best tech talent, which is a potentially very significant advantage.

Valuation

A few thoughts on the current valuation.

As mentioned before, Wise’s November 2017 Series E fundraising and the subsequent secondary transactions in May 2019 and July 2020 valued the business at a fairly consistent 8-10% of estimated annual volumes and existing customers at an average GBP 434/each. Implied LTM revenue multiples were around 11-14x.

The business margin structure has improved since then. It’s free cash flow margin is currently around 25% compared to between 3 and 13% over the 2017-20 period.

The current valuation is close to 3.7% LTM processed volume, 5x revenue and around GBP270 per customer.

Wise is trading at ca. 17x my estimate of forward FCF (ex. SBC and including the interest income cash flow stream), which is not a big ask for a business growing at >40% in my view.

Back solving for a 10 year IRR of 10% from current levels and assuming a “mature” EBITDA margin of 30% and take rates of 84bps, I need to underwrite Wise’s ability to grow processed volumes at ca. 12% CAGR over the period. Between 2013-2022, annual volumes grew at 200% CAGR and as discussed above, I expect growth to err on the upside of expectations in the short and medium term. At the time of the IPO you’d have had to underwrite a >20% annualized growth rate in volumes for a similar return. For the reasons discussed above, Wise may end up growing anywhere inside that range of 12 to >20% but today I’m paying much less for outcomes at the high end of the range.

Finally, a thought exercise around shared economies of scale. I’ll pick on Western Union, a +150 year business that dominates the remittance market and still today generates $5.2bn in annual revenues and close to $1.2bn in operating profit. Total volumes are not disclosed, but quoted figures I’ve found online mention >$95bn/year. This implies a take rate for Western Union of >5%, or 7x Wise’s.

My estimate of £77bn of volumes for Wise’s in FY22 would bring in close to £600 million in revenues and close to £80 million in operating profits. Wise wouldn’t have a reason to exist and would have never achieved what they’ve achieved had they charged Western Union rates, but as part of the thought exercise, at Western Union level of charges, Wise would generate almost £4bn in revenues and £0.8bn of Op. margin. These numbers contextualize the consumer surplus Wise helps deliver. According to Wise, customers are saving close to £1.1bn/year by using Wise rather than other means, which implies a competitor set take rate of close to 2.6%, 3.4x Wise’s.

The goodwill created by customer surplus delivered is nowhere capitalized on Wise’s balance sheet. Typically, businesses sharing their scale economies, willing to forego revenues and profits to deliver customer savings, end up with a durable competitive advantage that translates into high multiples of earnings. I believe Wise should fall within this category of businesses.

Also, for what is worth, every sell-side analyst who covers Wise today (including those with a Sell recommendation on the stock) has a target price significantly above the current price.

To summarize, I believe the current valuation significantly underestimates the potential of the business going forward.

Catalyst

Full year earnings driving analyst upgrade

Better communication from managemnet leading to better understanding of the opportunity by investors

Time / Execution