With a ticker symbol like XOOM, I am more inclined to zoom past the company than go to the effort of opening up the latest 10k (and yes, I understand that was a lame attempt at a play on words). This is especially true when it turns out there is no recent 10K, only an S-1 filing, indicating that the company has been public less than a full year. But, let’s live on the wild side for a moment….
Xoom Corp is involved in the money-transfer business. I looked at the two main players in this field a few years back, Western Union and Moneygram, so it seemed like a promising start.
What initially struck me as interesting about XOOM is that its business model is one that isn’t as easily replicated by the established players as you might think. First, a little background.
The money transfer business involves a sender and a receiver of money. For simplicity sake, let’s imagine an individual in the United States deciding to send money to Mexico. The US-based sender will go to their local Western Union agent (typically part of another retail establishment, grocery store or convenience store) and “deposit” the funds. The Mexican-based receiver will, after being notified that the money has been sent, go to the Mexican-based Western Union agent and collect these funds. The money transfer companies make money primarily through two different streams: first a transaction fee; and second, a foreign currency conversion fee (these companies buy the foreign currency at a wholesale rate and sell it to the receiver at a retail rate).
The key aspect of the money transfer business has been its reliance on a “network effect.” You want to send money through a company that has an agent in the country where you are trying to send the money. eBay is a great example of network effect, you want to go sell something where the most buyers are and visa versa. These type of situations lend themselves to develop into an oligopoly where there is only room for a few big companies. Western Union and Moneygram have dominated this business and it would seem that the prospects for XOOM might not be great given the network they would have to build out.
XOOM’s technology seeks to subvert the network effect barrier by eliminating the sending agent. XOOM’s technology allows the sender to initiate the process online or through its mobile app without the need for a sending agent. This change cuts down on the costs because XOOM has cut out the sending agent’s fee. At first blush, this competitive threat seems like a garden variety housefly to be easily squashed by Western Union and/or Moneygram.
However, it is unlikely that Western Union or Moneygram will suddenly adopt this technology/business model full scale (both already have a variant, but neither push it very much). Although the technology isn’t revolutionary–it is more of a business model change, because the technology would change the largest barrier to entry that has existed for their business–its network effect. The sending agent acts as advertising for its services and cutting them out or essentially competing with them could force some of them to discontinue offering their services. This is the similar reason to why GEICO has been able to compete so successfully against the established players like State Farm despite not having a truly novel idea. State Farm has “legacy” agents that it doesn’t want to upset by distributing its product over the internet. Hence, State Farm and others have been slow adopters of internet-based selling.
In other words, I think they have a good business model and if their product works well, they might move quickly to take market share from the established players before they realize what hit them. That being said, Western Union has agents in 200 countries, whereas 60% of XOOM’s business went to only two countries, India and the Philippines.
The are two other things I like about this company.
1. Low capex: Investments in capex over the past 5 years have totaled roughly $9m and I am rounding up. Low capex companies are good, in my mind, because they allow companies to return profits to their shareholders and maintain flexibility within their business. If you have to re-invest 100% of your profits in upgrading your facilities or equipment each year, that sounds like the “Water Cycle” from my kid’s second grade science class–not a business that throws off sustainable levels of excess cash. Additionally, not having to make large capex decisions relieves management of the pressure of making the $500m “capex investment” that subsequently needs to be written off.
2. Variable Cost Structure: Since the majority of the company’s cost of goods comes from fees to receiving agents, these fees only occur when customers are using the service, hence the variable structure. Variable costs provide a company with slack, when business is good, costs will rise. When business slows, costs will also go down. These sort of companies are a plus in my book, because their business model is adaptive by nature and doesn’t rely on management to forecast perfectly how their business prospects will play out each year.
You may notice a trend, I like companies where management doesn’t have to be that smart because someday (probably today) they won’t be. I seem to recall a quote about the “best companies are those that could be run by a ham sandwich….?”
The biggest problem with this company isn’t its technology or its business model. Instead, it is the valuation. Making about $10m in one year and being worth $1B in market cap is just too pricey for me.
I may be wrong on the valuation issue, say for example that XOOM takes large portions of market share away from Western Union and Moneygram. This could be a great opportunity to get in on the “ground floor” (as the penny-stock traders like to say), however, that’s just not my style. I am not saying it is wrong, it just isn’t my style.
To alter an oft quoted Buffett line, I prefer solid companies when they are on the operating table to those coming out of the delivery room.
Reading through 10-k filings is interesting and even though I won’t invest in XOOM, I am reminded of a few things I really like to see in companies:
1. Low capex
2. Variable Cost Structure
3. Interesting Business Model
This is one of the reasons I don’t use screens. This company probably would have never popped up on any screen I would have created, but I think the process is just as rewarding as the end result, although hopefully the end result is nice as well…and financially rewarding. If it isn’t, maybe I will have to look into that screens thing…