Xoom (XOOM) priced last week just above their filing range at $16 and then traded up sharply to close out the week at just over $25. The deal followed on the heels of the very hot IPO of ExOne (XONE) which priced above the range at $18 and quickly traded up to a high of $32. ExOne has benefited well from the hype around 3D printing. XOOM is a very different story (online payments) but with all the key ingredients for a strong IPO. Our initial analysis included a rough intrinsic valuation model that suggests a $40 to $45 stock price.
From a fundamental standpoint the strengths of the company are in the network-oriented growth in users and revenues from $50M in 2011 to $80M in 2012. High gross margins of 67% allow the company to invest and gain share even though they are already the low-cost provider in the market. The gross margin combined with declining costs as a % of revenue will expand operating margins and allow the company to reach 20% operating margins. These strong fundamental factors are what drives the valuation.
Here are some of the key facets of XOOM for investors:
- Online payments are an attractive business due to growth and positive returns to scale. Once fixed costs are covered, increases in transaction volume drive revenue growth with expanding margins.
- XOOM is focused on the lightly banked and international segment of the market. The prototypical example is an immigrant in the U.S. sending money back to his family. For many people in emerging economies there is little access to banking services, let alone PayPal accounts. Transfers in these markets are harder to do so as XOOM grows they will have built something of a moat to protect their service from direct competition.
- The solution offered by XOOM is a mobile app which is a big improvement over standing in line at a shady paycheck cashing firm offering to send money abroad with high fees and varying reliability.
- This particular niche market generates $100B worth of transfers from the U.S. alone. Worldwide the figure is 4-5x that amount. Overall volumes are growing at 2-3x inflation. Today XOOM has only 3% penetration of the U.S. opportunity and less than 1% globally.
- XOOM provides virtually instant transfers when they are funded from bank accounts. This compares to days or a week for other transfer methods. Payout options are also far more diverse and focused more on cash pickup at local establishments. Typically a family member will go to the local store or bank and pick up their money in cash.
- Risk management is a necessary strength of the company. XOOM is helped in part by transactions that tend to be smaller and more regular than large ones. This helps them provide speedy service and avoid major fraud and money laundering. Still as transaction sizes and/or volumes between parties increases XOOM institutes progressively higher levels of verification and compliance.
- Customer level economics support long-term growth. XOOM estimates their CAC at $41 and their cohort analysis shows good ROI that has been improving steadily since 2010. Total active customers increased from 517K to 776K (+50%) from 2011 to 2012. Annual revenues went from $50M to $80M for the same periods.
- The company is reaching positive operating margins and projects that they can reach a 20% operating margin if they execute well against their long-term plan.
- The biggest concern here outside of the obvious (competition) is churn. Using the difference between new customers and the end-of-period total active customers we see quite a bit of churn. That said the rate has been dropping and moved down sharply in the most recent period (2012). Also good news is the fact that a key productivity metric we call the "T-Score" has also improved dramatically and remains at a high level.
- Competition in the online financial services world is intense and includes large players like Visa and American Express, smaller ones including PayPal and Square and "alternative" financial services providers like Green Dot (GDOT), NetSpend (NTSP) and venerable money transfer firms like Western Union (WU) and MoneyGram International (MGI). Thankfully for XOOM they are going after what should be a defensible segment of the total market. However competition may ultimately put some pressure on pricing.
- Overall the quality of the story, existing operation, management team, business model and market opportunity make XOOM a strong IPO in our view. How close the shares come to our basic IV estimate of $45 remains to be seen but if the stock opens quietly we'd find it very attractive.
One small nagging issue is the fact that other alternative financial services IPO names haven't done very well in the market. Names like Green Dot, NetSpend and Higher One (ONE) have all been fairly disappointing after some initial success post IPO. They are very different from XOOM so may not be that relevant but still…