Xoom is a digital money transfer provider in 31 countries, focused on helping consumers send money in a secure, fast and cost-effective way using their mobile phone, tablet or computer. During the year ended December 31, 2013, Xoom's more than one million active customers sent more than $5.5 billion to family and friends. The company is headquartered in San Francisco.
This year Xoom's share price has languished, down 45%. The reasons for this relative underperformance, aside from it being overpriced to begin with, may be traced to company actions, market forces or both. Following are some of the reasons I believe the company's stock has seen this steep decline and why it may continue.
A surprise to me has been the lack of operating leverage present in the business model. My original thesis about the company was that the "money transfer engine having been built," costs would increase much slower than sales thus showing a superior business model and margins than the 800 pound gorilla, brick-and-mortar Western Union competitor. For the nine months ended September 30th revenue increased 27.7% and cost of revenue increased only 20.2%. So obviously cost of revenue (COGS) is not the problem with operating leverage. Instead operating expenses are the glaring issue which we'll get into more in a moment.
The Big Question
Whether Xoom is a technology company that happens to transfer money, or a money transfer business that uses technology as a means to an end is the earnest question about this company in my mind. I believe the latter should be the answer, but that Xoom aspires to the former. The answer has everything to do with how the company allocates the proceeds from its IPO, and I believe the direction of earnings.
5 Reasons to Sell
1) Lower Earnings
Xoom's earnings have been declining. From a paltry $5.1M in the first nine months of 2013, net income has declined to $2.1 for the corresponding period of 2014. If earnings growth is a focal point of the company it does not show. This is not 1999 and Wall Street no longer gives free passes to companies that have no intention of making money (unless your Amazon and even Amazon's stock price has been punished this year.)
2) Spending that Money
If the Xoom IPO gave the company a mandate to spend excessively, the company took this message to heart. Apparently, the cash burns a whole in Xoom's pocket. Operating expenses as a percentage of revenue increased for the 9 months ended Sept. 30th 2014 by 43.8% over the prior year period. Revenue increased 27.8% in the same period.
I believe spending discipline is one of the primary problems at Xoom. Technology and Development costs increased 62.2% during that nine month period and now represent over 23% of revenue. That is some number for technology and development. To put that number in perspective, the R&D spending at Ubiquity Networks, a company that relies on a continual stream of new technology products spent 7.8% of revenue on R&D in the same period. If the operating platform is so disruptive, margins should increase rather than shrink as fixed costs are absorbed more rapidly by increasing revenue. Stock-based compensation has been one of the primary cost drivers in expense increases and has grown from $2.8M in the first 9 months of 2013 to $6.8M in the 2014 corresponding period.
3) Revenue Growth is Slowing
Despite the significant increases in marketing and technology, revenue growth has slowed from 52% in full year 2013 to 27.8% for the first nine months of 2014.
4) New Office/Lease Obligations
Xoom has moved into new offices at 100 Bush Street in San Fransisco's financial district with leasehold improvements in the first 9 months totaling $8M. The company also has a new development center in Guatemala City. According to the latest 10q, lease obligations now total over $48M, and $10.4M per year over the next 3 years. Talk about putting a hole in earnings! Peter Lynch opined in Beating the Street, Peter Principle #7 that, "The extravagance of any corporate office is directly proportional to management's reluctance to reward shareholders."
5) Increased Competition
Aside from the lack of spending control, competition is the other greatest concern about the company in my mind. Maybe we cannot call Xoom's technology disruptive after all. Western Union has developed both an online and mobile money transfer platform as well. What's more, there are many more online competitors. A simple Google search for, "money transfer to India," brings up several competitors - all with better exchange rates on 11/19/204, the day I searched. They include ICIC Bank (money2india online platform), compareremit.com, riamoneytransfer.com, remit2india.com, as well as Western Union and others. In some cases the exchange rate on this day was a full 1% better than Xoom's rate of 61INR per $1. The fees were fairly similar although most beat Xoom in fees as well. Xoom did have the top free (organic) listing on Google for this keyword search.
For the same search for the Philippines another competitor popped up. In addition to riamoneytransfer.com, remitly.com came up first with an online transfer rate of 43.93 pesos per dollar compared to Xoom's 43.75.
The company warns about the risks of competition and growth in it's recently filed Form 10Q:
"We may not be able to acquire new customers in sufficient numbers to continue to grow our business due to macroeconomic factors including exchange rate fluctuations, increased competition, new regulations or other factors, or we may be required to incur significantly higher marketing expenses in order to acquire new customers. In the event that we reduce our marketing in any given period, whether in response to higher marketing expenses or otherwise, we may suffer a decline in new customer growth in that period or subsequent periods . For example, we reduced our television advertising during the 2014 World Cup due to increased advertising costs during that time, which reduction may have impacted new customer growth in the third quarter of 2014."
Now for the Positive
Xoom has little debt though they have opened a line of credit recently. The balance is very strong with over 4X assets to liability coverage. The company has the potential to show good operating margins growth by cutting or at least controlling spending and stock-based compensation increases. The money transfer market in general is a growing business, providing industry tailwinds. The money transfer business, or at least Xoom's business, is sticky and the company states that 90% of transactions come from repeat customers. The company has some plans to open money transfer to China but at a small percentage increases to revenue.
Obviously it's difficult to value a company with paltry earnings. The current P/E is 186X even after a 45% drop in the stock price this year. Price/Book Value is 2.07X and there are few intangibles on the balance sheet. Price/Sales is 3.8X. The balance sheet is in good shape with 4.7 times more assets than liabilities.
Just for giggles let's hypothetically take a look at what the company might make by cutting technology and development and marketing costs down to what I would consider reasonable levels, then adding them back to earnings. I add back $25M in Technology & Development (75%) and $6.1M in Marketing for 2014. This gives us about $29M pretax earnings for the year after adding back existing earnings. Tax it at an estimated 25% and I calculate an estimated $21.7M net income for a healthy 18.4% net margin. But even at that level the Price/Earnings ratio is still 26.4X even after the 43% price drop to $14 per share.
Despite a 43% drop in the share price this year, Xoom is still a sell in my book. Growth and spending trends are disturbing, and competition appears to be growing rapidly. Until Xoom decides to drive operational efficiency and reasonably pay for growth at the same time, earnings will remain mute.
Additional disclosure: The information in this article is not investment advice nor a formal investment recommendation to buy or sell this security. Investors should consider seeking advice from a broker or financial adviser before making any investment decisions. Investors should always conduct their own due diligence prior to purchase on any security named in this article.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.