If you travel a lot or run a business dealing with different currencies, you’ll know how difficult it can be to change money. Technology has disrupted almost every aspect of life over the last two decades, apart from, it seems, the foreign exchange market.
Currency dealers and brokers can still command huge margins on changing one currency to another even though it requires almost no investment and skill.
For example, right now, institutional investors dealing with millions of pounds can trade £1 for $1.20, but if I go to the Post Office to buy some dollars for a weekend away in New York my £1 will only buy $1.15, a difference of 4.4%. As the Post Office is likely to be buying and selling in the institutional market, it can pocket the difference.
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Of course, the Post Office has to make a profit on the currency it buys and sells, so I’d expect there to be a slight difference in the price. It also has to prepare for volatility in the market, so it tends to offer customers a worse deal to compensate for the risk of having to buy and sell currency and the risks associated with this trading.
The Post Office is actually one of the better places to change currency as in this industry it’s quite common for dealers to view foreign exchange as one place where they can still make a solid margin.
PayPal charges over 3% to change pounds to dollars and the UK’s largest online stockbroker, Hargreaves Lansdown, charges a fee of 1% for investors to change currency (on deals under £5,000).
These fees and charges might not seem like much, but they do add up. Businesses trading in different currencies can find themselves paying thousands of pounds a year in fees for what tends to be a sub-par service.
This is the market Wise (formerly known as Transferwise) was set up to disrupt.
Wise is a fast-growing disruptor in a fragmented market
Wise was founded by Estonian businessmen Kristo Käärmann and Taavet Hinrikus in January 2011 when they realised how much banks were ripping them off when transferring currency (and they still are – the rate Barclays charges today is worse than that offered by the Post Office).
Over the past decade the company’s growth has been phenomenal. In the first quarter of this year, it helped customers shift £24bn across borders, an increase of 49% year-on-year. That puts it on track to manage nearly £100bn of transfers this year, up from £54bn two years ago.
Clearly, Wise offers something customers like, and I think I know what it is.
Wise charged an average transaction fee of 0.61% in the first quarter. That was down from 0.67% in the prior year period. Unlike the rest of the finance industry, Wise is pushing fees lower as it grows. By comparison, in the company listing documents it noted that in 2020 £18trn moved across borders, for which financial services firms charged £190bn, 10.6% of the total.
At this point I should clarify what I mean by “charged”. There are ostensibly two ways currency brokers charge customers. There’s commission, and there’s the difference between the buy and the sell price, which is known as the “spread”. However, these numbers are really one and the same. If a broker charges 1% commission and has no spread the cost of the transaction will be the same as zero commission and a 1% spread.
Wise gives the market rate but adds a small fee on top. My app tells me that right now I can trade £1,000 for dollars at the market rate with a £4.43 fee. The exchange rate is guaranteed for two hours.
If I want to move £1,000 and have to choose between Wise’s 0.44% fee and PayPal’s 3% charge it’s a no-brainer.
The difference is even wider for businesses. Wise estimates the average annual cost of currency transaction fees to small and medium-sized businesses is around 17% of deal volumes. The cost is particularly high in emerging and developed markets.
Market fundamentals support Wise’s growth
I think it’s important to understand the fundamentals of the global foreign exchange market to understand why Wise has something special, and why customers are flocking to the business.
The company also offers low-cost foregin currency accounts for users around the world, which gives it yet another edge in this deeply fragmented market.
Sending currency around the world is a high-margin business, as once the network is set up costs are relatively low (that’s why it’s so astounding that the incumbents can get away with charging so much).
Thanks to this model, Wise is part of an illustrious club of profitable high-growth tech companies. This year the firm is guiding for an adjusted earnings before interest, tax, depreciation and amortisation (ebitda) margin at or above 20%. Refinitiv analyst estimates expect Wise to report a net profit of £91m this year and earnings per share of 8.7p. Net income is projected to jump a further 30% next year to £116m.
At 40 times forward earnings, the stock does look a bit on the pricey side. What’s more, while Wise might be grabbing market share with its low-cost offering today, a larger rival could slash fees, potentially decimating its growth. This is a crowded market, after all.
Then there are the costs of doing business in an industry where the risks of money laundering and fraud are high. The company has warned that the costs of compliance this year will eat into its profit margins.
Still, thanks to Wise’s customer proposition, operating leverage and the size of the market (£100bn in annual transaction volumes account for just 5.5% of market volume), I think the runway for the business from here is huge.
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