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By Nathan Zaia | 08-18-2014 01:00 PM

Building a Moat in Foreign Exchange

OzForex’s low-cost, online business model could prove to be a meaningful market disruptor, and the shares look like a bargain today.

Nathan Zaia: OzForex was listed on the Australian Stock Exchange in 2013, and it operates in international money transfer and foreign exchange markets. The key difference between OzForex and the traditional players--such as the banks, Western Union, and the smaller stores you see in your mall or at the airport--is that OzForex has no branch network. It's purely an online business. So, utilizing this low-cost business model, OzForex offers its customers two key benefits: speed and price. And there are also the additional advantages that come with most online businesses, allowing a consumer to transact anywhere and at any time.

So, given our positive view and belief that OzForex and other first movers like HiFX, WorldFirst and Xoom will prove to be meaningful market disruptors, we assign OzForex a positive moat trend.

Given the scalable business model, there is no incremental cost the more money you flow through the platform. So, as OzForex continues to grow its customer numbers and the money going through its platform, the cost per transaction begins to fall and, hence, cost advantages begin to form.

Additionally, counterparty banks that provide these dealing facilities have begun to become a lot more selective with whom they want to deal with, and this provides a barrier for new entrants coming into the market. HSBC was fined $1.9 billion in 2012 for acting as a conduit to money-laundering and just pulled the plug on the market entirely. Barclays, on the other hand, slashed the number of dealing facilities it provides in 2013.

In terms of value, OzForex's share prices have come under quite a bit of pressure in recent times after it missed the market's expectations on new dealer numbers. We, however, remain positive over the long term that this business can take a meaningful share of the market--a very large market. We think, at current prices, OzForex is undervalued, trading at a 30% discount to our $3.40 fair value estimate.

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