1.8 billion British Pounds Saved!
That’s how much Wise (a fintech firm) saved its 13 million worldwide customers in currency conversion fees, on the GBP 118 billion of cross-border transactions in 2023.
Which translated into an average saving of ~GBP 140 per customer!
What about me (Fun Liang)? For the past ~2.5 years, I have been moving around and living in twelve different countries around the world, using Wise as my primary card in all these countries (for card payments, ATM cash withdrawals, and bank transfers), involving at least 10 different currencies.
The results? Not only has Wise helped me to save >GBP 350 a year, they have made my life so much easier with its simple and convenient use. I have never needed to visit currency exchanges while moving around in these countries in different continents, or worry about being overcharged during conversion. The conversion rates charged by Wise are almost the same as the spot rates (displayed when you do a Google search)!
Whenever I am a happy customer of any business and think that the company is offering tremendous value compared to the other alternatives, I always check if the company is publicly listed, and whether investing in it could potentially compound my wealth too.
The good news is that Wise is indeed listed (in the London Stock Exchange), and is tremendously profitable while growing fast too (with 25% net profit margin and 46% revenue growth in FY2024)!
So, can Wise help us to compound our wealth too, over and above the savings it can generate for us?
Let’s examine Wise’s business, its ‘Scaled Economies Shared’ moat (sought after by the legendary investor, Nick Sleep), its latest financial performances, and the current concerns we have with Wise (including its valuation).
Wise’s Business
Wise (formerly known as TransferWise) was founded in around 2010 by two Estonian co-founders, Kristo Käärmann and Taavet Hinrikus, after they felt ripped off by the currency exchange rates charged by their banks on global transfers.
Determined to completely revamp the global money movement system, they have built their own payment infrastructure, to replace the old correspondent banking system used by the banks.
As shown in the image below, for a single money transfer, the old correspondent banking system involves many different intermediaries (e.g. four correspondents in the example below), and therefore requires many manual or semi-automated processes, and is slow, unreliable, and hard to monitor.
Meanwhile, if the transfer is executed through Wise, it involves only Wise’s own banks and partners network in the different countries, which it has gradually built up over more than a decade. This involves lower costs, is faster and is more transparent.
Wise has managed to achieve this advantage, because it operates local accounts (with its own liquidity pools) in each jurisdiction that it is present in. This allows them to move funds between parties (wishing to transact) without the funds actually ever crossing borders.
Since Wise acts as a middleman in the transaction flow, the currency exchange effectively settles against their own book, and therefore they can save on fees typically paid to banks as part of the correspondent banking system.
Currently, Wise offers three different products.
First, the Wise Account allows individuals to:
Hold money in ~40 different currencies while earning interests
Transfer funds to local accounts in different countries fast and inexpensively
Set up local bank account details for different countries digitally to easily receive money in those local currencies
Obtain a Wise debit card for offline and online transactions or withdraw money from ATMs in different countries (with Wise automatically making the currency conversions at low charges).
Second, the Wise Business account caters to businesses to help them operate like locals with multi-currency accounts. Businesses can make international payments with low-cost currency conversions. The Wise business account also supports expense management, invoicing, analytics, reporting, integration with accounting systems, etc.
Lastly, Wise Platform empowers other banks and companies to leverage on the infrastructure that it has built up for more than a decade, to provide global payment solutions at low cost and fast speed.
‘Scaled Economies Shared’ Moat
A very powerful aspect about Wise’s business model is its scaled economies shared flywheel moat, which was coined by Nick Sleep (from Nomad Partners, with a ~20% compounding track record over a 13-year period).
The scaled economies shared flywheel is a strategy where a company benefiting from economies of scale chooses to lower its prices and/ or improve its offerings to win market share in the long run, instead of pricing its products to maximise profit in the short run.
The lower price or improved offering in turn attracts more customers, allowing the company to gain even larger scale, and if the company keeps repeating this cycle. It becomes a flywheel, with its scale and competitive advantages growing continuously, making it harder and harder for competitors to compete and offer as much value to the customers.
Companies like Amazon and Costco have benefitted from this scaled economies shared flywheel to become dominant in their industries.
Similarly, Wise has also been working on developing its scaled economies shared flywheel moat. When it gains more volume and achieves lower unit costs due to economies of scale, instead of keeping those benefits and higher profits to itself, it actually targets to return the benefits back to the customers. This is achieved through lower prices (priced on a cost mark-up basis) and more investments in products to improve its offerings, thereby attracting even more customers with the higher values provided.
So far, it has managed to reduce its average fees to ~0.64% in FY2025 Q1 from ~0.70% four years ago, while significantly improving its payment speeds (with ~62% or ~95% of transfers being completed almost instantly and within one day, respectively, as of FY2024 Q4).
Wise’s deep integration with the local payment networks in different countries (instead of relying on the local financial intermediaries) makes the lower cost and faster speed possible. As of now they directly connect to the five local payment systems (the U.K., Hungary, Europe, Singapore, and Australia).
These direct integrations can take years (e.g. ~3 years for the Australia integration), and hence would take time for competitors to replicate and compete.
The scaled economies shared flywheel has been working well for Wise so far, with its customer base growing fast (for both its personal and business customers), at a CAGR of ~29% in the past 3 years (as shown below), or ~31% in the past 5 years.
Importantly, most (i.e. two-third) of the new customers joined Wise through word-of-mouth recommendations. This is a testament to the value that Wise is offering to existing customers, and the level of satisfaction among them.
Instead of trying to compete with Wise (by building up their own new payment infrastructure from scratch), many of the potential competitors (including large legacy banks, like Shinhan Bank in Korea, IndusInd Bank in India, and Mandiri Bank in Indonesia) have chosen to partner with Wise and leverage their platform to offer global money transfer services at low cost and fast speed.
Recently, NuBank, a very fast growing neobank in Brazil (with >100 million customers) has also partnered with Wise, leveraging Wise’s infrastructure to issue multi-currency accounts and debit cards directly through its own application.
These partnerships with leading players in different markets further validate the strength of the infrastructure that Wise has spent more than a decade building, and the great values that Wise can offer to customers. Although the revenue from Wise Platform is still relatively small, this offers a great optionality and could be a growth driver in the long run.
Latest Financial Performance
Does Wise’s growing scaled economies shared flywheel actually translate into good financial economics?
Let’s look at Wise’s latest financial performances in FY2024 (ending 31 March 2024).
From FY2019 to FY2024, Wise has been growing well, with a CAGR of:
51% for its total revenue;
58% for its gross profit; and
110% for its reported operating profit (EBIT) (or a whopping 219% y/y growth in FY2024).
Wise’s profitability has also been faring well, with its gross profit margin and reported operating profit margin improving to 77% and 40% respectively in FY2024.
Importantly, their return on capital employed (ROCE) has improved to a very healthy level of ~35% in FY2024.
So, on the surface, things look great…
However before we jump into any conclusion, we need to take note of some developments over the past two years.
Is The “Inflated” Profitability Sustainable?
Over the past few years, the total balance that Wise held on behalf of the customers has been growing fast, with increasing number of customers and adoption of the Wise accounts. The high interest rates (up to 5% on USD) that Wise offers on customer balances also aided the growth.
Note: These interest rates offered by Wise for customer balances of different currencies were as of 8 May 2024.
With interest rates rising globally in the past two years, Wise has been earning a considerable amount of interest income on customer balances.
Out of this interest income, Wise intends to retain the first 1% yield to cover the associated operational expenses. Out of the incremental income over and above the 1%, Wise intends to retain 20% as profit, and return the balance 80% to the customers (as interest) to enhance the attractiveness of the Wise account.
However, due to regulatory reasons in certain countries, Wise has not been able to return the full 80% in the past few years. For example, in FY2024, it had managed to return only 35%. This meant that it had earned an extra 45% which was an unintended windfall. In a way, the regulatory headwind became a ‘profit tailwind’, leading to “excessive” profits.
The positive aspect is that Wise has been proactive in disclosing that its current profits might not be sustainable. They have started providing new non-GAAP metrics (like “underlying” revenue and profits) that better reflect the more sustainable revenue and profits. These include only the first 1% gross yield used to cover the associated expenses, but not any of the interest income beyond that.
As shown in the chart above, in the past two years, about half of the reported GAAP profit before tax actually came from the net interest income. These “additional” profits may not be sustainable in the future, since Wise intends to return most of these profits back to the customers. Also the actual income would depend on the interest rates (which is completely outside their control).
Hence, it would be sensible to use Wise’s underlying metrics instead of the reported GAAP figures. In FY2024, these underlying metrics also grew well, with its:
Underlying income (i.e. revenue) growing by 31% y/y (to GBP 1,173m);
Underlying gross profit growing by 51% y/y (to GBP 853m);
Underlying operating profit growing by 209% y/y, to GBP 262m, translating into a reasonably high “underlying” ROCE of 21%;
Underlying profit before tax growing by 226% y/y, to GBP 242m, translating to an underlying PBT margin of 21%.
Going forward, in the medium term, Wise intends to sustainably reinvest into its growth flywheel, and targets its underlying income to grow by a CAGR of 15%-20%, with an underlying PBT margin of 13%-16%.
This targeted underlying PBT margin was lower than the 21% achieved in FY2024. That is probably what spooked Mr. Market, leading to a >15% drop in its share price after the earnings release.
Why We Are Cautious About Investing In Wise
Despite enjoying a growing ‘scaled economies shared’ moat and strong financials, there are certain factors that call for caution among prudent long term investors.
First, even though Wise has an emerging scaled economies shared moat and is growing well now by taking market share away from the legacy banks (and legacy money exchange firms like Western Union etc), there are other new digital players that are competing well with Wise too, like Revolut.
Even though there is still a lot of room for Wise to grow by just taking market share away from the legacy players, in the very long run, Wise could be subject to tough competition.
There is no doubt about the current attractiveness of Wise’s offerings, but Wise’s strategy of attracting customers can also be considered as ‘undercutting’. Over a long period, it would not be completely inconceivable for deep-pocketed competitors to resort to similar ‘undercutting’ (price war) with each other.
The switching cost these days is not very high, and there is not much indication of Wise enjoying any kind of ‘pricing power’. This coupled with the uncertainty about interest rates, could pose challenges for Wise in future.
Wise would need to widen its scaled economies shared moat to a level that would be hard for other players to breach.
In face of such uncertainty, it would surely be prudent to seek a large margin of safety.
Based on its underlying profit before tax (PBT) in FY2024 (of GBP 242 million), its (pre-tax) owner earnings (OE) per share was ~GBP 0.24, if we assume that its OE was similar to its underlying PBT.
Relative to the share price of ~GBP 6.80 (on 25 June 2024), the pre-tax OE yield was ~3.5%, which was not high, thereby not offering much margin of safety.
Furthermore, as mentioned earlier, going forward, Wise intends to reinvest heavily, and is targeting a lower underlying PBT margin of 13%-16% (lower than the 21% for FY2024). If its underlying PBT margin drops to say 15%, then the underlying PBT and OE for FY2024 would drop by ~27%, to GBP 176m or GBP 0.17 per share, implying an OE yield of ~2.5%.
Second, Wise has only been listed for about 3 years (since July 2021) and has not had a track record of good capital allocation yet.
The company has only been doing some minimal share buybacks thus far, and the management had repeatedly said that they were repurchasing the shares just to “reduce the impact of dilution from stock-based compensation”, which is not a good way to think about buybacks in our opinion.
Wise has recently (in March 2024) appointed a new Chief Financial Officer – Emmanuel Thomassin, who would join from Delivery Hero (where he was the CFO for the past 10 years). His appointment would be effective 1 October 2024, so we will have to see if Wise’s capital allocation improves thereafter.
Conclusion
Overall, the scaled economies shared moat is a very powerful moat that has made Amazon (which we have covered here) and Costco the type of great companies they are today.
Wise is currently well positioned to grow this moat to earn extraordinary return on capital while growing fast.
However, there are certain concerns about investing in Wise as a long term owner that we have highlighted above.
Having said that, a non-executive director of Wise (Matthew Roy Peacock) recently purchased a small amount of Wise’s shares from the market, spending ~GBP 20 thousand, to purchase 2,790 shares at GBP 7.16 each, on 13 June 2024.
Could that indicate investing in Wise at the current levels still makes sense??
Are there any other insights about Wise or its competitors that we might have missed?? Let us know in the comments below!
Note: We have identified other strong compounder companies that have less uncertainties in our Multibagger Research Series. You can check them out for free here!
Disclosure: We at MoneyWiseSmart, do not own shares in Wise under our company or individual accounts (as of the time of this article). The above should not be considered as a recommendation to buy or sell shares in the businesses discussed.
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