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July 15, 2021 | In this Premium Service edition of The Institutional Risk Analyst, we look at Wise Ltd (LSE:WISE), the money transfer business that is designed to disrupt the monopoly bank control over the multi-trillion annual flow in cash transfers. The company’s model is “fintech” because technology enables the model for payments, but the “f” word does not appear in the offering document. We believe that WISE is one of the most interesting emerging players in the world of global payments, a rare fintech play that actually makes money.
WISE will certainly upset a lot of large financial institutions. Banks and non-bank cash transfer houses that feed them volumes earned over $260 billion in 2020 moving hundreds of trillions of dollars globally. Just as Square Inc. (NYSE:SQ) attacked the antiquated bank model for vendor credit card accounts, WISE is assaulting one of the most opaque and least competitive markets in the world. WISE promises huge upside benefits for small business and consumers.
The graphic below from the WISE prospectus shows the different markets where WISE operates and the regulatory environment.
“Moving money internationally is broken,” notes the WISE prospectus for its listing on the London Stock Exchange. “Traditional banks are reliant on an outdated network of correspondent parties and held back by complex infrastructure. This means that both people and businesses have been overpaying for slow transfers, inconvenient customer experiences and are hit with opaque and hidden fees when moving money internationally.”
The graphic below from the WISE prospectus illustrates the company’s strategy:
WISE has created an ecosystem of affiliates and partners that enables the company to go around the traditional network of bank correspondents, a radical agenda that is unlikely to be welcome by larger banks, incumbent cash transfer providers or global central banks. Private models such as WISE, for example, could render the Fed’s promised “FedNow” cash transfer network obsolete before it is even operational.
The WISE network is comprised of different types of nodes in various markets, with a variety of levels of access to the national payments system. This is a key point because, in the UK and Europe for example, non-banks have direct access to the payments network.
In the US and many other nations, a bank cash and securities monopoly controls access to payments. Yet the pressure on the US and particularly the Federal Reserve Board to change is enormous, both from the perspective of liquidity (“Fed Prepares to Go Direct with Liquidity”) as well as consumer demands for faster, cheaper ways to send cash across borders.
“We have spent ten years building a replacement infrastructure for correspondent banking and have already made great progress in fixing the important problem of moving money across borders cheaply, conveniently and with transparent fees,” WISE states in the prospectus.
As a disruptor of a very old and staid part of the world of banking, WISE has an enormous market opportunity. That said, the company also is a target for every traditional bank, foreign exchange house and regulator around the world that views change as unwelcome. Non-bank financial firms are regularly demonized as being unsafe and unsound. These are biased and unfounded accusations, yet a reality that WISE and other non-banks must fight every single day.
In addition, WISE has taken the market and counterparty risk of global cash transfers onto it own books. By creating what is essentially an internal market for the exchange of currencies, WISE must manage its overall and specific country risk just like a depository institution engaged as a correspondent. WISE describes how it manages this risk, but the proof will be provided over time.
For example, WISE discloses that it has been dragged into a legal dispute with a Brazilian bank located aptly in the State of Parana. WISE states:
“Wise is currently engaged in a dispute with a Brazilian financial institution, MS Bank. Wise has filed a lawsuit pending service of process in the High Court of Justice, Business and Property Courts of England and Wales, Commercial Court for the return of approximately £6.0 million (comprising approximately U.S.$7.5 million and R$4 million) that were held in a liquidity pool for Wise transactions and are being improperly retained by MS Bank in violation of an applicable contract.”
No amount of technology and innovation, sadly, can counter the natural tendency of individuals and business located in badly governed countries to violate contracts and behave badly. Brazil is a “BB” rated country with a volatile economy and a weak social society, where the rule of law is fragile and frequently qualified by political factors. WISE has made a claim against MS Bank in a UK court, but it may have no effective recourse in Brazil. Enforcing a judgement from a UK court in Parana State, for example, is likely to be impossible.
Despite all of these risks and challenges, WISE has managed to achieve profitability, but note that there is a credit reserve for the Brazil dispute. Market and credit risk are significant factors facing WISE and its investors. That said, so far credit costs have remained relatively low even as the business has scaled its revenue quite rapidly and with little net-leverage besides guarantees on lease finance obligations. The WISE income statement is below.
The growth of the WISE model is impressive and, again, suggests that the business model is scalable and potentially profitable as a long-term proposition. Examine the discussion of free cash flow in the prospectus.
Ultimately founders of WISE state that they intend the push the cost of transfers to zero. WISE has also issued 1.6 million multi-currency, Visa and Master Card debit card that allows users to “spend money around the world at the mid-market rate, with low conversion fees and zero transaction fees.”
The graphic below from the WISE prospectus illustrates the firm’s impressive growth to date.
Ultimately WISE is a play on the relentless advance of technology that lowers costs and eventually forces change in the legacy world of banking and payments. We do not minimize the risks and challenges to WISE in leading this revolt against the old order in cross border payments, especially for consumers and small business. As WISE notes, the smallest users of cash transfer services bear the greatest portion of the cost of moving money from one country to another.
Based upon the offering prospectus, WISE seems to be generating increasing amounts of free cash flow as it grows its business, a rare example of a disruptor model that has achieved profitability without consuming vast amounts of capital up front. We’ve purchased common shares of WISE this week for our portfolio and intend to watch the progress of this fascinating early-stage business with great interest.
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