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MoneyGram International Inc. (NASDAQ: MGI) Investment Thesis 09-30-20

First post as a new member. Excited to join this community and looking forward to engaging with you all!

Summary:

• MGI is an overlooked and misunderstood growth stock trading at a value multiple. The bargain price and extreme asymmetric upside more than compensate shareholders for the risks involved

• The company offers P2P money transfer services, including cash, digital, and paper products, to underbanked and unbanked customers in 200 countries via its 350K agent network, website, and mobile app

• Its cash remittance business is a critical service for 1.7bn people worldwide and an important source of capital for emerging market countries

• A merger agreement with Ant Financial in 2017 at $18/share was shut down due to US national security concerns, and the company has had to work through legal and compliance problems since then which have weighed heavily on the stock price

• A $50mm equity injection in 2019 from Ripple Labs has breathed new life into the company and they just reported 5% y/y EBITDA growth and 54% GAAP operating income growth while generating $24mm free cash flow during 2Q20, which was one of the most challenging operating environments ever due to the COVID-19 pandemic and economic shutdown

• Its digital business is currently getting no credit from the stock market despite a multi-billion dollar private market value based on comparable companies. This is a hot sector that is attracting lots of public and private capital, and it would be far cheaper for a strategic to buy MGI than try to create a competitor from scratch

• The company has a leveraged balance sheet but minimal bankruptcy risk and I expect a debt refinancing sometime over the next twelve months

• My base case suggests the stock is worth $16/share or nearly 6x the current price; Blue Sky scenario based on SOTP value implies the stock is worth $54 or 20x the current price

A few items before we get started:

• The above 2020 and 2021 figures are based on my estimates

• Instead of EBIT I used Adjusted EBITDA (as reported by the company) because that is what the loan covenants are calculated with

• EBITDA and Adjusted EBITDA are used interchangeably in the write-up

LTM Revenues: $1.2bn (0.8x TEV / Revenues)

LTM EBITDA: $217mm (3.5x net debt / EBITDA, 4.5x TEV / EBITDA)

Cons. 2021e Revenues: $1.3bn

Cons. 2021e EBITDA: $230mm

My 2021e Revenues: $1.5b (0.7x TEV / Revenues)

My 2021e EBITDA: $250mm (2.9x net debt / EBITDA, 3.8x TEV / EBITDA)

My 2021e FCF: $39.1mm (18% leveraged FCF yield)

What is MoneyGram, and why does it exist?

MoneyGram International Inc. (NASDAQ: MGI) provides peer-to-peer (P2P) money transfer services, including cross-border transactions, for consumers. Typical customers are low-income, often migrant workers in blue collar industries that are paid in cash who send that cash back to their family in their country of origin. They are usually unbanked or underbanked and thus have limited access to traditional banking services, which makes MoneyGram’s service essential for them. According to the World Bank, there are 1.7bn unbanked or underbanked adult worldwide and cross-border remittances totaled $739bn in 2019 (Source: company filings). MoneyGram is a dominant player in this industry, and ranks second in market share behind Western Union (NYSE: WU). On an LTM basis the company has generated $1.2bn in revenues and $217.2mm EBITDA. The current leveraged capital structure, with 3.5x net debt, is the result of a rescue financing package from PE giant TH Lee Partners and Goldman Sachs during the Global Financial Crisis. Its market cap of $220mm brings its TEV to approximately $1bn or 4.5x EBITDA.

MoneyGram has been around for over 70 years. It has two reporting segments: Global Funds Transfers and Financial Paper Products. 80% of Global Funds Transfers revenues come from “walk-in” locations. MGI has a network of 350K agents, typically brick and mortar retailers, which host MoneyGram kiosks on premise, for which customers can send and receive cash. Importantly, cash transfers are location-agnostic, allowing flexibility and ease for customers to send and receive cash anywhere in the world. Cash transfer fees at walk-in locations are split 50/50 between MGI and the agent. Agents are further incentivized to install MoneyGram kiosks because they draw foot traffic. The other 20% of Global Funds Transfer revenues comes from MoneyGram’s digital transactions business, which is an important growth driver I address later. In total, the Global Funds Transfers segment provides 85-90% of total revenues, which also includes fees for FX transactions, bill payments processing, and investment income from the company’s float. The Financial Paper Products segment represents 10-15% of revenue which includes fees generated from selling and processing checks and money orders, bill payment fees, and investment revenue.

Settlement time takes 4 days on average for cash transfers and 6 days for paper products, giving the company a $3.2bn float to invest. About three quarters of the float is comprised of cash and working capital (i.e. funds to be received or due to counterparties). The balance is held in interest-bearing investments and available-for-sale investments. As of June 30 2020, the company had $714.3mm of interest-bearing investments, which consist of time deposits and CD’s from financial institutions ranked A- or better and maturities of no more than 24 months. The portfolio of available-for-sale investments is very small ($3.9mm) and is mostly residential MBS. The company has liquidity provisions it must adhere to, and I believe the 50% cash collateral held against the float provides plenty of cushion.

Through its extensive network, MoneyGram operates in over 200 countries, with digital capabilities in 75 of them. Their largest agent is Wal-Mart, who’s stores are the source of 16% of MGI’s revenues. The partnership with Wal-Mart is up for renewal in March 2021. The company has grown network agents at a nearly 5% CAGR since 2008.

Assuming 5 days average settlement, the float portfolio would turn over approximately 50 times per year, so with a $3.2bn float I estimate the total transaction volume handled by MoneyGram is about $150bn. Assuming $739bn total worldwide remittance volume implies 20% volume share for MGI. As one might expect, processing $150bn annually of mostly cash cross-border payments in over 200 countries, and doing so in a profitable manner, is extremely difficult and complex. It requires extensive expertise, IP, technology, brand equity, and vendor relationships. There is significant legal and headline risk involved in cross-border remittances as the company needs to ensure compliance with over 200 jurisdictions with varying degrees of financial infrastructure, legal systems, languages, and cultures. It demands constant vigilance and technology investment to prevent fraud, and ensure it is not facilitating payments for drug lords and/or terrorists. It needs to have a trusted brand which requires perfect or nearly perfect settlement execution. It needs sophisticated technology and employee know-how to minimize FX risk and balance sheet liquidity. It needs to pay for cost-effective advertising so that it can open more locations and take share. This is an unsexy, “roll up your sleeves and get your hands dirty” business. Most on-the-run, traditional financial institutions have historically shied away due to the reputational and legal risk of cross-border cash remittance payments, which is why these companies (i.e. MoneyGram and Western Union) exist.

Since 2016, global remittance payments have grown at about +4.6% CAGR (source: World Bank). Even if we assume 80% of that growth has been cash, consistent with MGI’s Funds Transfers segment, that implies cash remittances have grown at a 3.7% CAGR since 2016. Migrant remittances are an important source of funds in emerging markets. For example, in 2019 remittance inflow to Bangladesh reached $18.3bn, +18% y/y growth, representing nearly 6% of GDP (Source: World Bank). In terms of income for the country, remittance payments are second only to the Bangladeshi textile industry (Source: NPR).

Global Financial Crisis and TH Lee Rescue Financing

In the years leading up to the Global Financial Crisis, MGI was high-flying stock, with its market cap peaking at nearly $25bn in 2006. However, the company faced insolvency when its portfolio of mortgage-related securities blew up during the market meltdown in 2007/2008. The opportunity attracted TH Lee Partners, who along with Goldman Sachs provided rescue financing, becoming majority (79%) shareowners in March 2008 at $2.50/share. The company has since undergone several recapitalizations. TH Lee and GS partially exited their investment in 2011 and 2014 via secondary public offerings, both priced in the mid-teens. In 2017, the company announced a merger agreement with Chinese FinTech giant Ant Financial at $18/share, a deal which was eventually struck down by the Trump Administration in 2018, citing national security concerns. At $18/share, the implied TEV for MoneyGram was approximately $2bn, about double its TEV of $1bn today and over 6.5x the current stock price. TH Lee fully exited its position in the Fall of 2019 having made multiples of their original investment.

Since the Ant Financial deal fell through, the company has undergone legal trouble primarily related to insufficient compliance controls to protect its consumers from fraud committed by third parties. They settled with the US DOJ in November 2018 and agreed to pay a penalty of $125mm. $70mm has thus far been paid, and the payment date for the $55mm balance was recently pushed from November 2020 to May 2021. The company is negotiating with the US government to have the $55mm reduced or forgiven. It should be noted that WU also had a similar settlement deal it struck in 2017, which supports my earlier assertion that these businesses are difficult to operate and pose legal and reputational risk.

Since the legal settlement, MoneyGram has had to invest significantly to improve its compliance controls. Not only have these expenses eaten into the company’s margin, but the stricter controls have caused more friction with customers and led to a significant revenue decline. For example, customers had to start showing a valid driver’s license or other form of government ID in order to use their services. From 2017 to 2019, full year revenues decreased from $1.6bn to $1.3bn – a 20% drop. Free cash flow over this period declined from $48.9mm to $8.5mm. MGI’s stock lost 83% of its value in 2018.

The fact that MGI has already made these investments is important, as margins and cash flow should improve going forward. Venmo, the popular digital payments app owned by stock market darling PayPal (NASDAQ: PYPL), has had difficulty dealing with recent COVID-related fraud and was just portrayed negatively in a WSJ article for sending debt collectors after users with negative account balances (source: Wall Street Journal). I believe these risks have historically kept competition out, and investors in highly-valued FinTech companies are in for a rude awakening when they realize how much investment is needed to mitigate these problems. Network effects and brand value also contribute to MGI and WU’s moats, as they are trusted brands among these migrant communities.

Ripple Labs Equity Injection

The cacophony of problems and depressed share price following the DOJ settlement drew the attention of Ripple Labs. Ripple is the only blockchain company that offers products that are used commercially. Its XRP cryptocurrency and “On Demand Liquidity” (ODL) platform are used for near-instantaneous cross-border transaction settlements at over 300 financial institutions in 40 different countries. According to Ripple’s website, their mission is to “enable financial institutions to send money across borders, instantly, reliably and for fractions of a penny.” The company is taking a unique approach to ensure widespread adoption, as they are “working with regulators, governments, and central banks, not against them, to improve the way the world moves money” (Source: company website). In June 2019, MoneyGram and Ripple entered into both a financial and commercial agreement. Ripple injected $50mm of equity at $4.10/share into the company in exchange for 17% ownership by way of shares and warrants. In conjunction with this commitment, MGI refinanced approximately $900mm of first lien term debt via a new $645mm first lien term loan due in 2023 (Libor + 600bp, 1% floor) and $245mm second lien term loan due in 2024 (13% cash or 8% cash / 5% PIK-toggle), along with a $35mm revolver (due in 2022, currently undrawn).

For the commercial agreement, Ripple pays fees to MoneyGram for “developing and bringing liquidity to foreign exchange markets, facilitated by the ODL platform and providing a reliable level of foreign exchange trading activity” (Source: company filings). Ripple’s technology requires widespread adoption and sufficient liquidity, and enables nearly instantaneous transaction settlement with lower costs. Thus, the partnership is a win-win for both parties – Ripple gets more liquidity to its platform, and MoneyGram becomes the lowest cost and most efficient provider for cross-currency transactions.  The agreement expires in 2023. After initially reporting these fees as revenue, MoneyGram’s auditors advised the company to instead report them as a contra expense in the Transactions and operations support account on the income statement. Current run rate for these fees is about $40-50m per annum.

I believe this accounting change has contributed to the shares being overlooked by the market, as the net result has been improved margins rather than topline growth. In 2Q20, its most recent reporting period, the company reported its best GAAP operating margins (7.9%) and non-GAAP adjusted EBITDA margins (20.2%) in years. These improved margins helped the company grow adjusted EBITDA 5% y/y on a constant currency basis in the quarter, despite undergoing the worst economic contraction period in post-war history and GAAP revenues declining -13.6% y/y.

Digital Transformation

MoneyGram embarked on a digital transformation in 2016, and notes ~$25mm spent in 2018 and 2019 to develop a viable digital product, which is separate from the Ripple arrangement and reported within its funds transfer segment. This appears to have been well spent as they now operate a slick, user friendly mobile app on both iOS (ranked 4.8 stars in Apple Store) and Android, and digital transactions are experiencing explosive growth. In 2Q20, the company reported +106% digital transaction growth, an acceleration from +57% growth in 1Q20. This has continued to accelerate as recent reports indicated +124% digital transaction growth in July and +126% in August. The company has now reported eight straight months of triple digit growth in digital transactions. The digital segment now makes up ~20% of total funds transfers revenue and the CEO indicated on the 2Q20 earnings call that total revenues grew +10% y/y in June due thanks to growth in digital and a recovery in its walk-in business. Although this business has lower gross margins (20% vs. 50% for walk-ins), the company claims it has higher retention and skews to the younger generation. In the most recent earnings call, management noted Bangladesh and Pakistan as countries with high adoption, both of which have younger demographics than Western countries and thus growth prospects are better. They have also launched strategic partnerships with digital wallet providers in 28 African markets. Importantly, the digital business has not cannibalized its legacy cash and paper businesses. Network effects for digital payments are powerful, as can be seen by the incredible growth in companies like PYPL which commands a $214bn market cap. I believe MGI’s digital business is its crown jewel and yet the market currently assigns zero value for it.

Valuation for MoneyGram’s Legacy Business

I believe fair value for the legacy MoneyGram business (i.e. cash transfers and paper products) is approximately $2bn. I come at this value several different ways:

1. Replacement Cost/Asset Value: I believe MoneyGram is trading at half of what it would cost for a competitor to replicate the business from scratch. As mentioned, there is significant intangible asset value in the form of technology, IP, brand, and expertise that is not properly reflected on the balance sheet. From 2017 to 2019, the company’s average annual expense for Transaction and operations support was $296mm. This includes items such as marketing and advertising, digital transformation costs, compliance enhancements, and legal and contingent matters. If we capitalize $296mm using a WACC of 15%, we get $2bn. Let’s also assume that a competitor would have to pay a head hunter 10% of the annual Employee compensation and benefits expense ($253mm * 10% = $25mm) to find employees to hire and 10% of the annual Fee commissions expense ($689mm * 10% = $69mm) in order to find network agents. Looking at the rest of the balance sheet, let’s assume 80c on the dollar for PP&E ($158mm * 80% = $127mm), 25c on the dollar for Other Assets ($185 * 25% = $46mm), and 0c on the dollar for Goodwill, and back out liabilities (ex. debt and equity capital) at 100c on the dollar ($329mm). After these puts and takes, we get a total replacement value of $1.9bn. Note that this analysis assigns zero value for the company’s float.

2.  Relative Value: WU is MGI’s closest competitor. It trades on an EV/Sales multiple of 2.2x and EV/EBITDA of 9x. MGI trades at 0.8x and 4.5x, respectively. If we apply WU’s multiples to MGI, we get approximately $2bn TEV.

3.  Private Market Value: Ant Financial had agreed in 2017 to take MGI private at a TEV of about $2bn. I believe the issues MGI has experienced since that agreement are transient, not permanent, and thus the $2bn private market value is a reasonable proxy for intrinsic value.

If we subtract debt ($856mm) and add cash ($131mm) to the $2bn estimated value for MGI’s legacy business, my estimated total equity value is $1.2bn, nearly 6x today’s market cap. This is my base case expected return.

But Isn’t Cash a Melting Ice Cube?

The current narrative regarding cash is that it’s a melting ice cube, and we are on our way to a cashless society and/or world. While the trend towards digital payments will likely continue, not least of which as a result of the COVID-19 pandemic, I believe cash remittances will continue to grow for the next decade. Barron’s wrote a cover piece the other weekend titled “How COVID Killed Cash: Consumers were already running away from physical payments. After the pandemic, they may never go back.” In it, the author notes that, according to a recent study by the Federal Reserve, 26% of transactions are handled in cash in the US vs. 31% in 2016. This represents slightly more than -1% decline per annum versus the previously mentioned 3.7% CAGR in cash cross-border remittances over the same period. While cash may be on the way out in the US, it is still an important source of money in other countries, particularly emerging markets. These poorer nations have far less developed banking and financial infrastructure than we enjoy in the West, and it will likely take years before they are able to accommodate a digital financial system that we have grown accustomed to. Digital payments also work great with smartphones, however, only 45% of median adults in emerging economies have smartphones vs. 76% in the developing world (source: Pew Research). Certainly, smartphone adoption rates need to be much higher in order for a mostly cashless world to exist, which is likely decades away, if it ever happens.

There are also social, political, and cultural reasons for some countries to be slow to adopt digital payments over cash. How will the Italians and Greeks continue to cheat on their taxes if they go cashless? All kidding aside, I believe there will be political blowback to the transition to cashless societies. We’ve already seen this in the US, as pre-COVID there was political pressure in major US cities, including NYC and Philadelphia, to ban cashless stores because they were considered discriminatory to low-income people who are unbanked either because of fees or minimum balance requirements. In fact, there was a law passed in Philadelphia in 2019 banning cashless stores (Source: NY Times).  If the US, as the innovation and technology capital of the world, can’t legalize cashless stores, I think the probability of such an event happening worldwide is very low. Finally, let’s not forget that the US is currently experiencing a nationwide coin shortage due to pandemic-related business closures and US Mint production cuts – in other words, we need more cash!

Valuation for MoneyGram’s Digital Business and SOTP

During the 2Q20 earnings call, MGI CEO Alex Holmes said the following:

“If you look at our digital business as a stand-alone entity with 106% digital transaction growth, 220% app customer growth, high customer retention rates and strong profit margins, and then simply compare those metrics in our business to those of other digital players in the industry and their company valuations, our digital business alone should be valued in the billions, which easily highlights the significant delta to our current company valuation. This strong momentum, combined with our continued execution, suggests to me that a higher valuation for MoneyGram is more than warranted.” (Source: Earnings call transcript)

There is merit to Holmes’ assertion. Remitly, a private FinTech startup with a similar business to MGI’s digital funds transfer business, recently did a fundraising round with a $1.5bn valuation (Source: Tech Crunch). According to the company’s website, they currently support outgoing payments in 17 countries and incoming payments in 50 countries. MoneyGram supports both outgoing and incoming digital payments in 75 countries. This means that MoneyGram has more than double the digital payment capacity that Remitly has, which would imply the private market value for MGI’s digital business is double Remitly, or $3bn. Another competitor is Xoom, which was purchased by PYPL five years ago for $800mm, and is likely worth multiples of that today.

Thus, I estimate the SOTP value for MGI to be $5bn, or merely 2% of what the market thinks PYPL is worth. Essentially, investors can buy the legacy business at a discount and get the growing digital business for free. I believe the omni-channel approach and brand puts MGI in a strong position against digitally native FinTech’s who are trying to take share. At $5bn the stock price would be $54, a 20x return from today’s price.

Why Does This Opportunity Exist?

This opportunity exists for several reasons. First, the market views MGI’s balance sheet as too risky. I note there is a bifurcation today between the debt markets, which are trading at spreads near all-time lows, and equity markets, which have sought safety in large cap stocks with strong balance sheets, while shunning small caps with weak balance sheets. This can be attributed to the uncertainty with COVID-19, the resulting economic outlook, and the ongoing social unrest taking place in the country due to the polarized political environment. Given how well MGI performed during the original pandemic shutdown, I don’t view these as material risks to MGI’s business. I address the balance sheet below, but would like to reiterate MGI’s strong performance during the challenging 2Q20 period, with 5% EBITDA growth, digital transaction growth in the triple digits, the best EBITDA margin in years, and 54% GAAP operating income growth, while generating $24mm free cash flow (yes, they generated 11% of the market cap in free cash flow for the quarter).

Regarding the debt, while both the first and second lien term loans traded at distressed levels during the global pandemic-induced lockdowns, they have both recovered to nearly par value, indicating no near-term bankruptcy risk. This makes sense given the company is well within its leverage covenants (2.5x first lien, 5x total) and interest coverage covenant (2.5x), and it has $166mm of liquidity. In addition, after PIK-ing for the first few quarters, the company started to pay the full 13% cash interest on the second lien term loan, which I interpret as a sign of confidence from management. I expect the company to generate $250mm EBITDA and $37mm of free cash flow over the next twelve months. The 17% leveraged FCF yield and EBITDA growth will help take leverage down to under 3x, at which point I expect a refinancing of the debt. The Fed has indicated a commitment to keep interest rates at near-zero for several years, so I expect debt markets to continue to be accommodating. A refinancing would allow MGI to lower its interest cost and push out their debt maturities. As it stands today, they have no material maturities until 2023.

There are also technical reasons why this opportunity exists. As mentioned, TH Lee fully exited about a year ago and Goldman Sachs recently decided to liquidate (or at least significantly reduce, I don’t know for sure) its stake in the company at the beginning of August. It filed 13D’s for several weeks, indicating it exercised its right to convert preferred shares it owned into common and sell them. On a pro forma basis, Goldman had owned approximately 11.5% of the company through these preferred convertible shares via several different PE-like vehicles it managed. This was a legacy position from the 2008 rescue financing package, so while it’s concerning that GS decided to sell now, I believe it’s likely they were trying to liquidate these funds and make final distributions to LPs. I would note that these shares traded higher following the 2Q20 earnings release, after which GS “hit the bid” and started selling and pushed the price down. Goldman is the underwriter for the much-anticipated Ant Financial IPO, which could be another justification for selling MGI to eliminate any conflicts of interest. The shares are still up 40% YTD, which I believe is indicative of the improved short and long-term outlook for the company.

Catalysts

Two potential catalysts for MGI are a buyout or debt refinancing. Both are contingent upon the company to continue to perform well and for its digital business to keep up its triple digit growth rate. There were rumors swirling in June of this year that WU was looking to buy MGI; in speaking with MGI’s CFO, he called this “fake news.” MGI’s board also approved a poison pill in August to protect the company’s NOLs should someone acquire a 5% stake in the company. I interpreted this as a bullish sign, as the board would only care to protect those assets if they thought the shares were cheap and anticipated someone would take advantage. Where there’s smoke, there’s usually fire, and I wouldn’t be surprised if the company decided to sell itself, especially so it can get permanent capital to grow its digital business.

If they don’t get bought out, I expect the company to refinance its debt after another quarter or two of strong growth and cash flow accretion, lowering their cost of capital and causing the shares to rerate higher.

Risks

I believe the biggest risk to MGI is its relationship with Wal-Mart as an agent, which is up for renewal in March 2021. Wal-Mart is a long-term partner and I fully anticipate that relationship will be renewed. Wal-Mart was the source of 16% of MGI’s transaction revenues in 2019, so the termination of that relationship would have a material negative impact on MGI’s business.

The other biggest risk is execution risk. While digital transaction growth and margin expansion have been very impressive, past performance is no guarantee of future results. Deep-pocketed VCs could continue pumping money into FinTech startups that crush MoneyGram on price and force them out of business. However, I think the omni-channel offering and strong existing brand with migrant workers will protect them from this new competition. Imagine a migrant US worker from Bangladesh using his smartphone to send money home to his mother, who takes the cash out at the nearest local MoneyGram kiosk. That type of experience simply cannot be replicated with a digital-only product, and I don’t expect VCs to fund cash remittance startups anytime soon. As I’ve pointed out multiple times, it would be far more financially sensible to acquire MoneyGram than it would be to try to build a business to compete with them, even at a large premium to today’s price.

In conclusion, I believe MGI is an overlooked and misunderstood growth stock trading at a value multiple. The bargain price and extreme asymmetric upside more than compensate shareholders for the risks involved. 

Catalyst

Buyout

Continued execution and debt refinancing