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MoneyGram - Upside Branch Write-Up

“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.”

- MoneyGram CEO, Alex Holmes - Q2 2020 Earnings Call

[Note - Sometimes it is better to beg forgiveness than to ask permission. This write-up relates to Western Union, but is really focused more on MoneyGram (MGI). Only 5.5 months have passed since MGI was previously written up, which apparently means I cannot technically post another MGI writeup for two more weeks. I did not realize that rule existed. I hope you find this substantive and that it adds meaningfully to the conversation, as I put a fair amount of effort into it. MGI reports earnings on Friday]

Over the past five years, MoneyGram has built a DTC and API-based digital payments unicorn inside of a stodgy value stock business. As the world comes to understand the magnitude of its creation, MGI could be a multi-bagger.

Mr. Market’s perception of MoneyGram is beginning to shift, and that shift will accelerate as management improves disclosure around its Digital business. At the same time, two VC-backed pure-play digital peers - TransferWise and Remitly - are likely to go public this year at valuations in the many-billions, highlighting the value embedded inside MoneyGram. 

Its operating performance is beginning to reflect this transformation: exiting 2020, MoneyGram is already generating $120 million of run-rate equity free cash flow on an $800 million market cap and $1.6 billion EV.

In 2021, I expect its top line to inflect upward, its newfound operating leverage to reveal itself, and management to begin refinancing MoneyGram’s expensive debt cost down by nearly half (it currently pays over ~$77 million of annual interest expense).

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GoodHouse wrote-up MoneyGram effectively and thoroughly a few months ago at a substantially lower price. His/her thesis is #winning and remains intact. This writeup intends to build on that and dive specifically into an upside branch of the probability tree, driven by MoneyGram’s recent return to growth and its growing Digital transformation. In that sense, I’m not attempting to discuss a complete MGI thesis. 

[Side Note: MGI stock is very volatile, which has made finalizing this write-up very hard. I wrote most of it in mid-December. I’ve decided to just get it up on VIC before Q4 earnings are released on Feb 19th.]

Last quarter (Q3 20), we saw a glimpse at a new normal. Nothing particularly unexpected happened: the traditional Walk-In business normalized back to its healthy start-of-year trend and the Digital business continued its impressive growth. Yet, when combined, those drove MoneyGram’s strongest Money Transfer revenue quarter since 2018. If Q3 simply repeated ad infinitum, MGI would be an excellent investment. If the business improves further, it possesses massive upside: we are beginning to see strength revealed that has been years in the making.

Back in Q4 2018, MoneyGram was only halfway into a three-year restructuring. It was in the midst of a heavy lift. That restructuring continued through 2019, and today’s MoneyGram is a leaner organization, having removed ~$120 million per year of structural cost on a $1.2B revenue base. 

Likewise, capital needed to support the leaner, more digital organization also declined: average quarterly CapEx in 2018 was $14.5 million, $13.6 million in 2019, and $10.2 million so far in 2020.

As a result, during the most recent quarter, MoneyGram generated over $30 million of equity cash flow. Given an $800 million market cap, $120 million of annualized run-rate equity cash flow implies MoneyGram trades around 6.7x. There are reasons that Q3 was a bit inflated, but not astoundingly so. It is the beginning of what I think will be the new normal.

While the traditional Walk-In business is unlikely to be a strong secular grower, the Digital business has been transformational for MoneyGram. Even as Digital growth inevitably slows from its recent scorching levels, its free cash flow contribution likely grows rapidly from here. In addition to the high incremental margins on Digital revenue, MoneyGram’s equity free cash flow will benefit as high-cost debt is refinanced over the coming year.

Lastly, as the Digital business grows and gains mindshare among investors, I expect Mr. Market to increasingly view MoneyGram as a strategically valuable digital payments business. This could lead to a dramatical re-rating.

It is not a stretch to imagine MoneyGram stock trading over $30/share over the next 12-24 months, representing a >3x return. 

With a downside bounded by significant free cash flow, an improving capital structure, and a sale to strategic buyers, I view the risk/reward as exceptional: a Value downside with a VC upside.

Catalysts are coming:

• MoneyGram will report January’s Digital (MGO) growth and Q4 2020 earnings on Friday

• It should be able to refinance its debt later this year, dramatically lowering its cash interest expense

• Incremental margins from Digital are high, and Digital is growing rapidly

• I expect MoneyGram to improve disclosure around its Digital business beginning Friday

• Three unicorn remittance comps may IPO this year: TransferWise, WorldRemit, and Remitly

• In combination with MoneyGram’s improved disclosure around Digital, the world may come to perceive it not as a stodgy old-line company, but as a transformation that looks more and more like a FinTech unicorn

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Let's quickly set the backdrop:

MoneyGram's current CEO, Alex Holmes, took over at the beginning of 2016, and inherited many challenges. GoodHouse outlined those in the October write-up. In summary:

• Cash remittance is a mature business and a competitive industry.

• As the #2 player, at times MoneyGram is stuck in the middle. On the one side is aggressive competition from incumbents and digital challengers, and, on the other side, is a squeeze from large, important distributors (Agents) such as Walmart and CVS.

• Digital competition and COVID-19 are forcing uncomfortable change and are shifting customer behavior and loyalty.

• A few years ago, MoneyGram’s history of poor compliance caught up with it. To correct past errors, it had to aggressively attack questionable transactions, leading to a significant reset in run-rate revenue scale. This reset reduced transaction volumes at the same time competition drove down pricing. The result can easily be seen in 2018 and 2019’s numbers, as MoneyGram’s Walk-In Money Transfer revenue declined double digits.

• The compliance issues led to large fines, increased perception of risk, and high costs of compliance, legal, and ongoing monitoring.

MoneyGram was staggered by the succession of blows, culminating in a brutal 2019. 

The mix of stagnating traditional cash-to-cash remittance, competitive pressure, substantial regulatory overhang and penalties, a failed sale to Ant Financial for $13.25, and pending debt maturities forced MoneyGram to refinance its debt stack at a punitive cost and to accept an equity injection from Ripple Labs (of the eponymous cryptocurrency). 

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The cost of debt really tells the story. 

In mid-2019, MoneyGram refinanced an existing single tranche first lien into a two-tranche structure: a $645 million first lien at L+600 (1% floor) and a 13.0% $245 million second lien with warrants.

The company took its medicine and worked aggressively to stabilize its business. This included across-the-board repricing (downward) of its services to increase competitiveness, resetting its cost structure, and doubling down on its Digital transformation (both the customer-facing product and internal cost-takeout opportunities). Late-2019 seemed to mark a bottom, and the first 2.5 months of 2020 finally showed a return to growth.

As the world came to a stop in March 2020, remittance businesses froze. Most remittance transactions require an in-person leg and, as lockdowns began and employment cratered, MoneyGram’s business plummeted.

In the heat of battle, MoneyGram’s stock cratered, bottoming at $1.15. An already melting ice cube seemed to be sitting on a stovetop.

As you know, the world did not end. Q2 was the mirror image of Q1: it started weakly and ended strong. MoneyGram’s April transaction volumes were off -17% YoY before surging through June.

While June was a nice reprieve, it was unclear how much of that growth was “real” vs. a catch-up of deferred remittances. Regardless, the explosive growth of MoneyGram’s Digital business was breathtaking.

Therein lies our upside opportunity.

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Digital Revolution:

One of the first things Holmes did after taking over as CEO was increase focus on the then quite-small MoneyGram Online (“MGO”) business (MGO is the DTC portion of overall Digital). In doing so, MoneyGram also built tools that enabled digital capabilities beyond its four walls.

Digital includes any transaction that begins or ends with a digital landing point, encompassing website, app, and its API rails for integrating with partners and wallets. Holmes has described the effort as akin to building a startup fintech business with MoneyGram. 

Traditionally, MoneyGram was a cash-to-cash experience: a customer (Sender) would walk into a MoneyGram agent’s store (such as a Walmart) to “Send” cash. For a fee, Walmart would send the money via MoneyGram to a given country, where the Receive customer (your grandmom) would walk into a local MoneyGram agent and receive her cash (generally in local currency). Importantly, only Western Union and MoneyGram built their networks to support on-call money. This allows customers to Send money to any agent in a country, rather than to a specific agent in a country. If you MoneyGram your Honduran grandma, she can go into any MoneyGram agent in Honduras, and receive the cash. Other competitors require you to go to a specific agent in that country to get your cash. This differentiated flexibility is valued, and also matches well with the flexibility required to build a high-quality Digital product.

The traditional cash-to-cash business is increasingly supplemented by Digital tools, such as its website and app and integrations with bank accounts, digital wallets, and payments businesses around the world. MoneyGram built a modern API that allows partners like Visa Direct, AliPay, or Tigo Money to integrate with MoneyGram payment rails, knitting together otherwise disparate wallets and accounts. This enables end-consumers to send and receive payments through the MoneyGram network from one wallet (like AliPay) to another (like Tigo Money). Many of these wallet partners also have their own network of local physical cash-based locations, which become a de facto piece of the MoneyGram network (via the wallet partners’ brands).

In this way, MoneyGram is linking together various independent payments businesses with its rails. Each new integration makes MoneyGram’s API that much more valuable AND adds utility to the integration partner’s customers. The ability to send money from the US to Tigo Money in Honduras makes Tigo Money a more valuable product to its customers. As a result, the number of MoneyGram integrations has been skyrocketing, with new partners announced nearly every month. Examples: Africa, Philippines, Korea, UAE. 

While its API enables third parties to use MoneyGram rails, as important is MoneyGram’s own digital DTC business: MGO. In its traditional Walk-In business, you might reasonably question who “owns” the customer, given those individuals must go to a Walmart or CVS to transact. However, via MGO, MoneyGram is establishing direct relationships with its customers, increasingly disintermediating its agents. Over the past several years, MoneyGram has invested heavily in this DTC business.

MoneyGram’s mobile app is exceptionally high-quality (and very highly rated on the App Store and Google Play). You should download it and explore. For compliance and practical purposes, DTC users must supply personal information, which allows MoneyGram to more intelligently and directly market to consumers, increasing effectiveness and reducing cost. Likewise, these digital capabilities improve the customer experience by allowing end-users to transact from anywhere, rather than only via walk-in agents (which saves on commission expense). MoneyGram can reinvest those savings into lower prices for DTC transactions, creating a virtuous loop.

Unicorn Hunting

These two elements of MoneyGram’s Digital business - API + DTC - look very similar to VC-backed unicorns TransferWise, Remitly and WorldRemit. At scale, these can be extremely attractive economic models. While it’s unclear if Remitly or WorldRemit have hit escape velocity on profitability, TransferWise certainly has. This excerpt from their latest valuation announcement makes the point well ($5 billion, in a secondary round announced in July 2020):

“Meanwhile, TransferWise now serves 8 million customers worldwide, processing around £4 billion in cross-border payments each month [approximately USD 65 billion annually], across 2,500 currency routes and 54 currencies. The company also recently announced new regulator permissions to offer savings and investments options in the U.K. via the TransferWise borderless account, with the new product set to launch ‘in the next 12 months.’

“‘We’ve been funded exclusively by our customers for the last few years and we didn’t need to raise external funding for the company,’ says co-founder and current CEO Kristo Käärmann in a statement. ‘This secondary round provides an opportunity for new investors to come in, alongside rewarding the investors and employees who’ve helped us succeed so far.’”

2017 was the last time TransferWise raised primary capital. TransferWise is an absolute monster, as I believe the world is about to discover.

For Remitly, we do not know its current scale, though, in late 2018, Remitly disclosed it was annualizing $6 billion of GSV per year and in 2017 $3 billion. If we give it credit for continued 100% p.a. growth, it is annualizing $24 billion now.

MoneyGram has not yet disclosed GSV for its Digital business. I expect that type of disclosure to come soon. In the meantime, we can attempt a few assumptions to back into it. These are swags, intended to bound what’s possible.

Many of the above-mentioned digital-first businesses indicate that the cost to the consumer of digital transfers is somewhere in the 1-2% range. TransferWise is below that, largely due to its API-centric approach and lack of focus on transactions with a cash leg. In Q3, MoneyGram’s Digital revenue was $53 million and growing. If I estimate a nearly $230 million annual run-rate and assume 1.5% take-rate (higher for DTC but likely lower for API integrations), it implies a run-rate GSV of $14 billion annually. My best estimates for unicorn comps:

As you can see above, MoneyGram’s Digital business has an implied valuation is somewhere between $800 million and $3.0 billion, with a median of around $2.0 billion. The low-end is dragged down by TransferWise’s EV/GSV, given TW’s more API driven strategy (and thus receives less revenue per dollar transferred).

PayPal acquired Xoom in 2015 for $900 million. At the time, Xoom’s gross transaction value was ~$7 billion and was generating $175mm revenue. PayPal provides provides limited ongoing disclosure about Xoom.

TransferWise, Remitly, and WorldRemit are likely to go public in 2021, which will provide great benchmarks and even more KPI data. TransferWise already has excellent disclosure, even as a private business. I expect it will garner a $10B+ valuation. MoneyGram’s Digital business scale is in the ballpark of WorldRemit and Remitly. 

When these unicorns come public, I believe the implied value of Digital will get another step-up. Today, the above argues for a $2.0B valuation on MoneyGram Digital, and growing.

Growing indeed.

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MoneyGram’s Digital business has been scaling rapidly. Management has been calling this out for years, but only recently have we really seen the magnitude of the impact, as it formerly was growing off of a small base. The Digital business’s rapid growth was hidden by light disclosure and, where disclosure existed, it was obscured by two primary phenomena:

1. US-to-US was an important corridor for all of MoneyGram, including its Digital business. It turns out that US-to-US is a high fraud corridor. Growing authentication requirements and restrictions by MoneyGram created a headwind. At the same time, the rise of Venmo, Zelle, and CashApp - which provide great, low-cost US-to-US transaction services - hit MoneyGram’s US-to-US Digital corridor hard;

2. Digital revenue growth has been slower than Digital transaction growth. This was driven by MoneyGram overhauling its pricing strategy (lower) during the 2019 timeframe. Likewise, obvious factors such as promotional pricing for new customers and new markets cause revenue growth to trail transaction growth during high growth phases.

MoneyGram’s recent Digital revenue growth appears to be closing the gap on Digital transaction growth. The November press release relating to October’s Digital cross-border DTC growth made this clear: “Moneygram...today announced the Company delivered 150% year-over-year cross-border transaction and revenue growth for October in its direct-to-consumer digital business, MGO.” 

The carve outs are important - the 150% transaction and revenue growth only applies to a subset of Digital: DTC and cross-border. This does not necessarily reflect certain API transactions and it excludes the US-to-US digital corridor, which competes with Venmo, Zelle, and CashApp. US-to-US remains under pressure.

Compare to the disclosure in the August press release relating to July’s growth, 

“Overall year-over-year July digital transaction growth of 124% and digital revenue growth of 109% was driven by the following components: MoneyGram Online, the Company's direct-to-consumer channel, delivered 126% year-over-year transaction growth in July, led by cross-border transaction growth of 207% as strong adoption of the MoneyGram app continues to grow in markets around the world…”

Venmo, et al are worth a quick mention here. If you want to send money to your abuela in Guatemala, those companies face a few major challenges:

1. The regulatory compliance required for cross-border transactions is large, and – practically speaking - you cannot Venmo your Guatemalan grandma today;

2. “Cash” is an important element. Even if you could Venmo grandma in Guatemala, she very likely needs to turn that into physical cash. Venmo is not set up well for this yet in the US, much less the rest of the world. The agent network (and banks) remain critical; and

3. Depositing physical cash into your Venmo account is also not an insignificant feat, and many of MoneyGram’s Senders still operate in a cash-based world.

This was reflected in 2015 when PayPal (owner of Venmo), acquired Xoom, one of the OG’s of digital remittance businesses. You can see the acquisition comp in the table above with VC valuations. PayPal’s ongoing disclosure around Xoom is extremely sparse, but we know that it remains a distinct service from core PayPal and Venmo, though you can of course link your Xoom account to those.

MoneyGram’s traditional cash-centric remittance business may seem dated and quaint to the average hedge fund manager, but it remains critical to its many users. Both senders and receivers are often in cash-based jobs or cash-based economies. Even if you could Venmo your grandmother in Guatemala, there would not be much for her to do with it once she received it. She needs physical cash. That said, you cannot Venmo her: cross-border transactions remains a very sticky problem for most payments companies. Further, receiving a Venmo typically requires you have some form of bank account.

MoneyGram (and Western Union) have done a brilliant job of knitting together physical cash remittance with digital transfers and third party wallets. The result is a differentiated customer experience.

Quoting CEO Holmes from MoneyGram on the Q2 2020 call:

“I'm not going to single out Remitly, but if you take the vast bucket of what I would argue would be your swath of digital competition with these incredibly high valuations, I would put our Digital business up against them as second to none. And I would say that in many cases, we have a superior product. I think that the user experience that we put forward, the quality of the app, the quality of the service, the consistency of the messaging, the safety and security of it with respect to fraud-related type activities. I would say that the number of corridors that we can send to and receive into, the FX rates, and just generally, at the end of the day, the consumer experience associated with it really is unmatchable. 

“At the end of the day, when you take a look at what you get from our service in any market in which you try to use it and then compare that to anybody else, it's really extraordinary. And importantly, it generates a significant amount of profit. When we talk about a digital platform and business across 75 markets that has margin basically on average and - obviously, like anything in this space, it varies by corridor - but higher margins on average than the Walk-In space. How can you look at that business and say that it's not worth at least what valuations those guys are getting, if not even bigger than that, because it comes with the backing of a very large organization that is obviously incredibly well known with a massive global brand? 

“So it's fascinating to me to look at our valuation. I get it. I mean it's been a long time coming back. But I think that we've been doing exactly what we said we're going to do. We've been investing in return to growth. We're returning to growth. We're putting up phenomenal numbers. We've built an incredible platform.”

Dinosaurs?

So far, lurking outside this writeup are Western Union’s digital business (WU.com) and Euronet’s money transfer segment, Ria. Those two companies’ digital businesses are also growing rapidly, though slower than MoneyGram’s Digital effort. For example, Western Union’s digital business revenue grew 45% YoY in Q3 2020 vs. MoneyGram’s 95% growth rate.

Western Union still dominates consumer awareness rankings, as this analysis from 2019 shows. Importantly, MoneyGram remains far more prominent than its unicorn competitors. This strong brand awareness provides a TAM within a TAM, for driving efficient customer acquisition in its digital channel.

For Western Union, digital money transfers represent 21% of WU’s C2C revenue and 31% of its C2C transactions (Q3 was $230 million of digital revenue). We can see that WU’s overall scale remains a massive advantage, with everyone else chasing. That said, WU is operating in a different, more omnichannel manner. For instance, Dollar General is a large WU agent in the US. However, if you go to DG to Send or Receive, you are required to use the WU app. The app provides you a code which you bring to the checkout counter at DG, and the cashier facilitates the physical cash portion of the transaction. IMO, this is a good idea, as it brings Walk-In consumers closer to Western Union (and MoneyGram, which also employs the strategy in certain locations).

Like MoneyGram, WU says the preponderance of its digital customers are new to WU (80%), implying limited cannibalization. In this way, we can see that WU and MoneyGram are using their large physical-world presence to help drive digital world growth. The purely digital account-to-account business is the fastest-growing part of both MoneyGram and WU. The following quote from Western Union’s CEO on its Q3 2020 call packs a lot of useful information. Virtually everything stated below applies to MoneyGram, except MoneyGram focused on truly prioritizing digital earlier, is growing faster (taking share), and is more levered to a digital success than WU (due to starting valuation and capital structure):

“Westernunion.com once again led peer money transfer companies for mobile app downloads by a wide margin in the third quarter. So the targeted investments we are making in customer acquisition and engagement are clearly paying off.

“At the same time, we continue to see the general pricing environment as stable. The foundation of our digital success is an unmet omnichannel platform. The vast majority of our digital transactions are paid out at the Western Union agent location. The omnichannel capability continues to be a competitive advantage for Western Union as this type of physical payout transactions is challenging for digital startups to execute.

“At the same time, Western Union account-to-account capabilities with payout in the billions of accounts in over 120 countries, including real-time payouts in 80 countries to select bank accounts and wallets is allowing the company to continue to capture incremental growth in the fast-growing account-to-account channels with our account-to-account on transactions up over 130% in the quarter.

”As we previously discussed, we are extending the capabilities we have developed with our branded retail and westernunion.com offerings to third-party partners to target a new and incremental market, which was using correspondent banking for cross-border money transfer. We are focused on financial institutions who have customers with cross-border money movement needs that historically use more costly and less efficient services like the correspondent banking system, and now they are seeing the advantages of switching to our high-quality and efficient cross-border platform.

“We have seen the early success as our initial partnerships are delivering meaningful results, and the pipeline continues to build. This go-to-market approach and advantaged competitive position in digital should support strong long-term top-line growth for years to come. 

“Importantly, the digital business is value-enhancing for us: 

• First, it is highly incremental. Over 80% of westernunion.com customers are new to Western Union company, and our account-to-account is growing in a new attractive segment of customers that generally have not used our service in the past. In addition, the digital partnership business targets a large market opportunity that Western Union has historically not participated in, which represents roughly half of the $700 billion C2C remittance market. 

• Second, the digital channels have strong profitability on both a dollar and margin basis. Overall, the economics of the westernunion.com business today are similar in nature to the retail business. For digital third party, although the revenues per transaction is lower, margins are even higher and incremental to overall margins, and this business is still in early stages. As this business continues to ramp up, it should help drive margin expansion for the company.

“Now putting the pieces together, the digital business is an important source of incremental profit for [Western Union.]”

Note that WU stated that half of the global remittance TAM was previously unaddressable by WU and MoneyGram (correspondent banking), and now is in play. Digital remittance is unlocking a multi-hundred billion TAM that up until now has been dominated by a high cost, pain-in-the-ass correspondent banking system. Digital is a 10x improvement in service, security, and cost. The expanded opportunity is gigantic and explains how Digital can grow so rapidly without overly cannibalizing Walk-In. On a multi-hundred billion TAM expansion, I believe this can continue for years.

MoneyGram management has repeatedly said they believe its digital offerings are beating analog competitors and holding its own amongst in the digital space. For example, from the Q2 2020 call, the CEO stated:

“..we're capturing new customers. I think we're taking share from a lot of the other traditional players that are out there. I think we're actually [also] competing extremely well with some of the pure-play digital guys. And from what I've heard in numbers that have been mumbled around, I actually think we're probably outperforming a number of the pure-play digital partners as well.”

The brand relevance of MoneyGram and Western Union shows up in organic search results on Google. If you Google “send money” or “send money online”, you will see sponsored results from many of the large fintechs at the top, but the organic results are, in order: 1) Western Union; 2) MoneyGram. After that, depending on your search, it’s either Ria or Xoom (followed by Xoom parent Paypal and Walmart). The pure digital players are largely void on the front page of the search, unless they pay for sponsored search results. This highlights MoneyGram’s opportunity for low-cost customer acquisition.

While it is challenging to narrow in on precisely what the margin structure of MoneyGram’s Digital business is, we can use its disclosures in addition to WU, TransferWise, and Xoom’s old reports to make some assumptions.

For example, while we know digital transaction values are lower (as are revenue per transaction), we know there are more frequent transactions, higher customer loyalty, and higher margin % per transaction. WU highlights the last point in its Q3 2020 slide deck:

As noted above, while transaction value is lower for MoneyGram in Digital vs. Walk-in, Digital is more loyal, more frequent, and higher incremental margin. MoneyGram’s Q3 slides give some color.

An additional confounding factor is that the economics are different between wallet-to-wallet vs. MGO (where MoneyGram directly touches at least one of the Sender or Receiver).

As to margins, MoneyGram’s CFO said in Q3:

“Another important aspect of our money transfer revenue growth was that our newest and fastest-growing business was profitable. The company could not have been able to improve its operating margins if our Digital revenue was at a lower profit margin or was dilutive to EBITDA. The characteristics of our online mobile products include improved profitability because our margins are significantly higher on repeat customers. We see customer loyalty rates that are higher in the digital space and a higher proportion of our digital transaction are coming from repeat customers. As a result, we expect to achieve sustainable margin expansion on our mobile and online products.”

…

“What we're seeing evolving is that we can get higher gross margins and operating margins in the digital space, but it's still a little over 1/4 of our revenue. 

“So if we get to where Digital starts to become a much more meaningful part of our total transaction flow and revenues, you should see some margin expansion come with it. But it's a little bit unpredictable because it's still relatively small compared to the legacy business.”

And on the Q2 call, the CEO said:

“In the second quarter, our Digital business surpassed the margins that we see in the retail Walk-In business. Unpacking this a bit further, the Digital business is simply very different from the Walk-In space. This business is not about revenue per transaction, nor is it about fighting for the share of wallet at the point of sale. It's about creating a frictionless customer experience. 

“In the Digital business, we're measuring success in a similar manner to the way in which many other leading tech companies measure their success: total customers, monthly active users, transaction frequency and customer retention. And in contrast to many start-ups that haven't achieved profitability, we're also focused on the gross margin of this business because profitability matters, especially as our transformation accelerates. Because our relationship is established directly with the consumer, we have less commissions, less support costs and less infrastructure costs. In essence, we can charge less because it costs us less.

“Our high customer acquisition retention rates are really the best metrics to underscore the strong return on investment that we are achieving from our focus on delivering the industry's best customer experience. Our consumer direct channel [MGO] has nearly 50% higher customer retention rates than our Walk-In business, and these customers also complete 34% more transactions per month than the average Walk-In customer.”

And from the CFO on the same call:

“An especially encouraging aspect of the company's broad-based growth is that Digital properties are achieving scale. And they also generated profit margins that are better than the average margins in the traditional Walk-In business. So while Digital pricing tends to be lower than Walk-In pricing to the consumer, MoneyGram is currently able to maintain or increase profit margins in its newest and fastest growing business. 

“As we've stated in the past, MoneyGram has designed its Digital offerings with a lower cost structure based on our acknowledgment that future opportunities in this market would go to those with competitive prices. And while, in the short term, lower pricing can lower the growth rates of total revenue, MoneyGram has been offsetting this impact with rapid transaction growth well in excess of growth rates in all of our Walk-In markets. So this resulted in an increasingly significant contribution to earnings and cash flow for the second quarter, and we expect this to continue.”

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Cost of Capital and its Future:

MoneyGram has a $645 million first lien at L+600 (1% floor) due June 2023 and a 13.0% $245 million second lien with warrants due June 2024.

Prepayments on the term loans are allowable. Before June 29th of this year, MoneyGram would incur a 2.0% prepay fee, 1.0% for prepaying during the subsequent 12 months, and 0% thereafter. With growing free cash flow and improving EBITDA credit metrics, MoneyGram should be able to substantially reduce its interest expense. I expect it will refi in the second half of the year, as this coincides with the lower call premium and with a likely conclusion to its DPA with the DoJ.

How much lower might MoneyGram be able to get its interest rate? Western Union, which at 1.25 Net Debt/EBITDA is a much better credit, has a YTW on its June 2023 bond of 0.8%. While MoneyGram is not going to sub-1% any time soon, it shows what’s possible as its credit profile heals. 

With $240 million of run-rate Adjusted EBITDA and $750 million of total net debt (including its remaining DPA fine), MoneyGram’s $640 million first lien is 2.7x and its Total Net Debt/Adjusted EBITDA is 3.1x.

In the last two quarters, MoneyGram has averaged nearly $30 million of FCF (CFO less CapEx). At that run-rate, it can build $120 million of cash per year, organically reducing its Net Debt by 0.5x per year. Obviously, if EBITDA (and resultant FCF) grow, this process will happen even faster.

If my view of the future plays out, MoneyGram will have the DPA situation in its rearview mirror by June. While there is some possibility the last fine payment is waived, I assume it will be paid. 

If we assume MoneyGram Digital continues to grow $9 million of incremental revenue per quarter, with 60% contribution margin, then by Q2 2021, Digital business will be generating $80 million per quarter of revenue (from $53mm in Q3 20), with incremental EBITDA of $16 million per quarter. On an annualized basis, that $64 million of incremental EBITDA should have a very high pre-tax cash flow conversion ratio.

That could put total company Adjusted EBITDA at a ~$300mm run-rate by the end of Q2 of 2021.

With $100 million of free cash build by then (Q4 + Q1 + Q2), net debt could be around $650 million, reflecting a 2.2x Net Debt / EBITDA ratio. 

I believe capital markets will look favorably on this level of balance sheet repair. MoneyGram would be able to issue debt at interest rates of 5% or less.

Between debt paydown and lower cost remaining debt, MoneyGram’s annual interest expense could fall dramatically:

Today: ($640 x 7.0%) + ($245  x 13.0%) = $77 million

5% Future: $650 million x 5.0% = $33 million

This $44 million in potential savings is an incremental 5.5% pre-tax cash yield on equity, with remaining room for continued credit enhancement in front of it (see Western Union).

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Summer 2021:

This summer may bring a glorious collision of several positive events. 

At that time, Mr. Market would be looking at MoneyGram’s Digital business as an increasingly large and profitable fintech, with differentiated traditional cash capabilities. TransferWise and Remitly will be coming public, allowing us to put unicorn multiples on MoneyGram’s own unicorn business.

2021 will also almost certainly bring with it increasing disclosure around MoneyGram Digital, making it easier and easier to value a business segment that today can only be viewed via a mosaic technique. Given Square and PayPal both trade at >10x revenue and >50x EBITDA, I believe that version of MoneyGram could easily be worth something like:

+ 8x Walk-in Adjusted EBITDA: $120mm* x 8 = $1.0 Billion

+ 20x Digital Adjusted EBITDA: $150mm** x 20 = $3.0 billion

= Total EV = $4.0 billion

With Net Debt then of $650mm, that leaves $3.3 billion for equity. Given 85 million fully diluted shares, MoneyGram’s stock price could approach $40/share. The stock trades at ~$9 today.

Looked at another way, if MoneyGram is a $300 million Adjusted EBITDA business with $45 million of CapEx, that leaves $255 million of Adjusted EBITDA - Capex. Subtract $33 million of interest, leaving $222 million of runrate Adjusted pre-tax equity cash flow.

Today’s market cap is $800 million, which is approximately 3.6x that pre-tax equity Adjusted FCF. At 10-15x, the market cap would be $2.2 - $3.3 billion, or $26 to $39/share.

The above thesis rests on one primary driver: that the Digital business continues to grow in a linear fashion for the next few quarters similar to its linear growth of the past few quarters. I’m not forecasting continued exponential growth. Just linear growth in Digital of $9mm per quarter. Perhaps that is too optimistic, but it’s certainly a real branch on the probability tree. Not many situations give you a >4x in less than one year if you simply maintain the same linear trajectory for six months.

It is fairly clear that MoneyGram’s Digital business grew in Q4. For MGO, it reported cross-border transaction growth for October of 150% YoY, 136% in November, and 142% in December. As discussed earlier, with revenue growth now closing in on transaction growth, we can expect MoneyGram’s Digital revenue and margins to explode upward in the near term. On Friday, we will learn more.

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Strategic Exit:

Finally, it bears mention that I firmly believe the remittance space is set to consolidate. MoneyGram could theoretically be on either side of the consolidation, but I believe it is a more natural Target than Acquiror. Viable acquirors range from Visa, to PayPal and Square, to TransferWise and Remitly, and to - yes - Western Union. 

If I were Remitly, pre-IPO, I would fish up a small player like Azimo, to begin to aggregate scale. Post-IPO, with a cash rich balance sheet and a valuable currency, I believe a move to grab MoneyGram, given its large Digital business and strategic physical cash capabilities, would be well received. The strategic rationale and synergy potential jump off the page.

[End]

End Notes:

* I deducted $36 million of Ripple EBITDA contribution from Walk-in, since the current agreement expires in 2023 and will not garner a multiple unless the agreement is extended. Ripple provides approximately $9 million per quarter of net incentives for MoneyGram to use its ODL Fx system.

** I am using management’s definition of adjustments for things like Adjusted EBITDA. When I discuss free cash flow without calling it Adjusted Free Cash Flow, I am calculating a more pure FCF number. Management adjustments match the terms in the credit agreement.

Note: like many payments business, I believe MoneyGram is naturally hedged to inflation and  further QE/stimulus. As currency grows, the volume of transfers through its pipes grows with it. We saw this effect after the first round of stimulus in the US back in the Spring. 

Disclosure: Do not trust strangers on the internet. All investments involve the risk of loss. I may buy, sell, or otherwise modify my position in MoneyGram and related businesses without discussing those adjustments.

Catalyst

• MoneyGram will report January’s Digital (MGO) growth and Q4 2020 earnings on Friday

• It should be able to refinance its debt later this year, dramatically lowering its cash interest expense

• Incremental margins from Digital are high, and Digital is growing rapidly

• I expect MoneyGram to improve disclosure around its Digital business beginning Friday

• Three unicorn remittance comps may IPO this year: TransferWise, WorldRemit, and Remitly

• In combination with MoneyGram’s improved disclosure around Digital, the world may come to perceive it not as a stodgy old-line company, but as a transformation that looks more and more like a FinTech unicorn