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[SMALL CAPS] OzForex (OFX)

OzForex reported its first half result last week. It is at the smaller end of our portfolio's mid-sized positions and has been held since IPO in late 2013 (one of only 14 IPOs we have participated in the past 5 years).

A former favourite of the market, the share price has done it a bit tough over the past 12–18 months. After an initial stellar run immediately post IPO, the company has been impacted by lower volatility in fx markets (discourages fx volumes) combined with some management instability and commercial partnership changes, none of which has helped the company's cause.

We like the industry and structural change thematic around this business as the high-cost high-fee bank competitors gradually lose share of fx payments to the efficient low-cost online providers. We especially liked OFX for its high returns and

low capital needs. Further, there are high barriers to entry due to the systems intensity of the online model (competitors need to come up with a better mousetrap than current providers). Licensing is also an entry barrier (need a government license in

every jurisdiction – including one for every US state) as are the extensive local banking relationships OFX have established globally.

All this allows them to do global fx payments very quickly and efficiently rather than relying on traditional wire transfer methods used by most legacy competitors (where actual funds are transmitted across borders). For example, to do an AUD/USD fx payment using OFX's in-country commercial banking partners simply requires funds transfer of AUD from client to OFX account (in Australia) then concurrently from OFX USD account to US recipient's account (in the USA). Often these payments are transferred overnight at low cost and compares to 5+ days using competitors (and at much higher cost).

Most of the company's sins of the recent past are being addressed. The new CEO (ex ANZ) is very energised and has a strategy (called 'Accelerate') to double revenues and more than double earnings over the next 3 years (by FY19). This is being accomplished by increasing investment in:

•    Systems: OFX had previously underspent here – it is a critical business enabler especially in mobile platforms;

•    People: boosted management team with new chief technology officer, new marketing head and new COO;

•    Marketing: previously only did search engine marketing across seven separate brands, now will unify with one global brand 'OFX' and will use broader marketing strategies including social media

The result for the first half of 2016 saw the implementation of the first stage of the 'Accelerate' strategy, namely a large step-up in the cost base (opex +26%) and higher capex. Investors will cop this cost and capex burden as long as the earnings pay-off is also delivered. To this end, net fx payment revenues also rose by +29% in the 1HFY16 result.

We expect the periods ahead to have lower cost and capex increases yet continued strong revenue growth. The present valuation looks reasonable at less than 25x PE for a high growth/high return business. The fact that OFX is also potentially a target for an industry consolidator is also a nice-to-have.

Published on: Wednesday, November 18, 2015

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