Wise: Moving Money Around the World – Business Breakdowns, EP.99



Zack: (00:01:42)

This is Zack Fuss, an investor at Irenic Capital. And today, we’re breaking down Wise. Wise helps individuals and small businesses move money across borders. It offers significantly faster and cheaper international transfers than traditional banking routes because of its innovative closed loop system. 12 years after its founding, Wise serve 6 million customers and earned close to GBP 1 billion in income last year.

Investors currently value the business, which is listed in London at GBP 6 billion. To breakdown Wise, I’m joined by former payments exec and now investor at Sydney-based, TDM Growth Partners, James Revell. We cover the broken system of correspondent banking, which has led to slow, opaque and expensive transfers and then explore how Wise has counter positioned itself to take advantage of this large market. Please enjoy our breakdown of Wise.

Zack: (00:02:34)

James, thank you so much for joining us to breakdown Wise. I thought a good place to kick things off was just to very simply present to us what is Wise and what is the key product or core competency of the business.

James: (00:03:27)

So at its core, Wise is a cross-border money transfer business. It was founded in 2011 by two Estonians, it was founded actually as TransferWise, which goes to the point that they’re money transfer business. When we’re talking about money transfer, it’s probably worth breaking that down into what Wise is and what Wise isn’t.

It is more focused on retail payments, so smaller peer-to-peer or small businesses transferring money across borders, so between two different jurisdictions. It’s a digital-focused business, which is an important thing, which we can come back to later when we’re talking about margins. I mean it doesn’t really handle cash, which on the other side of the fence in the cross-border money transfer market, you have companies like Western Union and MoneyGram which many people might have heard of, which are more remittance businesses.

And when we talk about remittance, we’re talking about normally company servicing migrants. So economic migrants working overseas, needing to transfer money back to families in their home country. We’re also not talking with Wise about e-commerce.

So sometimes when we talk about cross-border payments, people might be thinking about card payments on foreign websites, we’re not talking about that in this case with Wise, we’re talking about normally bank account transfers. And interestingly, when we talk about bank accounts, Wise, funny enough, isn’t a bank. So it is a licensed financial institution, but it’s not a bank.

Zack: (00:04:19)

I guess to zoom out a bit and talk more broadly about how this business came to be, it has a pretty interesting founding story, and I think it helps to better appreciate what the product is if you haven’t used it. So maybe let’s just talk a bit about how we got from the founding story to where we are today.

James: (00:04:34)

So I think we go back to 2007, 2008, you’ve got the two founders, they’re two Estonians, so one’s called Kristo Kaarmann and the other one is called Taavet Hinrikus. Two Estonians actually living and working in London. They both have bank accounts in Estonia, but they’ve also set up bank accounts in the U.K., and that’s important. We’ll come back to that.

So living and working in London. However, Kristo is working as a consultant for Deloitte in London, and he’s being paid in pounds in the U.K. On the other hand, Taavet is working for Skype, funny enough, he was Skype’s first employee. He’s still being paid in euros back in Estonia. This is where their stories differ. So Kristo wants to move money back to Estonia to take advantage of some of the high interest rates that were back in Estonia back in 2007, 2008.

So being paid in pounds in London but having to transfer money back to Estonia every month. On the other hand, Taavet is being paid in Estonia in euros, and he was obviously incurring expenses in London, so needing to transfer money from Estonia to London. So every month, they would both queue up at the bank, they would wait in line, so it’s Kristo who wants transfer GBP 1,000 from the U.K. to Estonia, the bank says, “Sure, fill out this paperwork, we’ll charge you GBP 25 to transfer this GBP 1,000,” and Kristo is like, “Sure, what choice do I have?” Five days later, it takes a lot of time for his money to transfer.

He checks his bank statement and is expecting something like EUR 1,200 to land in his Estonian account. What actually happens every month is EUR 1,100 lands or EUR 1,140 lands. And Kristo actually tells the story whether he thought he had been scammed or someone had fat-fingered, made a mistake, so he inquired about it. And what he realized was and what a lot of people don’t realize, is there are a lot of hidden fees in that exchange.

So what the banks do, they’ll quote you a fee upfront, and then they’ll try to mark up on the foreign exchange. And that’s something that Kristo didn’t know. Taavet’s experiencing this, but just in reverse so he’s trying to transfer euros to the U.K., also having similar problems inconvenient, opaque, no idea when the money is going to turn up and he’s being charged hidden fees.

They actually met at a party, both were having a good old whinge about this, and they realized they could solve each other’s problems. So what they decided to do was they actually set up a Skype chat. And every month, they would go into Reuters or Google or wherever to get your foreign exchange rate from and they would agree, I will — Kristo transfer Taavet, you my pounds in the U.K. and Taavet, you transfer me your euros in Estonia. The end effect is they’ve made a cross-border transfer.

They’ve got what they wanted, their currency exchange, but no money has crossed a border. So they get the money pretty much straightaway. It’s completely transparent and they’re not being charged any hidden fees. So they basically solve this problem of cross-border transfers and they’ve kind of bypassed it. You might see it as a bit of a loophole or a bit of an arbitrage of the existing system. But they realized, people just really care about the outcome.

They don’t really care about how that money actually moves. So they thought they might be a big market here. They started a Skype chat and they expanded it to friends and friends of friends before they knew it, they were essentially running an order book with pounds on one side of the ledger and euros on the other, and they would match mate. So they would try and connect this, what is essentially a peer-to-peer market, the “cross-border money transfer”. And that, Zack, is exactly how Wise works today, but on a massive scale.

The only difference being rather than having to connect Kristo and Taavet or strangers and strangers. Wise has a series of domestic accounts that you can transfer money to. So in the instance we’ve just discussed, Kristo would transfer his pounds to the Wise U.K. account, Wise would then communicate internally with their Estonian account. Wise’s Estonian account would disperse euros to Taavet or Kristo’s Estonian account whoever and then exactly the same what happened in reverse.

That solves the coordination problem. But again, there is no money actually crossing borders and it’s all staying within that one single platform. And we’ll get on to it later, but that solves a lot of the problems that they saw upfront when they were going through the traditional banking rails.

The other beauty of this system is, Taavet and Kristo are mythical creatures here, they’re both being charged for a cross-border money transfer. But in reality, Wise is only incurring domestic costs. So that is essentially the leverage that this business has and why structurally they’re set up so differently to what exists today.

Zack: (00:09:18)

That was a really rich background of how they kind of went from what was an abstract and complicated means of matching friends and acquaintances in regards to the ability to exchange currency to a somewhat large business today. So can you help us to understand the size and scale of what they’re doing from outstanding start and what was it, 2011?

James: (00:09:43)

Founded in 2011, by 2014, they’ve done GBP 1 billion in cross-border transfers, which is enormous. Today, they’re on track to do around GBP 100 billion in transfer volume in the year, and that’s still growing north of 40%. That has translated through on track to do probably just shy this year of GBP 1 billion in total income. They’ve got 60% gross profit margin, so GBP 600 million in gross profit, and that’s flying through to about GBP 200 million in EBITDA.

So about a 20% EBITDA margin, which we can come back to, which is kind of a fascinating story. So it’s a very large business. It’s listed. It listed in 2021 on the London Stock Exchange via direct listing and its current market cap is about GBP 6 billion. Outside of just financials, it’s got about 6 million customers, and that’s broken down between a 5.5 million personal customers and about 320,000 businesses, and they’re normally then the smaller EBITDA businesses.

They don’t play in that enterprise space. They’re active in about 80 countries, about 50 currencies, which results in about 2,500 currency routes. Now this whole machine is powered by about 5,000 employees across 28 offices around the world.

Zack: (00:11:06)

I think we should go into a bit about what differentiates them and what are their true competitive advantages because I think it helps to better inform how over time they’re going to accomplish that goal? And what that potentially means for the rest of the players in the space and where their profit pools and margins may go as a function of it.

James: (00:11:24)

Maybe I’ll start with just providing a bit more context and background on the cross-border money transfer market, and that can set up this counter-position Wise has. So if you think about cross-border money transfers, it goes back thousands of years. There are history books written on this. Ultimately, back in the day, it would have been gold bullion or precious metal spices being loaded on to ships and transferred across borders.

Obviously, that is quite impractical, causes security concerns, costs and all sorts. Over time, we’re talking 11th, 12th century now, the bill of exchange was created, whereby you could essentially create an IOU which meant you didn’t need to transfer actual money or currency across borders, it’s more a paper-based exchange of value that could be redeemed at a bank. These were posted at the time.

And then that has grown into telex messaging when cross-Atlantic cables are laid and this electronic means that of communication between bank arrive. And so the history of cross-border transfers, if you think about it, money stopped moving across borders a long time ago. It was a lot of credits and debits of accounts with each banks held with each other, moving numbers around on ledgers as opposed to money actually being sent on a ship or through this kind of pipe. It’s just a series of relationships between banks.

That’s known as correspondent banking, and we can come back to some of the problems with that model. But maybe just to set up then how big this market is. So I think there’s about GBP 100 trillion of volume transferred across borders every year. If you cut out, say, the really big enterprise government or interbank transfers, you’re left with about GBP 2 trillion of personal cross-border transfers and about GBP 9 trillion of small businesses transferring money across borders. So this is a colossal market.

And that flows through to, say, a revenue line of anywhere between GBP 100 million and GBP 200 billion paid in fees by customers. In terms of the split of that market, about 2/3 still sits with banks, about 10% to 20% with money transfer operators like the Western Unions and the MoneyGrams and the rest is split up between the remaining players. The market is growing. So on average, growing about 5% per annum over the past decade. But interestingly, fees are reducing.

There’s some pressure on fee down was largely caused by Wise, but also by regulatory attention. But 2008, 2009, it was about 9% in fees. It’s now like, say, close to 6%, 7%. The tailwinds behind this market is largely been driven by globalization. So international trade and supply chains, global e-commerce, international traveler migration. And it’s received, like I said, a lot of regulatory attention. So the G20 and the FSB are really focused on this right now.

UN have set of goal that by 2030, cross-border transfer fees should be close to 3%. And why that is, is because it’s a very inefficient way of doing things. These are very high. And largely, unfortunately, the people that suffer are normally immigrants, trying to work overseas and transfer money every month back home to support their families. And so that’s one reason I think the regulatory attention has come. The other reason is because financial crime and the proceeds of crime transferring across borders, if that’s in cash, that causes a problem.

So underpinning this market is what’s known as correspondent banking which is the relationship between banks around the world. So if you’re, say, Commonwealth Bank of Australia, you need to transfer money to Barclays in the U.K., you may not have a direct relationship or say, you’re a credit union in Australia, it would very unlikely to have a relationship with the bank in the U.K. And so you’ll contact a bank in Australia who will contact a bank in, say, the U.K. who will then contact the recipients bank.

This chain of communication between banks is called correspondent banking. And what they’re doing is basically transferring the request and the amount of money they need to spend as well as the customer information. Now the way the banks do this communication is reliant upon an organization called SWIFT. So SWIFT is owned by 200 banks. It’s used by over 11,000 of them and it stands for the Society of Worldwide Interbank Financial Telecommunications.

So it’s essentially an electronic communication network that tries to put in place a common language and some standards around how a cross-border transfers work, what format data needs to come in. So you may have heard of SWIFT code or an IBAN number, these are identifiers that banks use globally to help them manage this complex network of communication, which underpins these transfers.

That doesn’t take away the individual effort put on to banks in order to complete transfers. And so maybe just to run through the process quickly. First of all, you’ve got to find a bank so you want to transfer money to Thailand, as a bank, you may need to go through three or four different banks to get to the recipients banking and so you’ve got to find a way of getting to the recipient bank.

Every step of the way you need to validate the data, you needed to complete the regulatory checks, you then need to potentially transform the data for the next bank along in the chain, you need to transmit it. You then need to sort out funding on the back end. So settling crediting and debiting accounts, this could be like a $50 transfer. And these six banks all need to communicate, they all need to settle funds and they all need to reconcile and make sure that all ticks were completed, all data has been transferred accurately and everyone’s got the money they need.

That’s set up, you can see that there’s a ton of problems caused by that. The first and the most obvious one, which has been growing over the past 10 years, particularly since the GFC, the regulatory and compliance burden along that chain is huge. So making sure that there’s no anti-money laundering going on. There’s no counterterrorism financing going on. You’ve got your sanctions checks, you’ve got to protect data.

So you’ve got be mindful of privacy, you’ve got prudential worries about liquidity and bank regulations and consumer protections like if something goes wrong, you got to solve disputes. So there’s an enormous amount of complexity just on the regulation and compliance side. There are interesting things like opening hours. So banks communicating across the world, they have different opening hours.

The way banks transfer money domestically between each other is normally done in a batch process model, whereby it’s only operating five days a week and at certain times of that day. So if you span a weekend, your money is not moving. There’s also a lot of paper and legacy technology involved. There’s liquidity and foreign exchange risks.

So if transfers between banks aren’t done simultaneously, which often they are, that creates liabilities between banks, which is problems and banks charge fees for that. So correspondent banking has a lot of inefficiency built in, and that flows through. So those are supply side problems flow through to problems for customers like our poor Kristo and Taavet back in 2008. It’s incredibly expensive. Every hand off along the chain, they need to be paid. It’s slow.

Each step along the chain, obviously, there’s some waiting time involved and it’s opaque. Often upfront where the transfer starts, you have no idea how much it’s going to cost when it comes out the other end. And ultimately, it’s inconvenient.

Zack: (00:19:24)

So I think where we should take this conversation is further exploring that closed-loop system that you’ve referred to. Because I think if my interpretation of the business is correct, that really is where the massive value unlock comes from.

To the extent that they are successful in making that the core strategy of the business, I want to help to better understand why even though it’s called cross-border, in many ways, it’s not, like the mechanic is such that things can stay where they are, but they can charge the fees that are associated with it and not only save their customers’ money, but also realize a very healthy margin.

James: (00:20:01)

You’re spot on, Zack. The Wise business model is based on them maintaining this global network of bank accounts that they own, so they’re Wise’s bank accounts. And then they manage so what correspondent banking involves and the problem or cause stems from the need to communicate outside of your company. So you need to engage a different company, you need to communicate with them. That’s often across border. It’s in a different data format.

It’s in a different language, different time zone. So communicating outside of your own company causes the problems. And what Wise does, it keeps that communication and keeps ownership of all those bank accounts within its own network. And so if it needs to transfer money to Japan from the U.K. it has a Japanese bank account, it has a U.K. bank account. And then they built this technology infrastructure that manages that communication flow and the liquidity between accounts.

But basically, they’re just moving money around on their own internal ( leadership ). And you as a customer experience the money being transferred across border, all Wise is doing is collecting your money in the U.K. and disbursing money from its own account in Japan to your recipients bank. It’s a loophole in the system. It’s arbitrage of a broken system that they’ve managed to fill.

Zack: (00:21:28)

It seems like a pretty basic value proposition. And I’m trying to better understand what else are they doing? What is the special sauce behind this business? And then what are the products and services that they can kind of wrap around that key competency in the way that you see a lot of businesses that do something that, correct me if I’m wrong, does seem somewhat commoditized and then create value in a way such that they can capture such robust margins.

James: (00:21:52)

I think this is the crux of the business. It’s a fascinating counter position they have to the status quo. The value proposition is hammered home by this business every single day to their customers into the market. So the first value proposition is price. They’re about 10x cheaper than the average cross-border money transfer fee. If you look at the World Bank, it’s about 6.5% fee to transfer your money overseas.

But Wise average customer price at the moment is about 65 basis points. So 10x cheaper. The second pillar of their value proposition to customers is speed. About 50% of all of that cross-border transfer volume arrives instantly and about 90% is done within 24 hours, which is phenomenal. I mean you hear that four years, 0% was instant. So that commitment to speed is something that if you’re going through a bank, you’re waiting up to five days, particularly if you’re a business, that lack of certainty is a big problem.

The third is transparency. So going back to the founding story, Kristo had no idea that there was that hidden fee and that markup being applied to the foreign exchange. In fact, studies have shown only about 4% of customers know the true cost of transferring money overseas. So Wise is extremely transparent about the fees it’s going to charge. It tries to be extremely transparent about how long it’s going to take.

And then they provide you with the phenomenal user experience along the way, giving you updates on where your money is both as a sender and a receiver. And the last and the fourth pillar they talk about is convenience. We’re just kind of tied into transparency, but they’re well known for how phenomenal their user experience is. They’ve got a 71 Net Promoter Score, which is phenomenal, particularly for a business with 6 million customers. And that flows through.

So to this day, about 2/3 of all customers are referred by other customers, which, again, we can talk about the efficiency of this business, but that shows you just how many advocates they have for their user experience. So that’s probably what I would call their customer value proposition. In terms of how it manifests in products and services.

Back in the day when they were called TransferWise, it was simply a way to transfer money across borders, and that would be pretty much the only product you could get from this business. Over time, they’ve actually expanded beyond that. And they’ve tried to create more of what you might see as a borderless account. So they’ve got three products. The first is what they call now the Wise Account, and that allows you to hold, send, spend or receive all of those currencies.

So they think you should have a borderless account and these ring-fenced domestic bank accounts are of the past and people will move more towards borderless accounts. The second is basically the same account, but for businesses. So a few more bells and whistles, small businesses like creating invoices, business cards, things like that. And the last, which is quite an interesting part of the business is called the Wise Platform.

And that’s essentially a product that allows other enterprises, normally neobanks, but it could also be other kind of ancillary services. So Monzo as a neobank, or Xero as a software accounting package. They can white label Wise’s functionality into their own features. So Monzo and Xero, both offering their customers cross-border transfers, but it’s all running on Wise’s infrastructure.

Zack: (00:25:32)

I look at the financials of the business, they’re likely to approach over GBP 1 billion in the next year or two, very profitable at EBITDA margins in excess of 25%-ish going forward, and then compare them to some of the scaled businesses that they compete within or are associated with who tend to grow at mid- to high single digits at lesser margins, if not negative. Can you just take me through the economics of this business and how they make these numbers work?

James: (00:26:00)

I think if we’re comparing it to your traditional remittance players, the obvious one to think about is Western Union. Western Union, I mean, there probably should be a breakdown of Western Union itself. It’s a fascinating history behind this business. Founded in 1851 essentially as a telegraph company. It’s got a history of basically communications and is added on money transfers on top of that.

So this is an enormous business. So it’s operating in 200 countries, it’s got 600,000 agent locations. So the focus of the Western Union is the ability to do cash to cash. And that typically services the remittance market, where you have unbanked customers who need cash and aren’t able to go through banks. So Western Union has this agent network around the world, it’s got 20,000 currency corridors, but it’s charging about a 5% take rate, compare that to Wise, is at 65 basis points.

So that’s a very different top line number. Western Union flows through to about a 40% gross profit margin compared to Wise’s 60%. The cost of services in the Western Union model is all related or largely related to commissions they pay agents around the world to accept and disburse cash. So there’s a very different cost of service. The only COGS on the Wise side are bank and partner fees where they need to dip into international money markets. But largely speaking, it’s much more efficient at that cost of service line.

And then in terms of profitability, this is, I think, one of the most interesting parts of Wise. They run an incredibly efficient business that allows them to maintain price at a very low point, yet maintain about it, like you say, a 20%, 25% profitability line. So maybe now let’s unpick some of their operating costs and see how they run this business so efficiently. The first being sales and marketing, so that organic referral network they have is incredibly powerful.

They used to run growth hacking or gorilla marketing stunts to try and raise awareness of how they basically account to positioning the banks in terms of fees and transparency. More recently, they’ve now got quite a disciplined paid marketing approach where they look for kind of a less than nine-month payback on paid marketing spend. I think it’s currently trending closer to three months.

The second, this is a really interesting one is how the way they set up their bank accounts in the various domestic markets and the way they connect in with those national payments bodies and central banks. Over time, they try and become more and more vertically integrated, removing any partners or intermediaries that had in the time when they first launched in the market.

So in their Investor Relations materials, you’ll see they published this chart, which shows how they enter the market in quite a simple structure. And then over time, they move up the stack to become more centrally integrated into the national infrastructure and become licensed more fully as a regulated financial entity.

By doing this, it removes any partner fees or kind of the friction of needing to rely on a partner bank in that market to facilitate those domestic transfers. This as they increase this vertical integration over time, again, they’re lowering operational costs and the unit costs.

In the U.K., I think it’s taken them almost 10 years to become completely fully integrated with the national real-time payments game. The third area is their infrastructure and their technology and how they’re digitally focused and are leaning into things like machine learning and artificial intelligence to help their operations team run more efficiently. So the scale of this business now is the onboarding or reviewing at least 20,000 customer applications per day.

And 85% of those are returned or reviewed within one hour. So a lot of this is trying to automate in the back end and digitize a lot of those processes as the business scales. The other thing they utilize is AI and machine learning to help try and forecast required liquidity pools in the various domestic countries they operate in, so they don’t have to rely on partners or go to the international money markets to get more currency if there’s a shortfall in one particular market. They use machine learning to try and estimate where they need liquidity ahead of time and then manage inflows and outflows from their bank accounts in those markets accordingly.

So maybe just to put it in a simple math perspective, for every $1,000 transfer, Western Union is earning $50 in fares versus Wise is earning $6.50. So huge discrepancy, the price to the customer at the top line. And so in order for Wise to run profitably, it has to be so lean.

So from that $6.50, it’s turning about $1.30 into earnings and Western Union is turning their $50 into $10 earnings. So Western Union wants to drop price to say a 4% take rate and so make $40 in fees. They make nothing at the EBITDA line. So you can see why having this low-cost model makes Wise such a threat in the market.

And the other thing to add is, despite only spending $5 in cost of services, operating costs on that transaction, Wise it still growing as total income at around 70% this year. So it’s at scale? I mean, it’s still less than 4% market share in the personal market and is growing at such a rapid clip yet it’s really not spending much in comparison to some of the competitors in market.

Zack: (00:32:02)

And then I guess if we were going to present it in just as simpler terms as possible, there’s a take rate associated with the company. But like beyond that, what is the revenue model?

James: (00:32:11)

If you think about their highest line, it’s that total income. So they’re making about GBP 1 billion this year of that total income. That’s broken down into two components. So the first is revenue, which is at 90% of that total income. And the next, which is fascinating and one that’s emerged recently is net interest income. And maybe we’ll come back to that. So if you look at that first pillar, just revenue, 80% of that revenue line is cross-border revenue.

So that’s a volume per customer, which they do about GBP 5,000 per customer per quarter roughly in terms of volume, and they’re charging that 65 basis point take rate, which is present to the customers, a cross-border fee upfront. That volume split is about 70% personal, so personal users and about 30% business users.

So that is their main revenue stream. And we can go back to a fascinating part of this business around what they call Mission Zero, which is actually trying to make cross-border transfers free which would eliminate that line item, which is very kind of intuitive but fascinating. So 80% of their revenue is coming from cross borders, about 20% has emerged over, say, the last five years, what they call just other revenue. Now that’s broken down between debit card interchange.

So they have a debit card associated with the account, which they earn an interchange fees on, domestic transfers, so people using a borderless account and transferring within one jurisdiction. And they also have another product called Assets, which is a form of investment products, so allows customers to basically invest in ETFs. So that’s the revenue component. Like I said, revenue is about 90% of total income.

And then recently, they’ve broken out net interest income, which hasn’t really been a thing in the past, but with the rising interest rates globally, they’re sitting on about GBP 10 billion of customer deposits. As interest rates goes up, the yield on those balances are going up. And so in the last quarter, they earned just shy of GBP 50 million in net interest income, and that’s growing at quite a clip.

So there’s a lot of conjectural, a lot of talk about this in the market. How big can that net interest income line get, particularly given Wise’s commitment to giving profit or sharing profit back to customers. So they’re still unclear and Wise has spoken about how they are trying to give that interest back to customers as they’re not a bank, it’s not that straightforward. So that’s a fascinating thing that will play out over the next, say, 12 months.

Zack: (00:34:48)

Because you mentioned it, I think there are two things that we wanted to find. One being just very basic level, what are interchange fees for the benefit of people who haven’t studied them. And then I think Project Zero as part of the structure of the firm is fascinating. Let’s just talk about how that guides the goals of the business.

James: (00:35:06)

Interchange fees are fees that card issuers earn when you use a debit card or a credit card. So if we’re talking more in the merchant acquiring market here now, but you go to your bank, a card gets issued, the card issuing bank earns interchange fees. These are Mastercard, which the card network is sitting in the middle. They work with the issuers on one side and the merchant acquirers on the other side.

And so in this instance, Wise is issuing these debit cards to its customers and when a customer uses that to buy something using a card, they’ll earn a percentage of that transaction. Maybe now to get into what is really fascinating part of this business is Mission Zero. Wise has set itself up to solve this problem in the market or the status quo around opaque, expensive and slow transfers and the key one being they think cross-border transfers should be as easy as sending an e-mail. So ultimately, cross-border transfers should be free.

And they have said this many, many times. They want it to be as low as possible. They give quarterly price updates to customers where they bemoan the fact that prices have had to increase due to volatility, they kind of get quite upset about that.

They have a very transparent price comparison tool when you’re considering making a transfer with Wise, you can compare it against lots of other providers in the market. And if there’s another provider that’s offering a cheaper rate, they’ll show that, which is a bit counterintuitive when you’re trying to compete.

Zack: (00:36:44)

You’ve quantified the profit pool, the transaction volume, which I believe exceeds trillion pounds of potential. But why doesn’t the entire industry profit pool just get destroyed by a company that’s willing to accept a take rate that’s so much lower than the industry standard?

James: (00:37:02)

It’s an interesting question. If you’re an observer from the side, you could argue this Mission Zero that they’re on is actually destroying their primary revenue stream. And ultimately, if they’re successful in achieving their mission, the business doesn’t exist anymore. You’ve got to think about, is this Mission Zero, a kind of tactical strategic way for them to counter position the status quo and build that customer base.

And then as they’ve done, expand the engagement of that customer with ancillary revenue streams like debit cards and investments and ultimately, they’ll pivot away from cross-border transfers. And it may just end up being a free service that’s supplemented by lots of other different features that they can charge for. Or they’re kind of zealots, the one cross-border transfers is 0, and that’s all they really care about.

And that’s why I think this is a bit of a marmite stock or — sure in the U.K. In Australia, we call it vegemite stock. It’s kind of like, hey, is this a commodity business that only really competes on price and that will continue to be eroded down to 0? Or is it a shared economy scale business, which is counter positioning status quo and the market is so big that the durability of growth left in this business is colossal. That’s where I think the different perceptions on this business line.

Zack: (00:38:25)

I guess what I’m really trying to better understand here is the value proposition makes a ton of sense. The differentiation seems reasonable to me. But what is the core competitive advantage they have? Why can’t someone else just copy their business model?

James: (00:38:38)

On the one hand, money transfer is, you could argue a commodity, transferring U.S. dollar to a euro, their customer doesn’t really care as long as they get their euros, where you could argue that this disjointed network of domestic currencies that relies on banks talking to each other create such a terrible experience. The service and the user experience wrapped around that cross-border transfer is really important and will forever be important.

One way we think about competitive advantage is using Hamilton Helmer’s 7 Powers, and maybe to call out some of the ones which stand out for us for Wise. The first is that classic counter-position, or as Clay Christian might call it, the innovator’s dilemma. This is where a newcomer, so Wise, adopts a different way or a superior way, a new way of doing business, which an incumbent, in this case the banks, can’t or doesn’t want to respond to or mimic due to the foreseen damage it will do to its own business. So just from a price perspective, Wise is, due to their efficient model, able to cut out a lot of that inefficiency and so they can charge 65 basis points and still earn a 20% margin. Banks are charging 6%, 7% on this and earning a lot of profitability out of it. So banks can choose to respond to this, but arguably, that counter position is so strong just from a price perspective underpinned by the fact that their infrastructure is completely different.

The second one, which I think has built up over 10 years and will drive a lot of growth going forward, is this process power around moving into new markets or new geographies, integrating with the local payment system. So like I said, they’re in 80 different countries now and what they do is they land and basically expand on a regulatory basis.

So they start with just a simple bank account, set up in the most simple financial services license that they can have. And then over time, like in the U.K. and in Australia, they’re actually the first nonbanks to be participants in the national real-time payments infrastructure. So they move their way up, becoming more and more efficient in terms of that money transfer infrastructure over time, which allows them to reduce price to the customer.

The amount of complexity, they’re managing something like 63 different financial license around the world. They know how to move into a country, they know how to work with local regulators. That process power, I think, is really strong. The next one, I think the very strong and it’s very important that their brand is well known and trusted. Trust is super important for any financial institution, but particularly if you’re not a bank, me transferring money to what it was called TransferWise back in the day, it was a bit of leap of faith.

You didn’t know too much about the business. And over time, I think they’ve built that trust up. And that’s shown through in the word-of-mouth referrals and the NPS and the growth of that customer base. I think that brand part is really important. There’s also a risk. If they mess something up from a regulatory perspective, there’s a risk to that brand and that trust.

The last one, which I think is the most pivotal part of this business is scale economies, particularly scale economies shared back with their customer. So Wise talks about the flywheel that they have. And this has existed from the get-go. So they created a, what we would say, is a better user experience for the customer. That resulted in volume, as they increase their volume, they can reduce their unit costs. The variable cost of transfer money comes down.

They then reinvest that into marketing, which drives more customers, new tech, new product to improve the experience, which creates that better experience to their customers. But ultimately, they lower the price. So they give that efficiency. They share that scale economy back to the customer in the form of a lower price, which drives a better user experience and then the flywheel starts again.

So it’s this classic paradoxical thing where they’re growing more by giving more back and by lowering price. This is, I think, the most fundamental thing to understand about Wise that they’re always is trying to drive the lowest price possible as opposed to what a lot of companies do, which is focus on profit maximization in the shorter term, where they’re pricing to the equilibrium whereby they price as high as possible without forcing a customer to leave and seek services from a competitor.

This is the most important thing about Wise. The other thing we need to think about or what we think about a lot is the fact that this business is incredibly focused on what we would call a one mission, one platform journey. Its entire infrastructure is one platform. It’s one code base. 99% of it has been growing organically, and it’s been the aggregation of small games over time.

So they’re focused on maintaining this one platform despite the fact they have a personal business, it all sits on that one platform. The second is this one mission, and we’ve talked about it, but that Mission Zero, they are incredibly focused on free, rich and transparent cross-border money transfers.

And if you talk about the culture and you understand from people who’ve worked there, how embedded this is into the fabric of the organization, you start to get a picture of this isn’t just a mission that they put on their website. This is something they live and breathe every single day. And we’ve spoken to Kristo, the CEO and Co-Founder, his argument is the only true competitive advantage of this business is the fact that they’re so focused on it and no one else is.

Zack: (00:44:33)

I guess when you think about their competitors, I know you mentioned Western Union, I think about the extent that PayPal plays in the space, MoneyGram, who do you think about as their true competitors beyond just the global banking system?

James: (00:44:50)

 Like you say, they operate in a very competitive financial services space. So if you put the banks to one side, which is about 60%, 70% of the cross-border transfer market, you’ve still got these money transfer operators like Western Union, which have huge amounts of brand awareness. They’re colossal in terms of the agent network. They’ve been doing it and talk about process power, Western Union have built this up over a very long period of time.

They’re about 10%, 20% of the market. But outside of that, I think there are some very threatening players in the market. The first being card networks. So Visa and Mastercard have made serious investments in cross-border transfers through acquisition and organic growth. They both have products which allow near real-time cross-border money transfers linked to cards. So there’s Visa Direct, the Mastercard Send.

They have also incredible brand awareness. They have the existing network, and they span around the world. They have the relationships with these banks and bank accounts. So arguably, they have everything in place to allow them to compete very strenuously with Wise. More recently, you also have a budding cohort of fintechs that are going after this space.

So Remitly is a digital cross-border transfer business focused on the remittance space, which is listed recently, neobank such as Revolut in the U.K. are quite well known for offering cross-border transfers, and they don’t necessarily need to charge for it. So one of the biggest risks I see for Wise is where a business decides to use cross-border transfers and foreign exchange is a bit of a loss leader, not charge for it and then cross subsidized through ancillary revenue streams.

And that’s what Revolut does. They charge subscription for access to the account and then you can basically get foreign exchange or cross-border transfer for free. And then there’s — in terms of individual players, there’s a merging threat around social media players. So Twitter and Metas or Facebook have both recently invested in — or toyed with investing in their payments capability, and they also have that global presence. They also have social media accounts.

And if you see the world moving towards a place where moving money around is it’s easy as sending an instant message, then the social media players represent a significant threat to this business. The one caveat I would say there, Zack, is Wise has that white label product we talked about earlier called Wise Platform where any of these players, if they don’t want to build it themselves or partner with bank accounts can partner with Wise.

Utilize the infrastructure that they built over 10 years and still for all intents and purpose of their customers, it’s a service being offered by them. They don’t need to know that it’s underpinned by Wise. So Wise in a way has reduced its friction of adoption and ultimately expand its way of attracting customers through these partnerships.

Zack: (00:48:07)

It is interesting, right? Because if you think about Meta, Facebook as an example and specifically WhatsApp, believe they have like a monthly active user base of over 2 billion, you would think the distribution advantages that they potentially have could be quite meaningful for facilitating this type of value proposition? But these companies scaled in such a way without the benefit of distribution, how exactly is it that they’re able to acquire customers so efficiently.

James: (00:48:35)

It goes back to that flywheel. 2/3 of all customers are referred by other customers, which is remarkable, particularly for a business of this maturity and this size. And I think it goes back to just a phenomenal user experience they have and the counter position they have to an existing process, which is broken. And so I, myself, I’ve been a user of Wise since 2017. I’ve told loads of people about it.

As an Englishman living in Australia, the amount of my friends that I’ve referred to Wise because it’s just such a better user experience. You hear it, say, at barbecue, I need to transfer money back to the U.K. because I got a mortgage there or there’s an expense I need to pay. I had to go to my bank, I had to fill out a bunch of forms. I had no idea how much it was going to cost, I feel like I got ripped off and you go, well, I’d basically sign up instantly to a Wise account.

And then four seconds later, the money appeared minus a small fee in my U.K. account. So there is that — I don’t want to underplay it, but that user experience advantages they have alongside price is a really strong flywheel.

Zack: (00:49:48)

So two aspects of the business, which are important, somewhat nuanced in many cases, a function of an increasing interest rate environment are the float of the business, the customer deposits that they have on hand and then the increasing net interest margin that they’re able to earn.

And I’d love to just spend some time talking about how those two dynamics, which may not necessarily be core to the business or actually quite powerful in enabling them to do what they are and building the business that’s more durable over the long term.

James: (00:50:18)

Yes. I think the net interest income has emerged globally is something that we as investors have to think about as interest rates have been rising. Wise currently sits on about GBP 10 billion of customer balances. And these are balances where you’re not earning interest. So they’re not a bank that can’t pay interest. It’s kind of lazy money.

I myself have U.S. dollars, I think, sitting in my Wise account, which I’ll just leave there until I’m next in the U.S. These balances have been sitting there, earning neither the customer money nor the company money. But now as interest rates have been rising and Wise is a regulated entity, needs to hold these funds as kind of liquid funds that they generally just hold them in super highly rated and conservative accounts normally with central bank.

They’ve started to earn interest on it. And the investment community has been watching this unfold. I mean, four quarters ago, it was basically a net interest loss, they were losing money on this. Now in the last quarter alone, they earned GBP 50 million or just shy of GBP 50 million. They’re on track. And, say, GBP 120 million this financial year from that alone. You’d think the company is rejoicing that they’ve got this new revenue stream coming on board and it can flow through to earnings.

What makes Wise so particular and why it’s such a fascinating business to breakdown. They’ve actually complained in earning calls about this. They are like we want to give this money back to customers, but we don’t know how yet because we’re not a bank, we can’t simply allow customers to earn interest. And so they’re trying to come up with a functional way and build a functional way of returning some of these earnings to customers.

The interest rates are rising faster than they can deploy this functionality. And so this operating leverage is coming through and they don’t know what to do with the profit. I don’t know many examples globally where that’s the case where you hear a CFO talk about them trying to give money back to the customer. And the way they’re kind of crafty trying to give it back to the customers without becoming a bank is allow customers to invest in government bonds basically.

So they would be earning the base rate — interest rate, but it wouldn’t be Wise paying them interest. They’re basically moving the money off balance sheet and earning money through a different vehicle. That’s what they’re trying to do. The other ways they’ve talked about doing it is lowering price further or a form of cashback and other ways of actually returning what they’re earning to the customer.

But I think this is one that in the near term, we’ll have to wait and see how it plays out. I think from a valuation perspective, you’ve also got to think about the quality of these earnings and the durability of these earnings versus, say, cross-border transfer fees. How long does this interest rate environment last? Where does it go? And how much ultimately is Wise is going to allow to drop through to EBITDA versus kind of returning it all before that.

Zack: (00:53:23)

The point you’re making there is it would be inappropriate to put a multiple on the earnings stream associated with that interest at their earning because their intention is to do their best to reinvest that interest into the customer experience, either by passing it along or providing incremental services?

James: (00:53:39)

Exactly. I don’t think in kind of a some of the parts analysis, you’d be able to apply the same earnings multiple on that revenue stream as you would to say their core business. But we’ll see.

Zack: (00:53:51)

And so if I kind of look across the strategy of the business, lower prices, more transparency, ease of use, all these things tend towards the ability to continue to grow and to take share. But what would you kind of identify some of the key risks associated with the business or potentially the tail risks that you’d identify in evaluating this company?

James: (00:54:13)

The first I would call out is what we said around if there is a paradigm shift with how people around the world think about money and transfer money. So is this a commodity business that is arbitraging a broken system of fiat currencies closed within the domestic countries that don’t talk to each other and you rely on this kind of hodgepodge connection of banks talking to each other sitting on the network of electronic communication.

If that shifts and one way that, that is shifting real time, is countries are modernizing their payments infrastructure. So people may have heard of real-time payments or instant payments where financial authorities are upgrading from batch payments that rely on a kind of ( archaic ) technology to real-time technology that allows money to move instantly, they’re actually upgrading the data format that payments information is exchanged and making that more consistent globally.

And so you don’t get that translation layer issue between countries. What countries are doing are examples of this, particularly with Singapore, they’ve interlinked or working on interlinking their domestic payments infrastructure with another countries. So Singapore has done this or is doing this with India and Thailand. And there are other examples around the world, whereby you basically plugging in the Singaporean real-time infrastructure with the Indian real-time infrastructure. And then it basically is the same functionality is transferring internally.

You’ve got to think about foreign exchange, but from a functional perspective, you can transfer money across borders as easily as you can functionally, internally, within those borders. So that interlinking I think, represents a bit of a risk to the business. One of the biggest talking points of this business going forward is around whether you believe money will be transferred or value will be transferred across border digitally and people won’t necessarily need to hold or maintain fiat currencies.

One of the big threats of this business is that paradigm shift towards, say, digital currencies, whether that be private, so potentially stable coins or central bank digital currencies, where central bank money, so digital cash is distributed around the world. And this isn’t kind of a paper tiger. There’s reports that around 90% of all central banks globally are researching or experimenting with central bank digital currencies. So I think this may play out over time.

But one of the things you’ve got to think about is that Wise is basically fiat money transfers between existing bank accounts. And if that paradigm doesn’t really exist anymore or is completely disrupted, so not faster horses, but cars, if there’s a complete shift in the way that money is transferred across borders, that represents a big threat to Wise.

The last one, which I think we’ve also touched on, which is a big one for me is the service area of risk for this business from a regulatory perspective is only growing. They’re already maintaining 63 licenses, financial services regulation and complexity has really increased since the GFC and continues to do so.

And there’s a particular focus on anti-money laundering and counterterrorism financing and the ability to know your customer, identify that customer and monitor transactions related to that customer going forward. That is a huge burden to most financial services businesses. And I wouldn’t underestimate how if you’re maintaining 63 licenses with 63 different nuances to those licenses, how the risk for this business increases from a regulatory perspective.

Last year, I think it was. They were fined by the Abu Dhabi financial authorities for not having appropriate controls in place. It was a small fine and it was an isolated incident and the company fronted up to it, and were very open and transparent about it, which is a great sign. But I think the regulatory risk has to be on anyone’s mind when they think about this business.

Zack: (00:58:30)

And you had mentioned that they made the decision to list in the U.K. via direct listing. Can you just talk a little bit about the decision to do so and how they went about listing in a way that’s non-traditional?

James: (00:58:44)

A direct listing is whereby you don’t actually raise any money through an IPO. And you basically take your stock and list it on a public exchange. So Wise did this in 2021. It’s atypical. There are a couple of high-profile examples. I think Slack did it, Spotify also did it. I guess it comes down to the incentives and the rationale for listing in the first place. Often companies do it to raise capital.

If you don’t need capital, there are other reasons you might want to less two obvious ones being you want to increase the liquidity for existing shareholders and the ability to buy and sell on a regular basis. And the other is, and I think Kristo alluded to this at the time is to increase awareness and ownership of your company.

So I think there’s this artistic sense within Kristo that he wants more people to be exposed to Wise because he thinks they’re solving a really important problem. And I think he likes the idea of customers owning part of the business. And I guess it goes back to that scale economy shared thing where he wants to share value back with the customer. He doesn’t feel like this needs to be a profit maximization business in the short term.

Zack: (01:00:04)

I’d also add maybe the benefit of being public helped with the brand awareness and thus, when you’re acquiring customers being more of a household brand certainly helps. I think another interesting aspect of it is in studying this company for the benefit of this conversation, candidly, I never heard of it. And despite a business that’s going to be doing in excess of $1 billion in revenue and payment transfers well in excess of presumably $100 billion at some point. It’s just quite interesting.

James: (01:00:33)

You’re spot on, Zack. For a business like we’ve said, so reliant on trust, the more people that know their story and being a publicly listed company, I think, adds to that trust. I was part of a business that listed in 2019, and it was one of the main reasons. It was also a financial services business. And when you’re going into RFPs or you’re talking to customers, if they can see your ticker on a stock exchange, there is added brand trust there.

Zack: (01:01:00)

So I know that when looking across their investor materials, the way that they back into their margin is unique in what they’re managing to, I believe it’s around 20%, how should people looking at the business, think about where margins go over time? And if it will ever be in an environment where they want them to exceed that? Or on the flip side, lower the margin further to continue to reinvest in the customer experience.

James: (01:01:23)

It’s a great question. I think it’s one of the most topical things that’s discussed by investors or observers of this business. Like you say, they manage the business to a 20% EBITDA margin. In a way, this is artificial. So like I said before, they take 1/3 of their gross profit and spend on keeping the lights on. They take 1/3 of it into growth and put it into growth and marketing and 1/3 falls through to EBITDA, which is where that 20% comes from.

Back in 2021 during the pandemic, they actually pulled back on some of that growth spend to be a little bit more conservative as the world didn’t really know what was going on. And their EBITDA margin for that year spiked to 26%. It gives you an indication that there is some underlying earnings power to the business that they are deliberately choosing not to allow to come through at this moment because they’re so focused on growth.

And so on a long-term perspective, if you think about how big this TAM is and how durable the growth of this business can be utilizing that scale economy shared flywheel, when and how big that earnings margin goes, I think is one for debate. If you look at it on paper, if they were to stop altogether that growth spend, which is 1/3 of gross profit, and basically could double EBITDA. So that margin goes from 20% to 40% if they just completely pull back on growth in marketing.

So do they do that eventually or do they just decide to ultimately continue to lower price until they get to that mission 0. I think that’s why it’s such a marmite or vegemite stock. But for us, as really long-term investors, we just think how long can this business grow for, and we think for a very, very long time.

Yes, you’re talking on a 10-year basis, I think they’ve got so much headroom and that flywheel is so strong that at some point, they may flip it into kind of a profitability scenario, but the one thing I think people need to think about is just don’t underestimate how long this business can grow for.

Zack: (01:03:30)

And then as you kind of reflect upon what you’ve learned about this business as you studied it and the broader payment space, what is a lesson that you can take from this business and apply to others from an investor’s perspective? And then some of the other early stage or late-stage growth companies that you look at, what are lessons you’d like to see them borrow from Wise and apply to their own business as operators?

James: (01:03:48)

The one thing we haven’t really touched upon, which I think Wise has, and being an operator myself is something that I could have learned from. The way they organize their people and prioritize their culture, I think, is relatively unique. I attended a talk with someone from TransferWise back in 2018. You talked about the way they prioritize resource allocation internally.

So what they have is they have small teams, so they have over — I think it’s over 100 teams, small, highly autonomous empowered, cross-functional teams each working on a solution or a feature. And that team is empowered to create its own vision, its own mission, its own objectives. To the extent it can even go and seek its own legal advice. So it’s fully — each team is fully autonomous. And they basically vie for prioritization amongst each other.

So it’s a lot of mini businesses within a business. Why I think that is fascinating. It has some problems, which potentially we can touch on. But why that resonates with me is the thesis around having very highly aligned but very loosely coupled people within your organization to overcome this inertia and this slowdown that occurs as the business gets bigger.

So if you have low alignment and high autonomy, you have very empowered silos, but they’re doing their own thing. They might not be pulling in the same direction. There’s probably some duplication or overlap or potentially even pulling in opposite directions. On the flip side, you can have very high alignment but low autonomy, which is basically a command and control type structure. Both of these can exist and do exist quite regularly, but they really struggle to scale.

Reed Hastings talks about this high alignment loose coupling where you tell people what to do, not how to do it. And I think this is what these small many businesses within the business is what Wise has managed to organize as they’ve grown up. And key to it is having that super clear mission, super clear vision, you’ve got your customer at the center of everything, you know why you exist, and that creates the alignment.

There’s a huge amount of trust and transparency within the business. And I think this culture focusing on one thing, you see in other scale economy shared businesses. There’s been great breakdowns on Floor & Decor or Costco, where it’s a relentless focus on one thing, retaining operational improvements and the benefit of unit cost efficiencies back to the customer. But it is that one thing focus and just doing that one thing really well and organizing a culture behind it. For us, as people and culture investors, that is so powerful, and I think it’s one of the untold stories of this business.

Zack: (01:06:51)

Well, James, thank you for joining us to breakdown Wise. It’s a fascinating business that in many ways seems early in its evolution. The positive aspects of lowering prices, increasing transparency and providing a service that’s needed seem like a recipe for success, and it seems like the business is doing exceptionally well.

James: (01:07:12)

Thanks very much, Zack.

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