Calculating Bitcoin's flow-on effects

Some companies will lose ground to Bitcoin, but others can embrace the digital opportunity.

The phenomenal rise of Bitcoin is viewed by local investors from a distance with little more than mild intrigue.

Indeed, even Reserve Bank of Australia governor Glenn Stevens has described the advent of the global digital currency as ‘fascinating’.

But the immediate question for investors is, will this new phenomenon have a material impact on the market? One Australian stock that would appear to be in the firing line is eServGlobal.

The growing global recognition, if not acceptance, of the virtual currency Bitcoin is already sparking speculation that it could bring the international money transfer industry to its knees, much like digital media to newspapers, or online shopping to bricks and mortar retail outlets. Earlier this week US heavyweights JP Morgan and BOM Merrill Lynch both indicated they were taking the growing popularity of digital currency as a serious issue for investors.

For those unfamiliar with the Bitcoin story, it is no longer a question of “if” but “when” it gains mainstream acceptance. While some believe that Bitcoin is trading in a bubble after its meteoric surge from under $US200 per Bitcoin in October to a record high of around $US1,200 in early December, the online currency has proven itself to be both a store of value and a medium of exchange – two necessary characteristics of money.

Bitcoin, which was created in 2009, took greater prominence after US Federal Reserve chief Ben Bernanke acknowledged the legitimacy of digital currencies.

You also know that Bitcoin has the potential to shake up the world of commerce after it rattled the Chinese government, which recently told its financial institutions not to treat Bitcoins as a currency. The growing use of Bitcoins would worry authoritarian governments because no one entity controls it, and because of the anonymity it offers to users.

The driver for the rising value of Bitcoins comes from the finite number that the digital currency’s programmers deemed would ever be in “circulation”. Only 21 million Bitcoins will be “minted”, and it costs next to nothing to send Bitcoins to someone, although intermediaries will charge between a 2% to 5% commission to convert Bitcoins to cash. (To read more on Bitcoin, see Alan Kohler’s Weekend Briefing last week).

Counting the cost of Bitcoins

At US-listed companies Western Union and MoneyGram, management have been put on notice with digital currency advocates touting the likes of Bitcoin as an industry “disruptor”. Investors in these companies have not fully woken up to this threat, although it is worth noting that the stocks have been under pressure at a time when the value of Bitcoin has soared. Western Union has fallen 10.6% in the past three months due to rising costs, while MoneyGram is down 1.2%. In contrast, the S&P 500 Index has gained 4.6%.

On the ASX, investors in eServGlobal should be alert, but not necessarily alarmed, by the virtual currency revolution. Virtual currencies pose a bigger risk to agencies that typically charge fat fees for international transfers. eServGlobal provides mobile phone users with an electronic or ‘e’ wallet to transact or exchange funds. The stock has been a successful small cap in recent times, and is currently trading at a two-year high of about 70 cents. It would seem that few, if any, shareholders in eServGlobal have shown doubts for the company’s model as the price has doubled since June .

Discussing Bitcoin with Eureka Report this week, eServGlobal’s chief executive, Paolo Montessori, dismissed the threat. Montessori says his group will weather the Bitcoin revolution quite well as its HomeSend offering allows mobile phone users to transfer money from one phone to another in 51 countries, on commissions that are amongst the lowest in the industry. Users of eServGlobal’s products pay up to a 7% commission currently, and this is set to fall to 5% by 2015 … and Montessori says it can fall further.

HomeSend, which is jointly operated by global mobile services company BICS and eServGlobal, is starting to gain traction.

While Bitcoin is capturing headlines, the reality is virtual currencies are still some years away from mass adoption for three reasons. The first is trust and familiarity. Western Union is an industry leader because people from around the world know its brand. It will take a while before the same level of comfort builds for the likes of Bitcoin.

The other is infrastructure. Sending Bitcoins around the world is easy, but converting them to cash is not – especially in less developed countries. This will change, but it will take time –which HomeSend can use to its advantage.

The volatility of Bitcoin is also an impediment to its adoption. The digital currency’s value changes too drastically at the moment. This will also likely correct itself in time to come, but this buys time for HomeSend to establish itself.

Even if the adoption of digital currencies ramps up faster than anticipated, they could provide an opportunity for eServGlobal. After all, the company’s technology is really currency agnostic and it could offer users a way to make purchases at a physical store using Bitcoins.

Commission structure

HomeSend charges a hub fee of 1.5% (shared equally between BICS and eServGlobal), while the sender’s and receiver’s telco typically charges an additional 2% each.

“But let’s not forget, for the telcos this is not only about creating new revenue streams,” says Montessori. “Their business case is built primarily around loyalty and anti-churn.”

HomeSend’s end-users are likely to be foreign workers in developed nations transferring money back to their less developed home countries.

People in underdeveloped countries, such as Africa and parts of Asia, rarely have access to banks but many have a mobile phone. Being price sensitive these users often switch carriers to get the best deal, but they are less likely to do so if they regularly receive funds.

This means telcos could be open to lowering fees for sending and receiving funds should the threat of digital currencies become too disruptive. If commissions are comparable, customers are more likely to stick to what they know.

These are important points given that eServGlobal is set to give an update on the adoption of HomeSend next week when it releases its full-year result. I have a feeling investors are going to like what they hear too.

Upgrading eServGlobal

Montessori points out that the recent soft launch of HomeSend has gone very well, with 10,000 transactions going through a month to Kenya alone with a £100 average per transaction.

HomeSend has struck agreements with various telcos that will give 1.2 billion mobile users around the world access to its funds transfer product. Not everyone will want to use HomeSend, but even if 1% of these users were to transfer $US100 every two months through HomeSend, it would add around $59 million to revenue at the prevailing exchange rate. (An earlier version of this article incorrectly stated the figure was $29 million).

Most of the revenue will flow through to the bottom line, as there is very little additional cost for handling an increase in transactions.

Analysts have yet to factor the revenue potential for HomeSend, which should become apparent in 2013-14. Consensus estimates are forecasting a 21% increase in sales to $34.1 million for the 2012-13 year ended October 31, that is driven by its existing core business of providing domestic mobile money solutions (such as allowing a user’s salary to be credited to a mobile phone and using the phone to pay bills or to make purchases).

But analysts have only pencilled in 16% revenue growth for 2013-14, and this only reflects the growth of its core business. HomeSend could be a game changer, and I suspect brokers will be upgrading their forecast post its results next week.

I had initially thought eServGlobal was approaching full value when I first featured the stock at the end of August. But early results from HomeSend has prompted me to upgrade my recommendation to “outperform” from “neutral”, as I believe the stock will be re-rated following its earnings announcement next week.

Think big, go smalls!

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