OzForex warns on profit as WU walks away

OzForex shares have tumbled almost 40% this morning after the company tagged a profit warning onto its announcement that Western Union had failed to come up with an offer after completing due diligence on Friday. It's unclear why WU decided not to make an offer, but it's easy to imagine that the two things are connected.

Underlying earnings before tax, deprecation and amortisation (EBTDA) for the year to March 2016 is now expected to land in the range $35m–37m, up from $34.5m in 2015, but around 10% lower than previous guidance of $38.5m–40.5m. The second half is now expected to produce around $17.9m in EBTDA, 16% less than the previous guidance of about $21.4m, and it will mark the second consecutive quarter where EBTDA has fallen sequentially. The profit numbers will be further reduced by one-off charges associated with the failed bid. It's not a good look for a growth company.

Disrupted

The problems are rooted in the business's rebranding. The plan – announced last August – was to unite the business under a single global brand, OFX, with a common web address (url). The new brand was launched in Australia in December, with six other regional brands (including the likes of US Forex, UKForex and NZForex) set to follow by the end of the year. The move makes eminent sense, with all the brands likely to benefit from streamlined marketing, but it's also potentially highly disruptive for a business where brand and url are everything.

Disrupted it has been. Given its imminent retirement, the company cut advertising spend on the OzForex brand ahead of its OFX's December launch, and the result was what must have been a sharp drop in new client acquisitions, given the big fall in second-half profit (which comes in spite of management's claims of a fourth-quarter improvement). The international business is still suffering from this hiatus effect with the regional brands being gradually transitioned, but the big global marketing push not expected until April.

None of this, of course, will have been helped by the distraction of Western Union's due diligence, and it also fell at a time when decreased volatility in forex market's reduced trading activity among new and existing customers. The profit impact was amplified by the company's high level of fixed costs relative to variable costs, particularly, management said, at a time when it is investing in transitioning its businesses to the new brand, although the big global push isn't due to begin until April.

We suspect that Western Union got a whiff of the weaker figures coming through and ran a mile. Of course they'd be able to get the company much cheaper now.

Confidence

On the plus side, management expressed great confidence that the rebranding would have a long-term beneficial effect on the business and reiterated its target 'to double 2015 revenues by 2019 to more than $200m' but words are cheap at this stage.

The stock is now down 45% since OzForex opens books to Western Union on 26 Nov 15 (Hold – $3.46). The new guidance suggests underlying earnings per share of a little over 10c for the full year, which puts the stock on a price-earnings ratio of about 19, which doesn't look crashingly cheap even after such a large fall. However, given that most of the earnings appear as cash and the potential for growth if the rebranding ultimately proves successful, it looks like a reasonable – albeit somewhat speculative – purchase.

As such, we're downgrading our price guide from Buy below $2.50 to Speculative Buy below $2. The Sell price falls from $4 to $3 and we're reducing our recommended portfolio weighting from 4% to 3%. These numbers are likely to increase, though, and the speculative tag is likely to be dropped, if and when evidence appears that the rebranding is having the desired effect. SPECULATIVE BUY.

Note: Our Growth and Equity Income portfolios own shares in OzForex. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.