Is OzForex Group Ltd the best new business on the ASX?

Is this business set to follow in the footsteps of Seek or REA Group?

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OzForex Group Ltd (ASX: OFX) hit the ASX boards last October amid great expectations and a frothy IPO market. Its not disappointed early investors though, and confirmed in late November that it’s on track to meet its prospectus’ forecasts for FY 2014. Since the announcement shares have soared more than 20% as investors turn bullish on its growth prospects at home and abroad. In total shares are up nearly 70% on the offer price of $2 per share.

The company raised eyebrows with an IPO valuation of 21.7 times forecast earnings for the 12 months to September 30 2014, with an indicative yield of 3.4% based on the IPO price and forecast profit. This included forecast profit growth of 30% in FY 2014 and a mighty 38% in the first six months of financial year 2015, however so far, so good, as the company impresses the market.

The business was founded in 1988 and built by undercutting the dismal foreign exchange rates offered by the big four banks on international money transfers. The client base has largely been retail and small-to-medium size enterprises, often wholesale importers or exporters of goods. The banks will typically charge clients a 2-4% spread, high compared to what a business like OzForex can offer.

It generates profits by aggregating hundreds or thousands of small customer deals and then on-selling the total amount in the interbank market at wholesale rates.

It’s relying on several strategies to grow profits. The Australian market remains its bread and butter with a focus on more online client registrations, customer service, and increased use of mobile services and apps to drive business and retail client numbers, transaction volumes, and general organic growth.

It also wants to expand its International Payment Solutions business for branded partnership clients like Travelex and MoneyGram International. For the first half of FY 2014, 12% of total fee and commission income before other expenses came from this division.

Thirdly, it aims to expand into Hong Kong and the United States. The US market is certainly attractive by virtue of its massive size alone. The company now has operational licenses in 32 states, to cover 75% of the US population, with plans to expand further. For the first half of FY 2014 North America represented 11% of total fee and commission income before hedging and transaction costs. The business is bullish on its prospects abroad, although total North American commission and fee income before hedging and transaction costs was up a modest 9% on the prior corresponding period.

OzForex also has the option to grow acquisitively. Despite FX services being dominated by the big banks until recently, the smaller end of the market remains fragmented, with one competitor, HiFX, already on a potentially crowded radar of acquisition targets.

The investment case appears sound and growth rates are impressive, but the risk remains that OzForex gets a taste of its own medicine if others undercut its own rates to win market share. With the banks said to be considering fight back strategies and large-scale competitors like Western Union fighting hard for their own slice of the action, OzForex’s spreads, fees, and volumes could all come under pressure.

Foolish takeaway

Selling for $3.36 OzForex is trading on a price-earnings of 36 based on prospectus forecasts of earnings-per-share of 9.2 cents for the year to September 2014. The share price appears to have gone from frothy to bubbly with the market reassured on confirmation of FY 2014 guidance and excited by the potential it has for acquisitive growth. It remains reliant on the strength of its core Australian business however, and on short-to-mid-term horizons looks a little expensive to me.

Bullish investors would argue as a disruptor business with a strong brand and first mover advantage it enjoys parallels to blockbuster internet success stories like Rea Group Limited (ASX: REA) or Carsales.com Limited (ASX: CRZ). Both businesses which have made massive profits for investors who were willing to look past the price to seize the value.

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Motley Fool contributor Tom Richardson does not own shares in any company mentioned in this article. He welcomes feedback on twitter @tommyr345

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