Specialized Payments Firm Flywire Is Poised To Rebound

Payment processing has been a great business since the world moved away from an all-cash society in the early 20th century.

Intrinsic to the model are a lot of characteristics we look for in potential investments. Sales are generated by taking a small cut of each payment processed on the network. Payment systems get integrated into a company's core business operations, touching everywhere from point-of-sale to customer databases and down to back office accounting software. This makes them a real pain to replace with another solution (particularly for larger businesses), creating high switching costs.

It's a reliable, predictable business that has also had a ton of growth over the years. The GreenDot Stocks portfolio has a few positions in the segment already with Toast (TOST) and Visa (V).

Today's Green Screen stock review falls more along the lines of Toast - a verticals specific payment platform. Let's take a look at Flywire (FLYW).

Flywire's Business

Flywire provides a software payment portal tailored to the needs of a few big, complex industries: education, healthcare, travel, and "business-to-business", or B2B, sales.

The offering integrates easily into some of the most common workflow tools used in these industries. Through it, users can invoice customers, provide flexible payment options (pay in full, pay in installments, financing, etc.), receive payments, and integrate with accounting and reporting systems. It also seamlessly handles cross-border payments, for example a U.S. customer paying a European hotel, or a Japanese student attending college courses from a Canadian school (just to supply a few examples).

Flywire makes money in two ways. First, it charges transaction fees - a small percentage on the gross dollar amount of every payment run through its platform. Value added services - such as customized integrations, currency hedging, payment plan management, etc. - are the second source of sales.

This is a smaller processor, doing $24 billion in payment volume in 2023 (compare that to PayPal's $1.5 trillion). However, they have a strong presence within their target verticals, with more than 2,800 education institutions, 90 healthcare systems, and 900 clients in the travel/B2B spaces. Overall, the firm sports 4,000+ clients.

The Revenue Picture

One of my favorite things about payment processing is the revenue predictability. This is a classic "toll booth" revenue model - a little revenue for every transaction on the platform. With over 80% of sales coming from transaction fees, Flywire easily passes the recurring revenue test.

Growth potential looks attractive, as well. Flywire already has an outstanding track record of sales growth, with a 45% 3-year CAGR.

But this seems to just be scratching the surface of the opportunity. All of its verticals have enormous payment volume. Addressable education payments are $660 billion annually, healthcare is $500 billion, travel $530 billion. That's over $1.7 trillion of payments in play, compared to $24 billion of volume in 2023.

These are some ripe industries for disruption. Many organizations in these fields still rely on disjoined software systems, or sometimes even manual paper-based systems, to handle very complex invoicing and payment flows that often involve intermediaries, financing, multiple payers, etc. Flywire offers a much more efficient and ultimately cheaper solution (they claim over 265% return on investment in 3 years).

Everything checks out here. This is clearly a majority recurring revenue operation with substantial growth opportunities, enough to generate 15-20% annual sales growth for the foreseeable future.

Moat Analysis

Flywire competes against a litany of payment processing offerings, particularly those with cross-border capabilities such as PayPal, Adyen, and Stripe. It also competes with legacy payment avenues like bank wires or money transfers. So, there is plenty of competition, in theory.

Like Toast, by focusing on a few key industries, Flywire can set itself apart as a superior offering. This strategy is a winning one, visible in a few different metrics.

For one, the firm's net promotor score is 62, indicating a strong base of satisfied users (30-100 is considered "good").

Secondly, Flywire has averaged a 130% net dollar-based retention rate over the past 3 years. That means it does not lose many customers, and tends to increase business with existing clients by 30% year-to-year!

This is a strong example of the HIGH SWITCHING COSTS in the business model. Invoicing and payments are "core and critical" to any business, and Flywire focuses on verticals where they are particularly complex. It would take a lot to dislodge the firm once they have are integrated with a client. This gives the company a strong economic moat to protect sales and cash flows against competition.

Management and Financials

Flywire is not founder-led, but CEO Michael Massaro has been at the helm since late 2013, joining the company in 2012 when it was still in its very early phases (it was founded in 2009). He has over a decade in charge now, and has led the company from almost nothing to a 2021 IPO and a current run rate of half a billion in revenue. At only 45 years old, and with $40 million of his wealth in company shares, Massaro has a long tenure ahead at the top, if he wants it.

The long-term vision has remained intact, and that's the main thing we are looking for with leadership.

Financially, Flywire is in good shape. The balance sheet has no debt and over $600 million in cash. Cash flow has turned solidly positive after many years of break-even-ish results. I expect this to continue as the business matures out of growth-at-all-costs mode. Like most processors, Flywire has made its share of small acquisitions, but none of them look like gross overpayments. ROI remains solid at over 20%.

Risks

There are a lot of good business characteristics here, but a few notable things investors should consider before thinking about creating a position.

One thing that sticks out to me is the firm's penchant for equity financing. It went public in May of 2021, and only 3 months passed before it announced a secondary offering. As if that wasn't enough, just 2 years later (in August 2023), a third share offering diluted shareholders even more! All told, share count is up an ugly 73% since IPO. With a pattern established, there's no guarantee the firm may decide to sell even more shares to raise capital - although that seems unlikely near-term, given a debt-free balance sheet and low stock price.

Second is that Flywire is not our typical cash gushing business machine. 2023 was its first year of really solid cash profitability. There is a meaningful risk that reliable cash generation may not materialize for the long-term.

Finally, this stock has not performed well since IPO'ing at $24 a few years ago. Today it trades under $17 - 30% under its IPO price. That's not to mention how far it trades below its secondary and tertiary offerings at $33 and $32, respectively.

All of the typical risks in the industry apply as well, obviously. Data breaches, degradations in service quality, competitive developments, and so forth could all affect the trajectory of Flywire's business and stock price.

Conclusion

I feel the market has pushed Flywire's stock down to the point where it has become a compelling buy opportunity. The underlying characteristics are stout - there is a very predictable recurring revenue stream, plenty of growth potential, a strong switching cost moat, and an established management team. It isn't without risks, and some of the firm's stumbles as a young public company were (hopefully) more learning experiences than signs of things to come.

Assuming a 5-year average growth rate of 22% (about in line with estimates), an industry average free cash flow margin of 14%, a high dilution rate of 5.5%, and using a slightly higher-than-average discount rate of 11.5%, I calculate a fair value price of $21 for Flywire. That puts it right on the cusp of the 25% margin of safety we are looking for! For now, Flywire goes into the Watch List, but this is one we could be making a buy action on very soon.