Few sectors have more potential to be disrupted by technology than financial services. Banks could lose almost a quarter of their revenue to financial-technology (fintech) disrupters in the next five years, a PwC report predicted this week. 

Almost all of the 500 PwC survey respondents across 46 countries said fintech companies would take some business off established financial-services companies. Wealth management, payment, funds transfer, and consumer banking were most at risk of disruption.

Consider the implications of technology for wealth management. In time, robo-advisers that use algorithms to construct and maintain portfolios for clients could replace higher-cost human advisers in some parts of the financial-planning industry.

Technology could remove intermediaries and layers of fees or transaction charges in areas such as fund transfers, and consumers could have more information and power to choose mortgages online and move between providers without help from a mortgage broker.

Nobody knows how the fintech space will play out. But I suspect incumbent firms, having watched how technology has disrupted other industries, will move quickly to snap up emerging fintech firms that challenge parts of their business. Australian banks, for example, are following this trend closely and investing in, or developing, fintech start-ups.

OzForex Group, an early mover in fintech, listed on ASX in October 2013 after a $439 million Initial Public Offering (IPO). The float attracted plenty of attention and was oversubscribed. But OzForex has disappointed since listing.

Its $2 issued shares hit $3.50 in March 2014, before customer-acquisition rate surprises and management changes drove it to $2.04. A non-binding takeover approach from US payments giant Western Union then saw OzForex spike to $3.55 and it looked like the online foreign-exchange group, touted as a takeover target, was about to be snapped up.

Western Union’s decision in February 2016 not to make an offer for OzForex after months of due diligence, and OzForex’s accompanying disappointing trading update, smashed the stock. Witness its share price dive by more than $1 earlier this year. 

Chart 1: OzForex Group

Source: The Bull

OzForex Group trades at $1.96 and has plenty of work ahead to restore market confidence. The earnings-guidance downgrade, in part due to a decision to delay advertising, reflects the intense competition and low barriers to entry in its market.

That’s the bad news. The good news is that OzForex, at least for prospective investors, looks more realistically valued. It needs to get more runs on the board and stop disappointing the market, but there is an argument that investors overreacted to the earnings downgrade.

The weaker second-half performance in FY16 was partly self-inflicted as management made a strategic decision to hold back on advertising as a new website was launched. With that milestone achieved, and with a strengthened management team in place, OzForex should have greater capacity to focus on its promising international expansion.

The long-term story is strongly intact. OzForex’s simple method of exchanging currency costs a fraction of services provided by industry incumbents. It has a huge addressable market as more individuals and firms use online services to lower foreign-exchange transaction costs for mid-sized transfers.

Like other successful disrupters, OzForex has a capital-lite business model, fat profit margins, is highly scalable, and can fund growth internally without taking on debt or issuing more shares. It’s a beautiful business model when it takes off in a global market. 

Its market share in Australia, thought to be around, 5 per cent, suggests plenty of room for organic growth. A strong balance sheet provides scope for OzForex to acquire smaller fintech firms and increase its market share or expand its services.

OzForex still looks a neat bolt-on acquisition for a larger global financial-services firm that wants a foothold in the fintech market and is attracted to its cash-generative capabilities. Western Union had a good look at OzForex at $2.50-$3, so a valuation below $2, despite the recent earnings-guidance downgrade, should put OzForex on the radar of other domestic or, more likely, international suitors.

Still, I’m always wary of buying stocks based on their takeover appeal. A takeover should be an added bonus and recognition that the firm was undervalued, not the sole reason to buy. Focus first on finding exceptional companies that trade below their intrinsic value. A takeover might eventuate if the market undervalues the stock for too long.

Three of five broking firms that cover OzForex rate it a buy, one has a hold, and the other a sell recommendation. A median share-price target of $2.60 suggests it is materially undervalued at $1.96, although care is needed when relying on a small group of analyst forecasts. 

Morningstar’s fair value for OzForex is $2.80 and its Accumulate recommendation is getting closer to an outright buy call. Macquarie Wealth Management has a 12-month price target of $2.60.

The current price seems to include little or no takeover premium and, understandably, has questions marks over OzForex’s capacity to deliver on its ambitious targets to establish a large global footprint in the immature online international-payments market. 

OzForex deserves a valuation discount given its recent habit of disappointing. But it has a valuable advantage in an industry with huge potential and is more robust than most fintech firms. It’s also trading below the $2 issue price, despite the progress made in the past two-and-a-half years and the growing recognition of fintech providers. 

As a small-cap company, OzForex suits investors comfortable with higher risk. It will take time to recover given recent disappointments.

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Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis at March 16, 2016.