Xoom Corp (XOOM) Goes Zoom: Are Expectations Too High?

Size matters in this industry. Both companies grew revenue at about the same rate but MoneyGram has gone in and out of profitability while Western Union is a model of consistency, growing net income at an annualized rate of 4% since 2004.

I’ll do a reverse discounted cash flow calculation to determine exactly how fast the market expects Xoom to grow. The first six years are dictated by the table above, with $91.2 million in net income in year six. I’ll use a discount rate of 12% and calculate at what rate Xoom must grow its earnings after year six to justify the current market cap of $800 million.

The answer: 5%.

The market is assuming that not only will Xoom become profitable by growing its revenue by 45% over the next six years, making $91 million by then, but also then be able to grow net income by 5% in perpetuity, faster than market leader Western Union has done and far faster than MoneyGram has done.

There is absolutely no reason to believe that this will happen.

Xoom doesn’t sell some hot tech product that everyone needs. Xoom transfers money. They do the exact same thing as Western Union. Western Union has an enormous network, a powerful brand, and over a century of experience. The expectations put on Xoom by the market are downright outrageous.

The Bottom Line

An absurdly optimistic scenario must play out in order for Xoom to be reasonable at its current market price. Xoom may very well end up being a successful company, but it will be a long time before it’s actually worth $800 million. Warren Buffett once said

“An investor needs to do very few things right as long as he or she avoids big mistakes.”

Buying Xoom is a big mistake.

The article Xoom Goes Zoom: Are Expectations Too High? originally appeared on Fool.com and is written by Timothy Green.

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