On July 1st, PayPal the global payments company agreed to acquire Xoom, an online remittance specialist for nearly a billion dollars.

Founded in 2001, Xoom is a surprisingly successful digital upstart in a fragmented industry dominated by a handful of global giants with large agent based networks (such as Western Union and MoneyGram) on one end and corridor specialists – who focus on specific countries / regions - on the other.

PayPal is not short of cash and has made making acquisitions on a regular basis. It recently acquired Paydiant, which sells mobile payments software to retailers, for $280 million. In 2013 it had acquired Braintree for $800 million. Braintree, like Stripe, enables retailers to accept payment cards and other payment methods online.

But does this acquisition make sense for PayPal?

3 Reasons Why It Is A Good Deal

There are clear reasons why Xoom makes strategic sense to PayPal.

1. International Payments

The international remittances industry is estimated to be over $500 billion globally and Xoom, fighting against entrenched incumbents, has done remarkably well and now boasts total remittance volumes of around $7 billion generated by 1.3 million active customers, a vast majority of whom are repeat customers. This deal will bring PayPal into this large and lucrative market.

More importantly for its core business, it will improve PayPal’s international payments capabilities. In most of Latin America for example, according to a PayPal executive, “the only way you can take money out of your PayPal account is having a U.S. bank account.”

1. Digital Synergies

Xoom is a digital disruptor and like PayPal it is big on mobile, which is expected to play a major role for all types of payments in the future. While 30% of PayPal payments originate from mobile devices, already significantly higher than competitors, Xoom claims 60% of its transactions as mobile.

1. ACH Funding

90% of Xoom’s remittances are funded from bank accounts in the US. 95% of these are instantly funded thanks to Xoom’s instant ACH risk management technology. In the US regular bank transfers take 3 days. This means Xoom does not make its customers wait till the transfers from their bank accounts are “settled” before they can send money abroad - but takes the risk itself (risk of customer not having sufficient funds in their bank account) using its own risk management processes.

There is no cash funding. Which means it does not have to pay high rates of commissions to agents, which can eat up half the revenues on a remittance transaction.

3 Criticisms of The Deal

But as always there are critics who have some very valid points to make which highlight the limitations or risks related to the deal.

1. US Only

Despite the success of Xoom, it remains a business focused on remittance outflows from the United States. The core remittance receiving markets are the Philippines, India, and Latin America.

This criticism is true - but the US happens to be the largest originator of outbound remittances in the world at $120 billion a year. If Xoom’s focus is limited, it is still pretty big in terms of market size. Also, there is nothing to hold PayPal back from expanding in the future. It already covers over 35 markets.

1. Risk Management

Remittance transactions are riskier than most other types of payments. Only a few months ago, Xoom’s CFO resigned when it was discovered that $30 millions was fraudulently remitted abroad. The running joke about risk management is that those outside the industry want in – and those inside – want out.

1. Cash is King

Long time industry analysts believe that the remittance industry is still cash based and PayPal if it wanted to grab a slice of the industry would have been better off buying MoneyGram which could have been acquired at nearly half the price PayPal paid for Xoom.

The quick rebuttal to this is that PayPal is a digital specialist and a company like MoneyGram with a physical agent network spread across the world, does not provide a good fit to its core business. Also, Xoom was founded on the correct premise that there are many remitters who have bank accounts and would prefer to make originate transactions remotely rather than pay cash to an agent, the traditional remitter model which is more suited to customers without bank accounts.

Summary

There are certainly challenges ahead for PayPal but none that PayPal cannot surmount. Overall the deal makes sense and the 32% premium seems reasonable.