Every once and a while I like to put up guest posts on Ragnar (see this awesome one on $PMD). As such, here is a post from one of my favorite people: Chris Olin. He is one of the handful of people who helped keep me sane during COVID. We are both long the stock, and think that it is a really good price, for the flows of cash that should be coming. :)
Ticker: OTC: CURN; TSX: CXI
Market cap: $65M [1]
Net Cash: $53M
Enterprise Value: $12M
Last Share Price: $10.20
Currency Exchange International (“CXI”) is a fast-growing, unlevered reopening play whose main business was laid low by covid. After reducing its cost structure and taking share from competitors that have shut down operations, the company is poised to benefit from a recovery in international travel and a return to double-digit revenue growth. Valued at less than 9x FY2023 earnings, the stock has 130%-250% upside from here.
Business Overview
CXI operates in the US and Canada and is organized into two segments: ~85% of revenues are derived from physical banknote exchange and the remainder are from facilitating international payments. Geographically, ~80% of revenues are from the US and ~20% are from Canada.
The banknotes business physically exchanges foreign currencies for both retail clients (at high margins) and for wholesale bank/corporate clients (at low margins). This business was hit very hard by covid as it is heavily dependent on international travel. Covid-related revenue declines aside, this is a decent business with few competitors, from which CXI has been taking share for many years, growing revenues by ~10% per annum pre-covid [2].
The company’s main competitors in the wholesale business are large banks which enjoy the majority of the industry’s market share. However, smaller banks often prefer working with CXI because they don’t always feel comfortable securing their foreign currency from a direct competitor and most also don’t want to rely on a single vendor. The wholesale industry also largely competes on service, rather than price. CXI has an advantage here with smaller customers who are often not worth the larger wholesalers’ time.
Over the last decade or so, several wholesale bank competitors (e.g., HSBC, Bank of Ireland) have left the industry, largely because the small size of the revenues compared to those of their core banking businesses doesn’t justify the regulatory headaches. CXI’s main non-bank competitor, Travelex, also completely exited the North American market last year, partly due to covid and partly due to financial problems that pre-date covid. Despite the loss of competitors and CXI’s market share growth, the company is still a distant #2 (in Canada) or #3 (in the US) and has a lot of room to grow once transaction volumes return.
Market Share Development
Source: Currency Exchange International.
Fortunately, the other business segment, international payments, has been unaffected by covid and continued its very rapid growth trajectory with revenues increasing by 29% in 2020 and 97% YoY in H1 2021. This segment was started from zero a few years ago and has quickly grown to become ~15% of the company’s revenues. Not all of this growth has been organic, as the company acquired a small Canadian payments business at the end of fiscal Q3 2020, but historical organic growth rates have been in excess of 25% and it is likely that this segment can continue to grow at ~20% per year for at least the next couples of years.
In the US, payments clients are primarily mid- and small-sized banks that don’t process enough international transactions to justify the costs of an in-house solution. The company also processes transactions for small non-bank clients in Canada that want a high-touch experience and don’t transact large enough volumes for the big banks to provide the desired service levels.
Compared to other non-bank fintech solutions, CXI is also a more attractive option for banks especially since the company is a regulated financial institution itself [3] and management has a long track record in the industry. CXI therefore offers its clients’ compliance departments peace of mind as well as cost savings. As in banknotes, a similar dynamic is at play in this segment as banks often prefer to work with CXI instead of outsourcing their payments business to a large commercial bank competitor. There is a lot of room for expansion in this segment and double-digit growth should be possible for quite some time.
Response to the Pandemic
As the banknote business sharply declined last spring, Management reacted quickly to cut costs by closing marginal retail stores, renegotiating rents, automating tasks (e.g., installing money-counting machines), combining overlapping roles, cutting salaries, etc., ultimately reducing operating expenses by about $2.5M per quarter as of the first half of FY2021.
A chunk of this reduction was due to variable costs and others that will increase again as the company gets back to historical revenue levels. However, it is likely that a return to FY2019’s $42M revenue level would be accompanied by at least a $1.75M-$2M permanent annual reduction in costs. That is quite significant given that the company only earned $3M in FY2019.
CXI has not only been playing defense, however. Since the pandemic began, the company has been aggressively signing new wholesale banknote clients onto their platform. Most of these were formerly Travelex customers and some were even referred to CXI by recent Travelex employees.
On the retail side, the company has expanded into locations that Travelex vacated using its agent model, where third-party retailers (e.g., Duty Free Shops) take banknotes for sale on consignment and share the economics with CXI. This has allowed the company to pick up some premier, high-volume airport locations that will likely be among the first to return to pre-covid volumes.
Management has also been winning new banknote business from foreign banks that need to source US dollars. This is a somewhat nascent business for the company, but it has the potential to become very big over time, potentially bigger than the legacy banknote segment.
While volumes from all these new clients and locations are currently small, the upside is that the base banknote business will be at least 15-20% larger than it was pre-pandemic once industry transaction volumes normalize. Furthermore, the company has also managed to raise prices on banknote transactions due to the reduction in competition.
As previously discussed, the payments business was unaffected by covid and grew 74% from the first quarter of FY2020 through H1 FY2021. Despite the difficulties in the larger banknote business, management continued to take steps to maintain the payment segment’s rapid growth, investing in additional salespeople and integrating the company’s offerings into additional banking software platforms (e.g., Jack Henry, Finestra, and Fiserv) that provide easy access to more potential clients.
Future Financials
CXI has very little debt and a sizeable net cash position of over $50M. Yes, some of this is inventory, but ~$25M is operating cash. The minimal debt that the company has is comprised of a couple revolvers that are used for working capital. Management has reduced the cash burn to $1-$2M per quarter, so the company can withstand a protracted period of reduced banknote transaction volumes if necessary.
However, the ongoing covid vaccine deployment, especially in North America and Europe, makes it likely we won’t have to wait too long for the company to return to profitability. 2022 will likely be close to a normal year and we are likely to see a full recovery in revenues by 2023.
Given the changes in the business in the last year or so, what might the company’s financials look like once industry banknote transaction volumes have returned to pre-covid levels? Perhaps the simplest method is to start with FY2019’s results as a baseline and add in cost savings and incremental growth from there.
In FY2019, the company enjoyed peak revenue of about $42M and $6.2M of EBITDA. The permanent covid cost reductions translate into $1.3-$1.5M of additional after-tax earnings [4], such that pro-forma “recovered” earnings start at $4.5M-$4.7M, all other things being equal. Yet we know that wholesale clients on the platform are up 15-20% over the last year and CXI is well positioned to capture much of the retail share formerly held by Travelex.
If transaction volumes are also up 15-20% over FY2019’s peak numbers in a normalized environment, then CXI should conservatively increase earnings on that additional volume by 15-20%. Banknote revenue was $39.1M in FY2019, so revenue from this segment might be $45M-$47M if the industry were fully recovered today. Add in a little more growth since the business will likely not be fully recovered for another year or so and we are likely looking at $53M-$56M of banknotes revenue in FY2023. Using the 11-11.5% profit margin implied by the new cost structure, the company is likely to earn an additional $1.5M-$2M in after-tax earnings from this growth. This assumes no operating leverage, but of course there will likely be some. [5]
That’s also just on the banknotes side. The payments business could easily be bringing an additional ~$7M of revenue over FY2019’s levels by FY2023. Several payments salespeople and support staff have been hired so far this year, so some, but not all, of the additional SG&A required to support this growth is already baked into our pro-forma baseline “recovered earnings [6]” number. Taking this nuance into account, a conservative analysis might indicate that this growth would add ~$2.5M in after-tax income over the next 2.5 years.
Adding it all up, the company is likely to earn $8.5M-$9M in FY2023, which compares very favorably to a ~$73M fully diluted market cap, especially for a company with a strong balance sheet that is experiencing double digit top-line growth.
FY 2023 Earnings Waterfall
Source: Author; Currency Exchange International
Prior to covid, the company frequently sported an earnings multiple of over 30x. Given the company’s relatively small market share in each of its segments, its attractive historical growth rates, and lack of net debt, a return to that valuation level doesn’t seem unreasonable. On my estimate of FY2023 earnings, a 30x multiple implies a market cap of at least $255M or ~$35 per share, nearly a ~250% return from here. A more conservative 20x multiple still values the company at ~$24 per share, providing a ~130% return.
Risks
In the short-term the obvious main risk is around international travel in North America. If such travel comes back very slowly, that would definitely be a negative for CXI. However, with the vast majority of Canadians and Americans vaccinated, I think it will be a hard sell to continue to place restrictions on travel.
There is also a risk that regulatory costs continue to be a drag on the payments business. Management was surprised a couple years ago when Canadian regulators kept asking for additional processes that required expensive employees to be hired. This “start-up” phase of the payments business went on far too long and there was clearly a learning curve for the company that needed to be overcome. You can look back and see how investors were also surprised and punished the stock. While revenues continued to grow quickly during this period, earnings stagnated due to the fixed costs required by the new payments segment.
That being said, the company is quite confident now that they have the right systems, processes, and personnel in place to satisfy regulatory requirements and that there will not be large future increases in expenses in the payments business, or at least not any that are not tied to increasing revenue. Management has been wrong on this before, but we did not see any big increases in FY2020 or so far in FY2021, so I think the team probably has it right this time.
Looking out over a longer horizon, cash is losing market share in developed countries. The previous trend was steady and slow, but covid has accelerated it. Whether covid-related reductions in use of cash persist is an open question. That CXI has already started to see recoveries in volume with the limited international travel occurring is a good sign. The company has also been so effective at gaining banknotes market share that, while a reduction in the overall pie wouldn’t be ideal, it might not be so bad for CXI. This is probably the most significant risk to the thesis, however.
Central banks are also talking about and, in some cases, experimenting with digital bearer cash that is transferred via blockchain technology. This is a near-existential risk for the banknotes business, but Western central bank efforts are in still in the nascent exploration phase and it will take many years for any digital cash system to be implemented. There are many regulatory and privacy hurdles to overcome for digital cash to be successful and there is a good argument that any such system will be unworkable, at least in the US.
Conclusion
When the banknotes business recovers, the company will look quite attractive: double-digit pre-pandemic growth rates, a streamlined cost structure, minimal required capital expenditures, and reduced competition, all for less than 9x FY2023 earnings.
Regardless of when international tourists start coming back in significant numbers to North America (or more importantly, when the market starts pricing their return in), CXI will be poised to benefit with its larger client base. The company has plenty of liquidity, no net debt, and will have no problems waiting.
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[1] All figures herein are in USD.
[2] Note that banknotes revenue growth can be volatile, depending on whether any high margin “exotic” currencies are popular in a given year. This was the case in FY2018 when Iraq dinars and Vietnamese dong suddenly came into vogue, adding $1.65M in revenue that was not repeated in FY2019. Top-line growth in FY2019 therefore appears anemic if you don’t make any adjustments.
[3] In Canada, the company runs its business through a regulated bank. While the US subsidiary is not a bank, the company and its management have decades of experience complying with AML and other relevant regulations, something that start-up fintech companies cannot claim.
[4] 26.5% tax rate.
[5] I’ve also glossed over the fact that banknotes revenue and payments revenue likely have different contribution margins, but payments was small enough in 2019 that I think this math still gets us conservatively in the right direction.
[6] This additional payments SG&A is included in H1 FY2021’s results, which is our comparator for determining how much cost was taking out of the business vs. FY2019.
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