Description

We think CPI Card Group is a decent business that is trading at a deeply discounted valuation with a fair value more than double the current share price.  Increased investor awareness, a potential debt refinancing and eventually a sale of the company could be catalysts for the stock.  Our thesis is:

1. The US payment card manufacturing business is a reasonably good industry with moderate growth
2. CPI Card is a reasonably well-positioned company in the industry
3. CPI has been left for dead by the investment community after some management missteps, which have been fixed 
4. CPI’s current valuation of less than 6x FCF is unduly punitive on an absolute and relative basis and based on both public and private market multiples
5. Debt refinancing and a potential sale of the company could be catalysts

CPI has been written up twice before on VIC, once as an extremely well-timed short in 2015 and once as a long in 2016:

2015 short:         https://www.valueinvestorsclub.com/idea/CPI_CARD_GROUP_INC/2692353219#description
2016 long:           https://www.valueinvestorsclub.com/idea/CPI_CARD_GROUP_INC/8318491615#description

Note:  there was a 1:5 reverse stock split in 2017. 

I think it may be helpful to briefly address the bear points of the 2015 short before we present the opportunity today:  As the author duly noted in 2015, CPI was over-earning at the time due to the introduction of EMV cards and the subsequent reversion in profits/margins left the company with excess capacity and a bloated cost structure that crushed its profitability and nearly bankrupt the company given its $300 million debt balance and associated interest burden and negative free cash flow.  As a result, the company sank down to a miniscule $20 million market cap, lost all analyst coverage, suspended earnings calls and was left for dead.  Kudos to Yarak on a great short. 

However, where we would disagree with the short thesis is the claim that CPI is a fundamentally bad business.  We think that it is a fair business, which had a near-death experience due to boom-and-bust product cycle. 

The US payment card manufacturing business is a reasonably good industry with moderate growth

At its core, we think that the payment card business is actually OK and characterized by:

• Large “installed base” with “recurring” replacement:  90% of cards manufactured today are for some sort of “replacement” either because a card gets lost, stolen, has fraudulent activity or a user changes from one card to another

Source: CPI 4Q 2020 PR https://www.sec.gov/Archives/edgar/data/1641614/000155837021001713/pmts-20210224xex99d2.htm

• Moderate growth:  the overall cards in circulation continues to growth – between 3% (domestically) and 6% (international):

Source:  CompoSecure 4Q 2021 PR: https://www.sec.gov/Archives/edgar/data/1823144/000110465921147443/tm2134804d1_ex99-1.htm

CPI Card is a reasonably well-positioned company in the industry

Despite the competitive nature of the industry, we think that CPI is reasonably well positioned with a roughly 40% market share of domestic cards (250 million cards produced in 2021 out of 600 million industry wide). 

• Moderate competition:  We will concur that the industry is definitely competitive but the players are relatively rational and consistent and the overall pie is not big enough or attractive enough to be ripe for disruption or to bring in house:
• Main competitors:  the main list of competitors has largely been consistent over the years(Gemalto, Oberthur, Arroweye, CompoSecure, Valid SA, a division of WestRock and a few others) though many have been acquired in one form or another.  A few comments on competitors:
• Fiserv:  First Data is actually a customer but Fiserv also does “personalization” services itself
• CompoSecure: 
• Recent SPAC that focuses on much higher end metal cards (the heavy cards associated with Chase Sapphire and Amex Black cards)
• Sells 20 million cards at $13 each compared to CPI at 300 million cards at $1.25
• JPM (37% of revenues, contract ends Dec 31, 2013) and Amex (35% of revenues, contract ends Dec 31, 2024) are 72% of revenues
• Oberthur is now known as IDEMIA and part of an Advent portfolio company that may be up for sale with Thales as a potential bidder
• Gemalto has been acquired by Thales
• Customers:  CPI does not disclose exact customers since 2015 but notes that the following:
• The top customer is 18% of sales:  we believe this to be Fiserv (First Data) which aggregates on behalf of many small issuing banks, so the underlying issuer concentration is much smaller and First Data has been a customer for over 10 years
• The top 10 customers are 2/3 of sales with an average relationship of over 10 years
• In 2015, CPI disclosed that the top customers were First Data Corporation, InComm, Wells Fargo, American Express and Green Dot

CPI has been left for dead by the investment community after some management missteps, which have been fixed  

As we mentioned, given the missteps by management in the past, the miniscule market cap, CPI has been all but forgotten:

• Analyst coverage:  there is virtually no analyst coverage with only one firm (Lake Street) covering the company compared to 7 in 2016, including Goldman Sachs
• Earnings calls:  the company suspended earnings call in 2018, had zero questions on their 3Q 2021 call and had 3 callers on their 4Q 2021 call (Lake Street, Voya Investments and Sabal Capital)
• Lack of institutional ownership:  due to its small market cap and private equity ownership, there is very little institutional ownership of the company, compared to at least a handful of large mutual fund families that were invested in the past

CPI’s current valuation of less than 6x FCF is unduly punitive on an absolute and relative basis and based on both public and private market multiples

We believe that the company is undervalued with upside to 2022’s “mid-single digit growth” guidance. 

We believe that given the company and industry moderate recurring growth and the ability to finally de-leverage the balance sheet ($20 million pay down of notes post year-end), a valuation multiple of 10x FCF is appropriate, leading to a roughly $20 - $30 stock price and almost 100% upside. 

Though there is perfect public comparable, we think CPI can be compared to some public companies and to several private market transactions:

• Public comparable:  NCR and DBD – we would claim that CPI is a better business than both of these companies and deserves a premium to them given the higher growth rate of US payment cards compared to ATMs and the lower capital intensity of CPI
• Private comparable:  Two public M&A deals that we think are relevant are: 1) the take-private of Verifone by Francisco Partners and 2) the acquisition of Cardtronics by NCR.  Though neither a perfect comparable, we believe they highlight private equity’s interest in lower-growth payments hardware and the multiples paid for these businesses:

Source:  Verifone Merger Proxy https://www.sec.gov/Archives/edgar/data/1312073/000119312518169570/d566935ddefm14a.htm#toc566935_24

Public comps from Verifone:

CATM Merger Proxy Private Transaction Comparison:

Though we are not fans of using EBITDA based valuation methods, conservatively using the lower of the average/median multiples in these transaction comp sets yields substantially higher prices for CPI: 

Debt refinancing and a potential sale of the company could be catalysts

We also believe that CPI can and will refinance its expensive 8.675% debt next year or the following year and we think the company’s credit profile is healthier than its debt implies:

Misc Points/Comments/Risks:

• Sponsor holdings/overhang: 
• Tricor Pacific Capital (based in Chicago and Canada) LBO’d CPI Card back in June 2007 for an undisclosed price
• At the 2015 IPO, Tricor’s cost basis was roughly $50 million compared to its current $98 million value
• Tricor is now branded as Parallel49 Equity
• Given the length of their holdings, we think that Parallel would be a seller at the right price, and we think that price is close to $30 given when the company registered shares on behalf of Tricor/Parallel ($36 price), their subsequent lack of selling and other discussions we have had with market participants
• Inventory / Source of future cash
• In late 2021, the company spent significantly to ensure adequate inventory given supply chain disruptions and ended the year with much higher levels than normal.  We estimate that this will turn into a source of cash as supply chains moderate in 2022

• 4Q 2021 margin miss, Guidance details, ASP and others
• We are happy to discuss more details on the 4Q margin miss (SG&A costs from higher medical, CO labor laws, SOX costs), details on 2022 guidance (strong credit and debit, weaker prepaid), ASPs and other factors in the comments section
• Risks: 
• Illiquid stock
• Small float due to sponsor holdings
• Levered 3.6x

Catalyst

Debt refinance, investor awareness, sale of business