Description

Is the market for banknotes growing or declining?

CXI is one of only three major suppliers of foreign banknotes to the United States and of US dollar banknotes internationally. It trades for 7x 2024 P/E or 4.5x-6x after excess cash. We think it will grow at double digit rates for many years and eventually trade at a double digit multiple to reflect that. Downside on a three year horizon seems limited given the current multiple, travel recovery, earnings growth, and excess cash. 

The company has been written up extensively on VIC, so this writeup focuses on adding new insights to what we think are the three key factors for the stock to perform well: (1) international growth, (2) capital allocation, and (3) catalysts.

International Growth

CXI is run by its Founder and CEO Randolph Pinna, who entered the banknotes industry in 1987 at the age of 18. He has built two and run three banknotes businesses over 35 years and in our view is the best operator in the industry. We believe his ambition is to build CXI into the world’s leading supplier of banknotes. In 2021 CXI, through its subsidiary Exchange Bank, became one of three banks licensed to export US dollars from the Federal Reserve internationally. This is key to Pinna’s vision.

We estimate the international US dollar banknotes market is worth $400mm+ in revenues per year and is growing at mid to high single digit rates. We believe that CXI will take $30mm of that in three years’ time and substantially more beyond that. That equates to about 12% growth pa on the company’s current revenue base of $70mm from this one channel.

Importantly, the global banknotes market is growing. 

You may have assumed that it is in decline; many investors do, which is one of the reasons the stock is cheap. In fact, the value of dollar banknotes held internationally has grown at 6.7% p.a. since 2002. This accelerated to 8.2% p.a. in the 5 years pre-Covid and accelerated further to 14.6% in 2020, contrary to the perception that cash volumes declined during Covid. Rather than declining, this $400mm+ market is growing $20mm-$30mm per year, giving CXI a very large growth runway ahead of it.

We estimate market share is split roughly $350mm to Bank of America and $50mm to newcomer Moneycorp, with the rest shared between CXI and resellers.

While private equity owned Moneycorp has grown aggressively in higher risk regions like Africa and the Middle East, Pinna has taken a more cautious approach with CXI. There is a good reason for this: The industry used to be dominated by a dozen large banks but all except BofA pulled out because the AML and KYC concerns could damage the whole bank’s reputation. HSBC was notably fined $1.9bn by the US government in 2012 and put on probation for five years after failures that allowed money laundering in Mexico.

Pinna is conservative and has most of his net worth in the company’s stock. He is only supplying banks that have robust compliance policies and, initially, are in countries which are part of the Financial Action Task Force on Money Laundering (FATF). Pinna has turned down banks that he considers to have inadequate policies, even in FATF countries. We estimate that roughly half of the market lies within FATF countries.

If you want to succeed in an industry having the Fed as your partner is a good place to start, and we think that investors underappreciate how strong CXI’s relationship with the Fed has become. 

We believe the Fed is guiding CXI’s expansion as it sees CXI as important in ensuring a continuous supply of dollars across the world. The elephant in the room is that BofA is the only major bank yet to pull out of the market and has been open to doing so for years. As you can imagine, the supplier of 85% of dollar banknotes pulling out would be harmful to the dollar. One credible source told us that the Fed had to lean on BofA to stay.

Nevertheless, rising costs for large banks like BofA have increasingly made serving smaller clients unprofitable, leading to a gradual retrenchment that accelerated during Covid.

With BofA retrenching, Travelex largely out after fraud at its parent company, and Moneycorp operating via a Gibraltar banking license that puts it at a disadvantage, CXI has an open field to grow into. And even in markets where BofA still operates, customers are increasingly looking for a second vendor to diversify their supply. 

For these reasons, CXI has won customers in Brazil, Canada, the Caribbean, Europe, and Singapore this year. 

As an aside, we think the perception of the US domestic banknotes market being in rapid decline is also misplaced. Data from the Bank for International Settlements suggests that cash use by tourists has grown at low to mid single digit rates for the last decade. Growth in nominal GDP (4-5% p.a.) and travel volumes (4% p.a.) mean there is a high single digit tailwind to offset lower cash use. We estimate that cash use by tourists will be roughly flat over the next decade.

CXI has around 15% share of the domestic market and share gains are likely to fuel high single digits growth. Like in the international market, increasing costs mean that the two big players - BofA and Wells Fargo - are retrenching from supplying smaller banks. With Travelex out, CXI becomes the obvious beneficiary. 

Capital Allocation

Pinna is yet to lay out and execute on his capital allocation priorities, and we share the frustration that investors on VIC have expressed. But we believe significant improvements are likely over the next twelve months.

CXI holds $101mm of cash and $15mm of debt, a sizable amount of net cash compared to its $116mm market cap. But we estimate that $80mm of this cash needs to be held as physical banknotes so should be thought of as inventories, meaning excess cash is $20mm. 

Still, increasing the credit financing inventories from $15mm to $40mm would result in a still conservative 0.5x loan-to-value ratio and free up an extra $25mm. That would bring deployable cash up to $45mm while still leaving a strong balance sheet with no debt beyond modest inventory financing. 

We believe that management is moving towards this thinking and now that the company’s Canadian bank is profitable it will be able to secure financing for inventories held in that subsidiary.

Cash is likely to be used for M&A and we are confident that Pinna will not overpay given his value focus. Most investors we have spoken with want CXI to buy payments businesses, as they view banknotes as a declining industry and payments as a growing one. 

We have a different view on what the company should buy and would welcome feedback in the comments. 

In our opinion, the payments market is extremely competitive and even with acquisitions CXI is probably operating at a disadvantage to the leading players given its lack of scale and narrow range of services. That is unlikely to change unless it becomes a fully fledged bank, which would be bad business to get into in our view. 

Growth in the company’s payments business has stalled after an initial jump from joining Fiserv and Jack Henry, which suggests CXI is struggling to win over potential clients. Buying expensive payments companies given this backdrop could result in the company wasting a lot of cash and getting sucked into a different market where it competes at a disadvantage.

On the other hand, we think that CXI is the obvious winner in the international banknotes market and has a tremendous growth runway ahead of it that could be accelerated through acquisitions. 

BofA has been looking to exit some or all of the market for years and is probably a less price sensitive seller. In our view, BofA faces three choices in a small market like the Caribbean: (1) Continue making very low profits while taking reputational risk. (2) Shut down. This could anger clients who do other business with the bank and also incurs severance and other shut-down costs. (3) Sell to CXI or Moneycorp. Clients continue with uninterrupted service and BofA not only incurs no cost but actually gets paid.

For CXI there are also clear synergies: Suppose BofA supplies 70% of a client’s banknotes and CXI 30%. By acquiring BofA’s relationship CXI has tripled its revenues but does not have to duplicate costs like the reps servicing the account.

So while the banknotes market is not as sexy, we think buying businesses at cheap multiples with clear synergies is likely to generate far higher returns than expensive payments businesses where CXI operates at a disadvantage. There is a history of disciplined Canadian listed rollups in boring industries that have done exceptionally well (e.g. Constellation Software, Terravest) and we believe that this is the path CXI should take.

The main challenges are that BofA has to be willing to sell regions and that these have to be small enough that CXI can fund the purchase. Both of those seem surmountable.

We believe that Pinna is open to making acquisitions in both payments and banknotes, but faces pressure from investors to buy in payments and chase growth. Part of the reason for this writeup is to get a discussion going on whether an acquisition in banknotes makes more sense.

Catalysts

Summer results are likely to be strong, with airlines, credit card companies, and hotels all highlighting a persistent travel recovery. US outbound air travel improved to 110% of 2019 levels in July from 108% in January, while inbound improved to 84% from 77%.

It seems particularly telling that two insiders bought stock in the last week of July when FQ3 results were largely booked. 

We expect CXI will generate $12.5mm in net income this year (an investment year to fuel international growth) and $16.5mm next year. That puts the stock on 7x FY24 P/E or 4.5x-6x after excess cash. We think the stock will trade at a double digit multiple over time as earnings growth demonstrates that this is a growth business, cash is used for M&A, and the company reaches a broader investor base. Downside appears limited on a three year horizon given the current multiple, travel recovery, earnings growth, and excess cash. We see the biggest risk as the stock going sideways due to cash not being used or used poorly.

The company is likely to engage with more investors after building out its senior management team earlier this year, which freed up time for Pinna to meet investors and focus on M&A. A non-deal roadshow is likely after the summer results.

We believe management is also evaluating uplisting to the NYSE but are hesitant to do so due to an estimated $500k in up front costs and $250k in annual expenses. Our feedback has been that being listed on the NYSE would enable the company to reach a much broader investor base and increase liquidity, likely resulting in an increase in market cap that is several orders of magnitude higher than $250k in annual expenses. If you agree we would encourage you to tell Pinna, who is open to talking with investors. 

Finally, here are two quotes from the last earnings call that highlight some of these points:

Pinna: "So then to your second question, why the hell is our stock trading so low? I attribute that to a lot of naiveness, people are confused with, well, are you a bank? Are you a fintech? Are you just a currency exchange? And so, we are working through our investor deck and we have as part of our plan in the next 6 months to improve our IR efforts to bring new eyeballs and awareness to the company. If you just do the math, you see how much cash we have and how much cash we're generating, it doesn't make sense. And so, we will just continue to focus on educating our investor base, our potential investors. But most importantly, the primary focus is on our efficiency and bringing profit to the bottom to those shareholders that have been smart enough to own our stock and hold our stock. That's our focus because if we continue to bring good net income to our shareholders, the sooner or later people will catch that this is a good long term value."

CFO: "our team is also having a heightened focus on the balance sheet, really working with the Board, working with Randolph on understanding each one of the leverages, return on equity, capital employed, really focusing on the cash flow over there"

Catalyst

Earnings, M&A, uplisting.