Description

CAB Payments was last written by ad17 last August; this write-up gives a lot of background on the company and the comment section gives some good color on the factors driving CAB’s guidance cut last October.  I would encourage everyone to reread the write-up/comments for background on the name.  

I wanted to revisit the name, taking into account CAB’s full-year 2023 results and updated commentary on forward estimates.  While CAB shares have nearly tripled from the October 2023 selloff lows, shares trade at roughly 50 percent of IPO prices.  And with CAB blessing current consensus revenue/EBITDA guidance, the company is implying that non-Nigerian FX/Payment growth is likely closer to 30%+, or levels near guidance given at the time of its IPO.  At 6-7x 2025 estimated earnings, CAB likely can likely work well even if top-line growth is closer to 20 percent going forward, especially given the company’s capital generation and longer-term capital return profile.    

To quickly review, CAB Payments (CAB) has been around since 1833 processing payments for the British Crown.  Given the extensive reach of the British Empire (“The sun never sets on the British Empire”), CAB had an extensive local presence and trading relationships throughout the world with a notable concentration in frontier Africa.  The bank was something of a sleepy financial organization providing basic banking services and trade financing before the bank was taken over by private equity firm Helios Investment Partners in 2016.  The new owners pivoted the business towards FX payments and payment processing, taking advantage of the CAB’s extensive network of banking relationships throughout Africa and parts of Asia.  

CAB operates a foreign exchange (FX) and payments platform to enable customer transactions in 150+ countries.   CAB’s markets typically exhibit lower liquidity levels, but -- importantly -- CAB focuses on sending hard currencies (dollar, pound, euro) into emerging markets, requires customers to open deposit accounts to pre-fund transactions, and then takes a percentage of the total transaction value as a fee.  Additionally, 70+ percent of CAB’s top-line is denominated in dollars.  Somewhat counterintuitively, CAB tends to do better (at least shorter-term) during periods of turmoil in frontier markets (devaluation, coups, etc.).

CAB cannot discuss the specific details of its client agreements, but the existing base is widely believed to include The United Nations, multiple money-center banks, including Santander, and technology and payments companies Wise and Mastercard. CAB is also benefiting from a structural market share shift from the correspondent banking channel to the specialist channel where take rates can be ~10 percent of those in correspondent banking.  (see ad17 write-up).   CAB listed on the London Stock Exchange in July 2023 and targeted top-line growth of 45 percent for 2023 and 35-40 percent over the medium term.  Despite underlying specialist market growth of ~20 percent, CAB’s high growth achieved over the past three years and ambitious growth projections over the medium term, investors shunned CAB’s IPO and the stock fell 20-30 percent over subsequent months.  CAB had flagged lower growth levels in the Nigerian Naira (NGN) currency corridor, but CAB claimed that this slowdown was factored into its guidance.  The bottom fell out in mid-October when the company revised downward 2023 revenue to levels 17 percent below prior guidance.  The difference primarily stemmed from a sudden change in policy regarding the Central African Franc (XAF) corridor as well as certain new restrictions related to the West African Franc (XOF).  The XAF and XOF corridors each accounted for roughly 7 percent of total 2022 revenue.   

The XAF is pegged to the Euro at a rate of 655.95 XAF/Euro.   CAB often bought XAF at lower rates versus the official peg from banks that operated inside and outside of the XAF jurisdiction.  To preserve a dwindling pile of foreign reserves, the Central Bank of African States (BEAC) encouraged all banks having XAF subsidiaries to stop selling to CAB or to any other outside party and instead transact all currency inflows at the official peg rate.  For the XOF corridor, new restrictions centered on remittance and aid organization flows in an effort to have only local banks process these transactions.  CAB’s revised guidance assumed Q4 XAF and XOF revenue of ~£0/£3.3 million respectively versus £8.5/£10 million in XAF/XOF revenue during the first nine months of 2023.  These types of policy interventions in the XAF/XOF corridors are not unusual but are normally ineffective.  Often such moves worsen the currency shortage as aid organizations or others sending remittances simply choose not to transact at an overvalued exchange rate or simply have difficulty transacting directly with local African banks.  Many outside investors also believe that the XAF peg is widely overvalued.   While CAB has dealt with these types of dislocations multiple times in the past years, this was its first major disruption as a publicly traded company and the scope of the disruption was larger than past episodes.  

As noted, the XAF corridor only accounted for seven percent of total revenue in 2022 and therefore an overhang from this corridor should have been manageable, particularly considering the growth in other parts of its business.  The problem was that the sudden change happened in the early part of Q4 (the seasonally busiest period when many remittances occur) and CAB had assumed that many of its newer clients would transact in the profitable XAF and XOF corridors.  CAB cut its 2023 top-line guidance to ~20% growth (the company ultimately came in at ~£137 million vs. revised a guide of ~£131 million) from the originally forecast ~45% growth (~£158 million), and this guidance implied sharply negative year-over-year Q4 growth.  While many investors likely discounted CAB’s 35-40 percent guidance at time of the IPO, none anticipated that the company would sharply reset 2023 guidance less than one month after reaffirming these projections when CAB reported 2023 first half results.  Following the guidance cut, CAB’s stock declined ~70 percent in one day and the reputation of CAB’s management team took a massive hit. 

Investors might have scratched their head listening to the XAF/XOF commentary during the full year conference call this past March when the team essentially said, “restrictions have eased, albeit some are still present, but all of this is very manageable” and wondered if these were the same two corridors which sent the stock plummeting last October.  CAB did not provide XAF/XOF specific projections but noted that both corridors are expected to be in the top ten markets going forward.  The team suggested that both corridors recognized that (as CAB predicted back in October) some restriction easing was needed to attract hard currencies.  In follow-up calls with the company, CAB has noted that it had no choice but to give the update it did last October as it had to assume restrictions would remain in place indefinitely and CAB had been assuming a spike in customer revenue in its fourth quarter (CAB is no longer assuming any seasonal/new client surge in XAF/XOF fourth quarter revenue).  Some investors (and The Financial Times) believe that CAB failed to properly disclose its revenue volatility in its IPO prospectus and will never trust the management team again.  CAB counters that while it has dealt with restrictions in multiple markets, the scope/duration of the intervention in XAF/XOF markets was unprecedented and it (incorrectly with the benefit of hindsight) was assuming faster growth in these corridors in the seasonally strong fourth quarter.  It will take time for CAB to restore investor confidence and, admittedly, this could hinder multiple expansion.  That said, if CAB’s non-Nigerian FX/Payment growth is anywhere close to levels forecast at the time of the IPO, it seems likely unlikely that the company trades for at a middle single digit multiple.  

On the plus side, CAB did provide some new disclosure showing that CAB’s concentration among its top customers has eased, especially in relation to NGN revenue, which was only ~7% of back half 2023 FX/Payments revenue versus ~20% and ~33% of full year 2023 and 2022 FX/Payments revenue.  Certainly, CAB remains susceptible to market restrictions but as the company continues to grow (150+ countries/110 currencies), the vulnerability of any one corridor should ease.  Additionally, all else equal, a lower interest rate environment is probably favorable for most African economies as a weaker dollar likely eases some inflationary pressure which can lead to social unrest, dollar shortages, dollar flight and unpredictable/unconventional policy responses.   

Additionally, it is important to note that outside of Nigeria, CAB posted strong, currency and F/X growth.  CAB has continued to expand its client base – the company now has 509 clients (+12% y-y) and noted there is a customer pool of over 10,000 globally.  CAB has emphasized that specialist market share continues to grow, with new clients preferring specialists given faster settlement, cheaper costs, and better customer experience.  New clients can become larger customers quickly with CAB noting that 3-5 new customers move into the largest 10 each year.  

Meanwhile, CAB continues to build its network of local and regional banks as well as payment providers, allowing CAB to secure the best local currency rates quickly in its targeted markets.  

Importantly, CAB noted that 2024 consensus expectations calling for ~7 percent top-line/4 percent EBITDA growth were reasonable.  While this growth is pedestrian relative to the 35-40 percent medium-term guidance originally given at the time of the IPO, this forecast also assumes that Nigerian growth is down roughly 70 percent in 2024 (CAB told investors to annualize second half NGN results) and that net interest income falls 10-15 percent on lower assumed interest rate levels (jumps in interest rates on excess cash/marketable securities accounted for the sharp increase in net interest income).   For this reason, hitting this top-line growth likely assumes ~30 percent growth in the company’s non-Nigerian core foreign exchange and payment business (non-Nigeria foreign exchange and payment revenue grew 28 percent in 2023).  

Additionally, CAB has every reason to provide conservative forward guidance after the guidance change in October of 2023.  The Nigerian projections look especially conservative.  Following a devaluation earlier this year (again, CAB acts as middleman in these exchanges and therefore is not subject to sudden losses), the Nigerian naira has stabilized, and previously backlogged foreign exchange volumes have cleared during the first quarter.  Both data points suggest that CAB’s naira revenue could rebound more than expected in 2024.  And again, CAB also noted easing of previous regulatory pressures in the XAF and XOF corridors and noted that both corridors are expected to be among its largest markets in 2024.  

It is also worth quickly reviewing how large CAB’s targeted market is and how small CAB’s current share is relative to this addressable market.  CAB’s IPO prospectus notes that the global cross-border payments industry where CAB operates in is enormous with total flows of $271 trillion globally with CAB targeted corridors of ~$2.3 trillion and a total revenue pool of $256 billion with a CAB targeted market of ~$6.6 billion.  CAB operates within a much smaller niche of the global cross-border payments market, concentrated in receiving markets in Asia, Latin America, the Middle East, and especially Africa.  

Source:  CAB Payments IPO Prospectus

CAB’s market sizing data came from consulting reports (McKinsey) prior to CAB’s IPO.  This is still likely the best guess at the addressable market size but obviously there are assumption upon assumption involved in these projections.  CAB tries to corroborate the original McKinsey data with SWIFT data disclosure but there are simply too many gaps in the data for SWIFT to be taken at face value.  Overall volumes were lower in 2023, hurt by some slowdown in overall cross border payment flows, particularly in emerging markets, but CAB had higher take rates and therefore increased its total market share.  

In CAB’s annual report, the company calls for roughly 5 percent market share by 2027.  If the underlying cross border flows are around $2 trillion currently (assuming some discount to McKinsey estimates), growing at 4% annually, this implies cross border flows of $2.3 trillion by 2027.  If CAB’s weighted average emerging/developed take rate were to remain constant at 26 basis points (this would likely increase assuming emerging markets, where CAB has take rates 9-10x major market take rates, continues to grow faster than developed markets), then the total volume process would be around $117 billion by 2027, and CAB would have roughly £240 million of FX/Payment revenue in 2027 (~30% CAGR).  

In early April of this year, CAB announced that it finally received a Dutch regulatory license, which allows the company to make outbound calls to European customers.  Previously it was forced to only take inbound inquiries from various European institutions.  This application became necessary because of Brexit restrictions.  It is staggering that CAB has been able to achieve such strong customer growth with this major sales restriction in Europe.  Approval was originally expected in the fourth quarter of 2023 but was delayed until April of this year and CAB believes that that this license will provide a major boost to its sales efforts.  CAB also expects to receive a US Representative License in the second half of 2024, which would allow CAB to target US national and regional banks more efficiently, presumably with a compelling “one hop” pitch to multiple institutions.  

The “big enchilada” would come if the company ever attains access to the Clearing House Interbank Payments System (CHIPS), which would allow far greater flexibility to process dollar-based payments from current clients.  Access to the CHIPS would allow CAB far greater flexibility to process dollar-based payments from current clients.  As an example, if Rwanda wants to send dollars for external payments, it is exceptionally difficult for the country to secure dollar clearing services directly from J.P. Morgan (JPM) or Citigroup (C) in a post-September 11 world.  For these types of transactions, CAB has a custodial banking relationship with JPM/C to process dollar payments.  CAB, however, is subject to risk limitations imposed by the banks and therefore likely only processes a fraction of the volume demanded.  If CAB had access to CHIPS, it would enable the company to directly clear US dollars.  Additionally, a US banking license would allow CAB to offer more complete overdraft services and better marketing capabilities in the states where branches are located.  CAB has not quantified the clearing opportunity, but this would easily become the company’s largest growth driver should it materialize.  Understandably “we would mint money” commentary in private conversations with the company have less credibility given CAB’s October guidance cut but the license would almost certainly be a game changer.  

The biggest hurdle to the US bank branch/CHIPS application is CAB’s private equity ownership – Helios currently owns ~45 percent CAB and this ownership needs to drop to 25 percent for the full application process to begin.  Once the full application process begins, it typically takes ~18 months to complete although CAB believes this timeline could be accelerated.  The dollar clearing opportunity was one of the key reasons Helios decided to list versus sell to another financial sponsor who would have faced the same ownership restrictions.  After the stock selloff last October, further Helios sales appeared more problematic.  Following the recent rally, however, secondary sales are a possibility.  It is also conceivable that Helios sells its stake to other strategic or financial owners to move below the 25 percent threshold more quickly.  

With a CET1/Risk Weighted Asset Ratio of 25 percent and near certain capital generation over the coming years, it was disappointing that CAB did not introduce a buyback program concurrent with its full year earnings.  CAB had already paid a dividend prior to the IPO so regulatory approval for a buyback would not appear problematic.  CAB claims that it wants to retain capital for growth and the company has noted that an investment grade rating would help on two fronts. First, The World Bank as well as certain development banks cannot do business with CAB because of the company’s non-investment grade rating and therefore an upgrade would likely expand CAB’s client roster.  Second, certain central banks cannot have deposits with CAB because of its non-investment grade rating.  CAB already has a fantastic deposit franchise as clients provide deposits to access foreign exchange and payment services or to store dollar reserves -- their primary motivation is not to chase yield.  CAB expects its deposit base to grow at roughly 5 percent annually and therefore the bank benefits from a higher-for-longer interest rate environment.  An investment grade rating would turbocharge CAB’s strong deposit franchise.  

Following the October stock selloff, CAB indicated that while the investment grade rating was important, the bombed-out share price changed the equation.  So why was there no repurchase program this March?  One of the factors was likely the recent management change, which was not entirely unexpected given last October’s events.  In February, CAB announced that Neeraj Kapur (former CFO Vanquis Banking Group (formerly Provident Financial)) would take over as CEO from the end of March.   While Kapur may have a good reputation, he does not have previous CEO experience, and this is a fair criticism/concern.  Regardless, it does seem reasonable that CAB wanted the new CEO to have some input over capital allocation decisions.  It is also possible that CAB wants to show even more excess capital ahead of a CHIPS application, but this is less clear.  If current consensus expectations are directionally close, then CAB should build substantial capital in the years ahead and likely be poised to provide meaningful capital distributions over the coming 3-5 years.    

While CAB has proven that its growth will not be linear, the company still appears to have a powerful secular growth outlook.  CAB has a small share of an enormous market that continues to grow.  Meanwhile, specialist firms are forecast to roughly double their market share versus correspondent banking providers over the next 4-5 years.  These two factors alone could drive 15-20 percent top-line growth.  As a regulated bank with a nearly 200-year history in various African markets and growth opportunities in multiple other markets, CAB has unique advantages over many other specialist firms.  While CAB’s topline growth may not reach the 35-40 percent growth forecast at the time of its 2023 IPO, growth at roughly half these levels can still provide large upside relative to current levels.  

The below forward projections assume roughly 20 percent compounded annual top-line growth over the next 4-5 years even if Nigerian revenue finishes 2027 below 2023 levels (unlikely).  These projections do assume CAB can grow its non-Nigerian FX/Payments business at roughly 30 percent annually for the next several years – even if CAB does hit these projections, it will almost certainly not be linear.  That said, it is worth reemphasizing that the underlying specialist market is expected to grow at ~20 percent annually so CAB is operating with a powerful revenue tailwind.  

If CAB’s targeted 5 percent market share by 2027 materializes, the below projections would understate total growth.  For net interest income, I assume deposits grow at 5 percent annually while Bank of England rates falls to 3.25 percent by the end of 2026 and all other income/interest expense ratios stay constant as a percentage of BOE rates.  I assume mid-40 percent margins, expanding towards/above 50 percent – CAB originally targeted 55-60 percent margins over the medium term.  Following the earnings revisions, the company said margins would be closer to 50 percent, but CAB did not provide updated medium-term guidance.  

I do not assume any share repurchases, but as previously noted, capital return seems highly likely.  One of the shorter-term wildcards is whether the Dutch regulatory license will significantly juice sales efforts in the back half of 2024/2005 and whether the expected US bank license in the back half of 2024 has a meaningful impact on 2025 earnings.  It is possible that current projections are materially underestimating how large these impacts could be on sales efforts.  Certainly, a successful CHIPS application would dramatically change CAB’s revenue trajectory, but this is still a couple of years out (and obviously I do not assume this happens).  The below projections are above some sell-side estimates/in line with others – there is a low degree of confidence among the analysts who are still shell shocked following last October’s events.      

CAB is rapidly expanding into North/South America (and thus materially growing its staff/office space), so the execution risk is very real.  CAB operates in a volatile part of the world and further unexpected currency and regulatory interventions are possible.  CAB has a strong history of compliance, spends a lot of money on systems/training and has yet to have a major incident.  Certainly, it is conceivable that some rouge trade or compliance issue occurs, and this causes a public black eye for the company.  This risk is real but it should be remembered that CAB is a bank and therefore has multiple different regulators onsite looking at the company’s operations and risk management capabilities – this certainly doesn’t assure there won’t be any problems but it does provide some comfort.  

Of course, CAB has no debt and should generate substantial excess capital over the coming years.  Admittedly, it will take time for investors to regain trust/confidence in CAB following last year’s earnings guidance fiasco.  At roughly 6-7x forward earnings, shares look materially undervalued even if the company only grows at the same underlying rate as other specialist payment providers.  Frankly, I have seen far worse growth stories than this command valuations of at least twice CAB’s current multiple – some multiple expansion towards ~10x doesn’t seem herculean.   And certainly, there is a possibility of an acquisition – CAB’s nearly 200-year history provides the company with a distinct relationship advantage in Africa and the company has multiple different growth vectors.  There was outside acquisition interest prior to CAB’s IPO and a new bid is certainly within the realm of possibility.  There is some risk that Helios could force a less attractive exit, but this risk is likely less acute now.  Helios only has one Board seat, and any deal would require a shareholder vote.  Further secondary sales by Helios would further ease this concern as well as provide some optimism on the CHIPs opportunity.     

Risks:

-Unexpected, irrational currency/regulatory intervention in key currency corridors 

-Execution risk on new growth corridors 

-Rouge trade/unforeseen compliance disaster 

-Strong dollar pressuring African inflation rates, which lead to more regulatory/currency intervention

-Unexpected competitor breakthrough into core African currency corridors 

-New CEO

Catalyst

-Execution/Upward Earnings Revisions 

-US Bank license

-Helios selldowns/progress on CHIPS application