CMPO - CompoSecure: You Can Leave Home Without It

2024-01-21 01:49:03 ET

Summary

• CompoSecure is a global provider of physical credit and debit payment cards known for its high-end metallic cards.
• The company's financial results have shown limited growth, with a decrease in revenue and gross margin in Q3 2023.
• CompoSecure is diversifying into security and identity protection, particularly in its Arculus product line for cold storage solutions for cryptocurrencies.
• However, the long-term outlook for physical payment cards appears limited as digital and contactless payments gain broader acceptance.

Introduction

CompoSecure, Inc. ( CMPO ) is a global provider of physical credit and debit payment cards, specializing in high-end durable metallic cards, with an expanding reach into cold storage solutions for cryptocurrencies with its Arculus product line. Examples of CompoSecure’s client partnerships include Chase Bank ( JPM ) for a Disney (DIS) 100-year celebration Visa ( V ) rewards card, the Marriott Bonvoy ( MAR ) American Express ( AXP ) card, and the Capital One Venture X premium Visa card. The CompoSecure payment cards are generally marketed as upscale payment options that require paying an annual fee to use but include a range of attractive rewards for travel and leisure activities.

CompoSecure came to the public equity markets via a SPAC transaction with Roman DBDR Tech Acquisition Group that closed in late December 2021. CompoSecure was founded in 2000, and current CEO John Wilk has been in the role for 6 years while serving as president and Chief Revenue Officer for one year before becoming CEO. Prior to his work for CompoSecure, Mr. Wilk had extensive leadership experience in banking (Bank of America, JP Morgan Chase) and financial services and software.

Financial Results and Guidance to Finish 2023

CompoSecure has a limited but growing track record as a publicly traded entity, having just passed the two-year mark, although some financial data is available for 2020 as well. Sales did show start growth when using 2020 as a benchmark, going from $260.6 million in 2020 to $378.5 million in 2022, 45% growth over 2 years, although that pace of growth has ground to a halt in 2023. In releasing the Q3 2023 results in November, full-year guidance was pegged at $386 million to $392 million. While still growth relative to 2022, at the midpoint it would be just 2.7%, and Q3 revenue of $97 million was a 6% decrease versus Q3 of 2022.

Gross margin likewise was challenged for the period, falling from 58% in 2022 (and nearly 60% in Q3 of 2022) down to 50.5%. On a GAAP earning basis, net income rose to $38 million compared to $22 million in Q3 of 22, but this was due largely to the revaluation of warrants impacted by the share price changes. Given the dual share-class structure, net income available for common shareholders was $12.3 million, for a fully-diluted EPS of $0.34 for the quarter, a significant improvement to the $0.18 in the prior year period, but on a year-to-date basis through three quarters, the EPS of $0.75 trails the prior year's $0.94. All in all, the signs are not really pointing to a terrific earnings performance for 2023.

The balance sheet on 9/30/23 was in reasonable shape, with $23.8 million of cash and overall current assets of $128.2 million, against current liabilities of $52.9 million, and long-term debt of $202.8 million. One item to take note of is the convertible debt, with a $127.3 million balance. The notes to the financial statements in the 10-K report explain the terms of this debt in detail. This debt carries a 7.00% interest rate, maturing in December of 2026. The conversion price is fixed at $11.50 per class A share; the noteholders can exchange at any time. CompoSecure can exchange with the note holders starting in December 2024 if the value of its class A shares exceeds the conversion price by 130% for a sustained period.

Initiatives and Risk Considerations

CompoSecure excels in delivering an attractive physical product with its metallic payment cards, an item that comes with a certain air of exclusivity and luxury. For example, American Express is a major partner with a generally wealthier demographic than Visa and Mastercard ( MA ), although it has historically lagged their payment networks in terms of retail acceptance due to charging higher fees to merchants (although it has now largely reached parity with the other payment systems). CompoSecure has extended its partnership with AmEx through July of 2026.

The CompoSecure metallic cards tend to be issued to users who are willing to pay annual fees in exchange for greater rewards for travel, dining, or entertainment. Mr. Wilk, the CEO, observed back on the Q4 2022 earnings call that:

Card issuers are finding that their fee-based products remain attractive for both new and existing consumers and that travel and entertainment remain 1 of the strongest segments of consumer spend. . . physical cards continue to represent a significantly higher percentage of online and in-store forms of payment. This trend reinforces our belief that payment cards will remain the primary transacting method for consumers.

However, this points at the same time to the reality that physical cards for payments may not have the longest time horizon as a predominant form of consumer payment for goods and services. An online or mobile order does not necessarily require the physical card in and of itself, and payments in a brick and mortar point of sale could well shift in time to the likes of Apple Pay ( AAPL ), Google Pay ( GOOG ), and so forth. Even “virtual” or “digital” credit cards are growing in popularity for use in online transactions, a sort of one-time numeric sequence created for a specific purchase that is tied back to a consumer’s physical card. The common thread is that these payment options can conceivably eventually bypass the requirement for a physical card altogether, requiring just the underlying willingness of lenders to extend unsecured credit or a way to direct payment to be settled through a customer’s assets on deposit with a bank or other financial institution.

However, for CompoSecure, the more important product than the cards themselves could well be its efforts in security and identity protection to combat fraud. In some cases, these steps are supplemental to the physical card, such as having a fingerprint reader embedded in the card that is required to match for point of sale transactions. The company is also rolling out dynamic CVV technology, which provides consumers with a new customer verification code over intervals, as opposed to the static CVV that is more standard today. While this technology is being used with its metal cards, there is nothing inherently physical about changing the CVV for a credit or debit card account.

The improvements in security features are also key to the company’s strategy with its Arculus project, which is being used currently for applications with cryptocurrency. Mr. Wilk described the vision this way:

At its core Arculus authentication capabilities can deliver secure log-in or step-up authentication, incorporating seamless multifactor authentication. . . The synergy with our metal card business is that we can add functionality to a metal payment card, making that same physical card and authentication token to store private keys and ensure user authentication.

Arculus has met some critical objectives by the end of 2022, and the ongoing goal is to emphasize business-to-business applications and market adoption. It offers Arculus-branded cold storage devices that are the size of a credit card and work in conjunction with a smartphone app, and it is priced competitively with many other cold storage wallets. However, I think it is worth considering that cold storage solutions were going to have limited mass appeal. Although many more people may find themselves holding Bitcoin, specifically after the SEC's recent approval of multiple Bitcoin ETFs, I doubt that many casual owners of crypto assets will convert to wishing to have cold storage.

The larger impact of the ETFs could instead be on the demand for crypto, potentially making its price more stable, and if the value of these assets does rise over time, then the security offered by cold storage will continue to offer a good value proposition for certain niche of crypto investors. With the well-known turbulence that has impacted crypto exchanges such as FTX and Binance, there is clearly appeal for some crypto investors of using cold storage for crypto assets instead of leaving assets potentially at risk of either hacking or malfeasance on an exchange.

CompoSecure is not limited to the cold storage solution, however, and has also partnered with CoinZoom, a centralized exchange, for debit cards . The cardholder in this case may have multiple hot wallets for different currencies and can go into the app to change which wallet (currency) to convert to fiat at the point of sale (currently limited to US dollars I believe). So long as the wallet holds enough of the crypto selected in fiat terms, the sale will go through.

Valuation

Potential investors should be aware of the two classes of stock. The Class A shares are those that trade on the public market and confer voting privilege. The Class B shares are not publicly traded but do grant voting rights. The Class B shares number approximately 60 million and hold an overwhelming majority of voting power; the B shares are convertible to class A shares.

There is scarce competition in terms of publicly traded peers. CPI Card Group ( PMTS ) is CompoSecure’s most direct competitor in the payment cards space. On the basis of relative valuation to CPI Card Group, CompoSecure has some favorable metrics, especially on price to operating cash flow comparison, while holding a premium to its peer on EV/EBITDA basis of 7.18x versus 5.35x. Neither one appears to boast very expensive multiples generally, reflecting relatively low expectations for growth and profitability.

For much of the past two years, CPI Card Group's shareholder returns were vastly superior to CompoSecure, but that gap tightened in late 2023, only to have CPI Card Group re-emerge, although nobody who bought and held shares in either firm in January 2022 would likely be pleased with the losses generated by either.

The lag in performance for CompoSecure does not appear to have a singular explanation. In December 2023, JP Morgan elected to downgrade CompoSecure to neutral, but that ratings downgrade is already too deep into the share's downward trajectory to be a reason. Instead, I suspect the limited number of public shares, the generally negative market reaction to de-SPAC deals, and exposure to cryptocurrencies may all be contributing factors. In addition, while CompoSecure remains a growing company, the growth has slowed substantially in 2023, and missing those original goals for the year have likely kept a lid on the valuation.

Concluding Thoughts

With all the advances in fintech over the last decade, the humble credit and debit card remains a go-to source of payment for everyday transactions all over the world. As a provider of the physical cards and security features enabled on many of these cards, CompoSecure sits in an interesting junction between banks and lenders, companies trying to attract loyal customers, and consumers making daily choices about how to facilitate their purchases. However, on a long-term outlook, the case for physical cards in circulation being a growing sector strikes me as a muted possibility, as digital and contactless payments gain more and more share. Alex Clere of Fintech Magazine wrote on this question in an August 2023 article , with a general consensus among the experts quoted in the piece being that physical cards are likely to decline but not disappear totally anytime soon.

That leaves me pondering CompoSecure as an investment. For its payment cards, high-end and fancy as they may be, I do not see a strong case in which the overall volume of market share for physical cards in the payments ecosystem is higher 5 or 10 years from now. Rather, I think the chances are strong that fewer and fewer people will carry one, much less multiple, payment cards. The days of the old American Express tagline of "don't leave home without it" (one of the great advertising campaigns of the last century) are already a bygone era. For CompoSecure, the efforts to expand into the crypto space for cold storage may help diversify revenue streams, but I think this will prove to be marginal at best.

So in spite of the tempting valuation metrics, I cannot articulate a long-term investment thesis in support of CompoSecure as anything but a speculative investment with potential upside in the near term, but not a stock to buy-and-hold.

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