CURN - Plural Investing - Currency Exchange Intl: Earnings To Double Over Next Three Years

2023-11-02 10:20:00 ET

Summary

• Currency Exchange International (CXI) is a major supplier of foreign banknotes in the US and internationally.
• CXI has the opportunity to grow its business outside the US and take substantial market share in the global dollar banknotes market.
• The company also has a significant amount of cash that could be used for acquisitions, potentially leading to increased earnings and higher valuation.

The following segment was excerpted from this fund letter.

Currency Exchange International ( CXI:CA , OTCPK:CURN )

CXI is one of only three major suppliers of foreign banknotes in the United States and of US dollar banknotes internationally. Banknotes are typically used for travel and the Covid induced downturn masked major market share gains made by the company after its key competitor Travelex exited. CXI is run by Founder Randolph Pinna, who owns 21% of the company and has high integrity, delights customers, and a 35-year track record of building two banknotes businesses that have delivered strong shareholder returns. The company trades on 8x P/E today and we expect earnings to nearly double over the next three years. That puts the stock on just 4x our estimate of profits in three years’ time, net of cash generated in the interim. We started buying shares at US$14/shr in mid-2022, it trades at US$15/shr today, and we believe intrinsic value will be US$55/shr in three years. The stock ended Q3 down 24% from its peak earlier in the quarter.

As outlined in our last letter, we see two key opportunities for the company. Both of those disappointed investors in the quarter, but we expect that disappointment will be temporary.

We think CXI’s first opportunity is to grow outside the United States.

The company is one of only three licensed to supply dollar banknotes from the Federal Reserve to banks across the world, which is a market that we think is worth around $380mm in revenues. We expect CXI will take substantial share in this market, which is material versus the company’s total revenues of $77mm today.

Building out the international business has proved frustrating. While the company has signed on several major banks as potential customers, the US banking crisis earlier this year made these customers reluctant to rely directly on supply from a small company like CXI, even though CXI does not take deposits and does not carry traditional banking risk.

The company has only $130mm in assets, which means that if a customer like the Bank of Singapore makes a payment for $100mm of banknotes CXI’s assets would temporarily almost double until it shipped those banknotes.

CXI and its customers have found a solution, which is to use a major bank with hundreds of billions of assets to act as a middleman and guarantee transactions for a small fee.

We see this as a frustrating delay for a couple quarters and so while we were wrong in our timing, we have not changed our value of the company.

We think CXI’s second large opportunity is to use its cash.

The company holds $98mm in cash and $6mm in debt, a huge amount of net cash compared to its $95mm market cap. We estimate that $80mm of this cash needs to be held as physical banknotes so should be thought of as inventories, meaning excess cash that could be deployed is closer to $20mm. Still, investors are increasingly skeptical that this cash will ever be deployed as it appears to grow every quarter and management’s capital allocation plans could be clearer.

We have a different view. On the recent earnings call management stated that their most likely use of cash is to make acquisitions and that some incumbents in the banknotes market may want to exit.

We see this as a potentially excellent use of cash if the company remains disciplined in the price it pays. Virtually any merger of banknotes businesses would result in large synergies as much of the cost base - such as vaults, IT, and staff - does not have to be duplicated.

While management provided no further details on potential acquisition targets, there are only three other major companies in the industry: Bank of America, Wells Fargo, and Moneycorp. We view a deal with Moneycorp as unlikely as much of its business is in regions that CXI views as high risk. On the other hand, both Bank of America and Wells Fargo have downsized their business over time, which suggests they are willing sellers of some or all of those operations.

We believe that CXI’s roughly $80mm in banknote inventories could be financed with credit facilities at a conservative 0.5x loan-to-value. That financing would free up an additional $34mm beyond the $6mm in credit facilities that are already used. Combined with the company’s nearly $20mm in excess cash brings deployable cash for an acquisition above $50mm while still leaving a strong balance sheet with no debt beyond modest inventory financing.

A $50mm acquisition at CXI’s valuation of 8x P/E would (i) increase earnings by roughly 50% before synergies, (ii) demonstrate that the company’s cash is not 'trapped', and (iii) likely lead to a much higher multiple as investors start pricing in future cashflow being deployed in further high return acquisitions.

The company has yet to make acquisitions of this size and so some investors have concluded that it will never meaningfully use its cash. On the other hand, we believe that while having to wait is frustrating management fully intends to use its cash but that deals like this take time and they are keen to not overpay – an attitude that we support. Founder & CEO Randolph Pinna has been involved in several large M&A transactions in his career.

We expect that investors will greatly reappraise CXI’s intrinsic value over time as the business grows outside the US and management deploys cash. We also believe that the potential downside over a 3-5 year horizon is low if we are wrong given the company’s fortress balance sheet, 8x P/E valuation, and double-digit growth rate.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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