Description

Background

Currency Exchange International (CXI) is a provider of foreign currency exchange services in North America. Roughly 90% of revenue prior to the pandemic was from selling foreign banknotes into the retail and wholesale channels. On the retail side (an estimated 40% of the banknote business), CXI operated 46 storefronts in high tourist traffic locations like Manhattan and malls in Florida. The company avoids airport locations believing the rents are too high. The wholesale business (60% of the banknote segment) supplies banks and third party FX retailers with currency to sell through their branch locations. The remaining 10% of revenue comes from a fledgling corporate payments business, offering wire transfers and FX forwards.

CXI was founded in 2007 by CEO Randolph Pinna. Mr. Pinna has been in the foreign exchange business his entire career, starting a predecessor company, Foreign Currency Exchange, in 1989 and ultimately selling that business to Bank of Ireland in 2002. He started CXI by acquiring some of the retail locations out of the Bank of Ireland. Mr. Pinna owns about 21% of CXI stock, currently valued at about US$12 million.

CXI went public on the TSX in 2011 and experienced rapid revenue and EBITDA growth over the ensuing few years (see graph below). Revenue grew from $8.7 million in 2011 to $22.0 million in 2014 while EBITDA increased from $2.8 million to $7.2 million over the same period. The growth was driven by an expansion in the retail store network as well as the addition of wholesale client relationships.

In 2012, the company applied for a bank license with the Canadian banking regulator. CXI management believed that customers, especially financial institutions, were becoming increasingly sensitive to anti-money laundering compliance concerns and so having a bank license would differentiate CXI relative to competitors and accelerate revenue growth. The company also expected some cost savings from the bank license because it would facilitate the acquisition of currency directly from central banks and provide more favourable interbank FX rates. The bank license was granted in September 2016.

While revenue has continued to grow nicely over the past five years, the EBITDA trajectory has been decidedly less favourable. In 2019, revenue was $41.8 million, growing at a 14% clip since 2014 while EBITDA was $6.2 million, down about $1 million from 2014. EBITDA margins have been cut in half from the low-30s to the mid-teens. This enormous margin compression appears to be mainly a function of increased infrastructure costs associated with the bank license. As a bank, CXI must have the people, systems, and processes in-place to operate with a higher level of compliance than as a non-bank. The build-out of this infrastructure has been a significant margin drag. I also suspect that, in the early days of the company, some highly profitable retail locations were skewing the consolidated margin profile. As the business has grown, the impact of these retail locations has been diluted.

Heading into this year, CXI appeared to be at an inflection point. Revenue growth was accelerating on the back of a new relationship with Duty Free Americas, the acquisition of eZforex, and some easier comps on the speculative exotic currency trading piece of the business (some people will trade currencies like the Vietnamese Dong at CXI’s retail locations; this is a mid-single digit component of revenue). Margins also looked set to improve as the infrastructure build-out associated with the bank license was complete. In Q1, revenue grew 17% while EBITDA margins expanded y/y for the first time in a couple years. And then the pandemic hit…

Investment Thesis

At the current share price of C$11, the thesis on CXI is simple. The downside is minimal because of the company’s large cash balance of about C$11.00 per share at the end of Q2, falling to C$9.00 over the next 12 months in a bad case scenario due to continued operating losses. The upside could be significant with a recovery in travel. Even a return to 2018 EBITDA of just over $8 million could drive greater than 50% upside to the shares.

1.   Downside risk is low

CXI ended Q2 with US$56.2 million or C$11.50 per share of net working capital less debt. The working capital of the business is overwhelmingly (90%+) in cash because banknotes are required as inventory to run the business. The company closed the acquisition of a corporate payments business in Q3 which I am guessing will consume US$3 million of cash ($0.50 per share). Management guided to a burn rate of $800k for April on their most recent conference call and they expect the go-forward trajectory to be improved. As a partial offset, there will likely be some additional restructuring charges in the balance of F’20.

Assuming the company continues to burn $800k per month through the end of April ’21 before turning at least break-even, I get to a bottoming in net working capital per share of about C$9.00 in Q3 2021.

Of course the concern for shareholders would be that the banknote business never comes back and that additional large restructuring would need to be undertaken to right-size the company. I take comfort from the following: (i) future rent commitments are modest at only $6.3 million over the next five years offering good flexibility to right-size the store base without significant expense, (ii) the CEO is aligned with shareholders through his large personal holdings in the company; shareholder value will be a focus for the management team, (iii) the Canadian bank license is likely worth something to a strategic buyer, and (iv) the payments business is less impacted and should be profitable irrespective of the travel backdrop.

2.   Upside could be significant when travel returns

While I dare not prognosticate on the trajectory of the pandemic or any lasting change to either the propensity to travel or to use cash as a medium of exchange, it is sufficient to note that the upside from some normalization in travel is likely to be significant for CXI. Specifically:

• The travel downturn is having a significant impact on weaker competitors, presenting CXI with growth opportunities. Specifically, Travelex is going through a bankruptcy process and many smaller competitors have closed their doors. Mr. Pinna noted on the June conference call that the pipeline of sales prospects is “extremely full”.
• According to cash handler Loomis, the pandemic is proving to be an accelerant for banks looking to outsource cash handling operations. Wells Fargo and Bank of America are two of the larger competitors to CXI on the wholesale side of the business, so we may see the two banks leave a void in the market that CXI can fill.
• Assume EBITDA returns to US$8 million as seen in 2017 and 2018. CXI could finance its cash inventory position at low rates and so would be able to withdraw C$9.00 of equity from the business without having a major impact on the earnings stream. If the EBITDA is valued at 5x, this would drive a share price of C$17.25 – 55% upside.
• The payments business is relatively less impacted by the travel downturn and secular concerns about the move away from cash. The company should gain additional traction here following the recent closure of a Canadian payments acquisition.
  
  

Conclusion: CXI shares can be thought of as a low-risk cash alternative at current prices with significant upside optionality from a recovery in travel. It is difficult to argue that the stock is worth materially less than the current C$11 share price given the substantial cash on the balance sheet while a normalization of travel in ’21 and beyond could easily drive the shares significantly higher.

Catalyst

Recovery in travel.

Growth in the payments business shifting the investor narrative about the company to be about more than just banknotes.

The company has never repurchased shares, but the topic is frequently raised with investors. Management could decide to begin a buyback.