Currency Exchange International: Pivot To Banking Could Double Revenue

Currency Exchange International “CXI” (OTCPK:CURN) is a Canadian financial services company which trades over the counter with a market cap slightly above $100 million. While much of CXI’s retail business was shut down during COVID, CXI pivoted from focusing on selling foreign banknotes to consumers into a B2B bank operating a sizable SaaS business. I think that the market has yet to fully appreciate the growth potential of these new initiatives and realize that CXI is no longer just selling your uncle his Euros at the airport. As these new divisions of the business grows, and investors catch up to the changing mix of CXI’s business, I think the stock could rerate higher, delivering a gain of several hundred percent over the next three years. Below, I outline this thesis, first by showing how it checks the boxes for a small-cap growth investment as outlined by Peter Lynch and others, and then showing how the business has transformed over the last few years. I then list several catalysts which could drive growth and model potential valuations.

Since this is an illiquid, microcap bank, exposed to global trade, travel, and financial markets, the risk is high. Shares dropped by over 50% during the pandemic. Nonetheless, I think the potential for a 100%-200% total return over the next three years justifies this risk, and I am planning to buy shares. In recent micro-cap screens, CURN was the second-most promising company I found (after MAMA, which I wrote about recently). I am rating CURN a STRONG BUY with a price target of $36.

Several types of stocks look undervalued going into 2024: (1) small-caps, (2) financials, and (3) equities outside the U.S. After a 2023 rally led by the Magnificent Seven in which the Nasdaq soared and the Russell 2000 lagged, small caps look cheap. And most bank stocks have yet to recover from their spring drop during the SVB crisis. Many foreign markets also have underperformed U.S. ones over the last several years – the TSX is trading at a P/E of 12, about half that of the U.S. market. CXI has been undervalued for several compounding reasons.

The Basics

1: Moderate valuation implies slow growth

Looking at competitors, CXI seems fairly valued. But in light of the company’s past multiples and growth rates, it’s clearly trading at a substantial discount.

CXI is currently trading around twice the price it IPOed at in 2013. In the mid-2010s, revenue doubled, and shares traded around $20. But then the company operated at a loss during the pandemic, revenue halved, and shares tumbled back to $8. Since 2020, revenue has increased nearly 4x, and earnings have increased 3x. Meanwhile, shares are up 2x. As a result, CXI is trading at the lowest P/E and P/S multiples ever. On a sales and earnings basis, it is trading at about one third of its pre-COVID valuation. Shares could rise to $55 based on multiple normalization alone.

Relative to its industry, CXI is trading at average multiples.

(data downloaded 12/26/2023. Small companies have market caps less than $1bn; bigger ones have market caps of $1-$5bn)

CXI’s slight premium is explained in part by superior profitability.

CXI is also growing faster. Since 2014, revenue and net income have grown at a CAGR above 20%. The share count has increased at 2% per year (which will hopefully slow due to a recently announced plan to buy back shares). As a result, EPS has grown at only 12% per year. But even so, CXI is a growing company which is being priced like a stagnant one.

2: CXI is small, boring, and ignored

CXI is almost entirely off the radar of the professional investing community. No one has covered the stock on Seeking Alpha in over a year. Only one investing group is covering it. There is only one analyst issuing estimates. On the latest earnings call, there were three analysts. As far as I can tell, there is little institutional ownership. According to Etrade, there are seven large block shareholders who own 25.6% percent of shares. Since the CEO himself owns ~20% of shares, I surmise that funds only own about 5% of shares.

There are many reasons that CXI is unappreciated by the market. First, it is a micro-cap which trades over the counter.

Second, it is complex and boring. On the Q2 call, CXI’s CEO answered a question about this, saying “…people are confused with, well, are you a bank, are you a fintech, are you just a currency exchange?” I personally think of CXI selling foreign currency (banknotes) to travelers – a dying business. Attach this to a regional bank and an opaque business services company, and it makes CXI hard to understand or model. This difficulty is compounded by the fact that the company does not break down its income statement by operating segment, so it is hard to measure growth rates and margins.

Third, CXI operated at a loss during the pandemic, and valuations are still recovering. This process has been slowed by the SVB failure this spring.

3: The Balance Sheet is Solid

As of the Q3 earnings call, CXI has a Tier 1 capital ratio of 24.3% and a total capital ratio of 34.5% By comparison, most large U.S. banks have Tier 1 ratios ~12 and total capital ratios ~15%. In other words, CXI has about twice as much capital as a large American bank. Compared to its more direct competitors, CXI is in a significantly stronger financial position. CXI has around $10 million in debt compared to nearly $100 million in cash. While some of this cash is used as inventory and reserves, more than enough of it could be used to pay its debts in a crisis. On the Q3 call, Randolph Pinna explicitly addressed this point, saying that “we’re taking it quite conservatively. We are a Canadian Bank, as you know, the Canadian Banking System is very sound and very risk averse.”

4: Randolph Pinna is a classic Owner-Operator

CXI CEO Randolph Pinna founded the predecessor of CXI in 1987. While I have been unable to definitively verify his age, several personal information websites say that he is 54. According to LinkedIn, he started college in 1991. Pinna is probably in his mid-to-late 50s. This means that he probably has at least another decade left at CXI. The strongest reason to think that he will stay and generate more shareholder value is that he owns 20% of shares. His stake is probably worth at least $20 million, many times his annual salary. In 2022, combined executive compensation at CXI was less than $5 million.

Moreover, it seems that Pinna is running the business well. He has a 96% approval rating on Glassdoor and CXI has very high ratings from its employees and its customers: Glassdoor: 4.5. Indeed: 4.2. Trustpilot: 4.5. After laying people off, automating tasks, and cutting salaries in 2021, CXI increased wages twice in 2022. To me, this is convincing evidence that Pinna has built CXI into an organized and effective company.

The Business

CXI facilitates foreign exchange payments and banknote transfers. They have six vaults to hold foreign currency and deliver it across the U.S. and Canada. For consumers, who account for (I estimate) about 60-70% of sales, they offer banknotes at around 200 retail locations and through a D2C mail business. For corporations and financial services companies, they offer banknotes (about 15% of sales) and FX payment management software (about 15% of sales). They have about 2,500 corporate and financial clients.

Over the last two years, the retail business has recovered from COVID, and the wholesale (corporate + financial) business has accelerated. I think this is a classic “melting ice cube” story.

1: The retail business is in a declining industry

CXI has an entrenched position in this market, and a good operating model, but the industry is shrinking. I think that CXI will be able to expand their business slightly as they take market share over the next few years, but then the business will go into permanent decline.

CXI’s main competitors are Wells Fargo and Bank of America. During COVID, a fourth competitor, Travelex, went bankrupt and left the U.S. market. Today, CXI is the only supplier of foreign currency in many US airports. As travel has recovered since COVID, sales have improved. Going forward, this business is expected to decline, as cash becomes less widely used. But I think that there could be a ‘long tail’ on its use, since people still use cash when they first arrive in a new place. What matters here is not the digital payment system adoption in the home country, but in the target country. If you are travelling from the U.S. to Mexico, will you be able to buy digital pesos in the United States? Will your financial apps work in your target destination?

CXI is much smaller than Bank of America or Wells Fargo, but they have some advantages. By my calculation, the spread between spot rates and offered rates was about 50-75% higher for CXI than for Bank of America. Otherwise, their services were similar. But the catch is that Bank of America and Wells Fargo only offer this business to their own customers, who total something like 80-100 million people. This leaves a huge number of Americans who lack the option of ordering foreign currency through their bank. And I don’t think that they will expand their offerings. This is a small business for these huge banks, and they seem to offer it only as a courtesy to their customers. Another option is to withdraw local currency directly from an ATM, but the rates on these transactions are probably worse. In short, CXI charges a small premium for convenience.

Over the last decade, this business has expanded significantly. In 2013, CXI had 26 retail locations and 23 affiliates. During COVID, when Travelex went bankrupt, CXI took over and rebranded many of their stores. Today, while CXI operates about 40 company-owned stores, they have a much larger number of agent locations, for which they provide branding, back-end support, and currency…