Background
Currency Exchange International is a foreign currency services provider with both retail and wholesale operations throughout North America, primarily in Canada and the US. This is a micro-cap company with a current market cap of 69M CDN/54M USD that is listed on the Toronto Stock Exchange under the symbol (CXI) and Over-the-Counter-Market (CURN). Trading in the stock is generally very thin, but has seen an uptick recently on the Toronto Exchange.
According to the company website (here) the company was founded in 1998 by
Randolph Pinna. That timing may be a bit
misleading as Pinna founded another company that was part of a “friendly
acquisition” by the Bank of Ireland. He
remained at the bank until 2007 as the CEO of the North American Foreign
Exchange Business. CXI was incorporated
in 2007 in Florida and became a public company on the Toronto Stock Exchange in
2011.
Pinna owns approximately 21% of the equity in the company
and is therefore fully aligned with shareholder interests. Although I have had no personal exposure to
Mr. Pinna, his approach and demeanor on conference calls is straightforward and
absent of the jargon sometimes associated with company executives. A recurring theme in those who knowingly write
about Mr. Pinna is his high energy and high regard for personal
relationships. His tenure and experience
in the retail foreign exchange and banking foreign exchange are an extremely
important asset for the company. In
addition to the shares owned by Pinna, Pembroke Management, an institutional
and private client wealth management firm based in Montreal and Toronto owned 11%
of CXI before recently selling enough stock to be under the 10% reporting
threshold. The recent uptick in trading
may indicate continued selling by Pembroke or other large shareholders who are
unwilling to wait on a recovery.
Investment Thesis
I initially invested in CXI in early 2020 as a growing, low
risk company with little debt at a reasonable (or potentially value) price. With virtually no debt and the high level of
excess cash, the downside risk and potential for insolvency seemed very low. CXI has
seen excellent revenue growth over the past 10 years, however, profitability
has taken a hit since 2017 as the company has been expanding its network and
building out their banking business. This
reduction in margin was reflected in the stock price with a distinct downtrend
since the fall of 2018 when the stock was selling near it’s high of $24. My investment was a bet that CXI would be
able to improve margins significantly and further scale the business. While pre-2017 margins were very high, I did
not (and still do not) expect margins to return to previous levels. This is mainly due to the change in business
structure associated with their banking business. The thesis seemed to be on track at the start
of 2020 as I began to purchase my position in CXI. It seemed CXI was nearing an inflection point
as they began seeing improved operating margins.
But, as the impacts of the pandemic began hitting in early 2020,
international travel was one of the first and hardest hit industries. It’s hard to imagine a worse business more
directly blunted by the smashing blow of global responses than international
travel. CXI’s direct tie to this segment
of the market continued to punish the stock from its already downward path initiated by the margin compression mentioned above.
Revenues for CXI in the 3rd fiscal quarter were slashed by nearly 70%
over the prior year and the outlook in the short term and even medium term shows
little sign of improvement. While
international travel was one of the first businesses to be impacted, it will
likely be one of the last to recovery and the trajectory remains a guess by
even the most informed sources. Even as
this impact continues to push the stock price down, I still consider the
potential for insolvency very low. That
said, the price could easily see additional downward movement. My average price of approximately $13.85 in
early January of 2020 has taken a major hit as Currency Exchange
International’s price as of this writing is in mid-$8 range. (note
that to avoid confusion, all figures in this write-up will be in the CXI
reporting currency of USD.)
With the further depressed price and the smaller size of the
CXI position relative to other stocks in my portfolio, I am now purchasing
additional shares of CXI ahead of any signs of recovery. With the price now close to the liquation
value for the company, I essentially consider my current purchases of CXI an
option play on recovery in international travel. There can be no doubt that further downside
risk to the price does exist. I expect
the pace of this risk will, however, roughly approximate the reduction in
liquidation value as the company burns through its cash reserves Below,
I present a series of scenarios that I see as the likely course that CXI could
take in the coming months.
While recovery is certainly nowhere in sight, the company
has sufficient resources and is developing a three-year plan to ride out what
will likely be protracted effects of the global pandemic. And, while survival for the company is
anything but certain, they have stated in their regulatory filing that they are
in a good position for at least 1 year.
I will revisit this write-up at the end of 2021 to update the investment
thesis with the latest developments.
Other write-ups on CXI used for reference:
Value Investors Club: February
10, 2014 - 10:16am EST by MSLM28
August
23, 2020 - 2:01pm EST by ChapterTwelveCapital
SeekingAlpha: Contributor Articles (all)
Forward Scenarios
To explore the potential outcomes for this investment, I
considered a series of potential outcomes for the business. To keep the analysis as simple as possible, I
chose to look at 4 possible cases and assign a rough probability to each. While admittedly these probabilities are
somewhat artificial, they represent my view of potential paths. These outcomes are:
- Permanent damage to the international travel industry with no long-term profitability for that segment.
- The slow recovery in international travel, exceeding 3-4 years.
- Moderate recovery in international travel, in 2-3 years.
- Full return to pre-pandemic international travel in 2 years and/or positive future business developments.
None of these cases will be the future outcome as the number
of variables for the world economy, pandemic spread and containment, country
and airline responses, etc. far exceeds any reasonable means of
prediction. However, these cases provide
a basis of how I am thinking about my investment in CXI. I believe my edge in this investment is the
company size and extended time over which the recovery will be expected to
materialize. For position sizing
purposes, I have assigned that edge somewhere between 2 and 5%, calling it
3.5%. My financial models for each of these
scenarios will be updated each quarter to account for revenue recovery status
and for actual actions taken by the company against the cash burn rate. Below is a summary text of each of the 4
scenarios…
1.) Permanent damage to banknote business - Because of the high insider ownership and strong balance sheet, I give the chances that the company will quickly burn through all of its excess cash and subsequently borrow money to keep the company afloat a 5% probability. This applies even in the case of a protracted recovery in international travel. I have previously owned a company that fell into bankruptcy during the grips of a multi-year recovery that never materialized. This (painful) experience is used as a basis for my assessment of CXI’s prospects for a similar outcome. Any sign that the company is on such a track and could continue to burn cash, ultimately posing a risk of insolvency, will be cause to exit the stock. In the case that significant signs of recovery do not emerge, a restructuring should be expected within 12-18 months (mid 2022).
2.)
Slow recovery in international travel, exceeding
3-4 years. This scenario is potentially
the most concerning for the stock’s medium-term performance and future actions
as exit signs will not likely to be clear.
For this case, I chose to consider 2021 and 2022 financial performance
to be flat against full year fiscal 2020 performance. While cash burn may be slowed in this case, it
would be extremely unlikely that the company could return to profitability in
any year before 2023. I would expect the
low end of the price to ride the cash position down. For this case, I have estimated up to a 25%
share price reduction from today’s levels ($8.30 USD) to the low $6 range. Below $5 would be cause to consider exiting
the entire position absent clear signs of recovery. I have assigned a 20% probability to this
scenario.
3.)
Moderate recovery in international travel
extending 2-3 years is my base case for the stock. It is not likely the spread of the virus will
see a dramatic decrease (globally) before mid-to-late 2021 or possibly
2022. I would not expect to see much
recovery in CXI prior to a sharp downward trajectory in worldwide cases. However, with this case, I would expect some
adjustment in CXI’s spending with the potential for closing a limited number of
their retail outlets in an effort to improve their cash burn. The company has stated it is developing a 3-year
plan for this case. I would expect some
details of that plan to emerge over the coming quarter. I have assigned the probability of this path
to be 50%
4.)
A fourth, more optimistic scenario, is a
moderate recovery in the pace of international travel coupled with a catalyst
in CXI’s business. One such case would
be the reduction in competition in the bank note business. This would result in higher eventual revenues
for CXI or/and significant improvement in the commercial business. This could include acquisition of a major,
new customer(s) or the widescale adoption of their foreign exchange currency
software. In comments to the VIC
write-up recently, mm202 noted that the CXI software solution is, “top notch”
and he/she claims to have done some due diligence on the system. I cannot comment on this potential catalyst,
however. I have assigned a probability
of this total scenario at 25%. I have
lumped the potential for a 5th outcome in with this scenario. That is, the buyout of the firm by a large
institution or private equity. As with
Pinna’s first venture, the assumption that he will someday be looking to cash
out of the company is likely, but has no timeline that can be assigned. As with most buyout cases, I can claim little
more than a guess of a 15-30% premium to the market price at the time of
announcement.
Final Comments
A popular counter-argument to an investment in CXI is the
death of paper currency, a trend that began over 50 years ago and continues
today. Certainly, betting against the
downward slope of the use of banknotes seems almost naïve, if not insane. However, it is the overestimated rate of
decline that an investment in CXI is attempting to capitalize on. The overestimation of the demise of many
legacy businesses has repeatedly made for fertile grounds for value investors
and I see CXI as a niche player with a longer than expected runway in this area. The experience of Randolph Pinna and his team
in this area should not be underestimated.
A strong balance sheet, reduced
competition, and deep market knowledge are all positioned in CXI’s favor for
the near and medium term. As the banknote portion of the business wanes,
room for investments in adjacent business or even a dominant position in a
corner of the foreign exchange business could easily be a longer-term story
that moves the company forward.
