Currency Exchange International Stock: Highly Attractive Opportunities (OTCMKTS:CURN)

The following segment was excerpted from this fund letter.

Currency Exchange International (OTCPK:CURN) (CXI.TO)

During my time working for the Spurs, I was lucky enough to spend considerable hours learning from some of the best talent evaluators in the business, who taught me to search for things in players that others didn’t care about or wouldn’t see. Because the Spurs regularly won a lot of regular season games, they tended to receive draft picks toward the end of the 1st and 2nd rounds. For those not familiar, players selected toward the back end of each round are typically not All-Star caliber. As a result, we made it a point during scouting evaluations to highlight lesser-known skills or intangibles in the pursuit of an impact player. There was a phrase for players who were less skilled overall but played hard or made an impact in other ways, consisting of ‘he plays bigger than he is’. This implied that the player’s effort level and impact made on the floor outshined his actual skillset or physical abilities. ‘Punching above his weight’ would be the boxing equivalent for our non-basketball fans.

In the case of Currency Exchange, I’m convinced that both the company and management are punching above their weight by quietly attacking a number of profitable initiatives while operating in a forward-thinking manner set to capture several highly attractive opportunities. I’m partial to management teams that ‘play bigger than they are’ and I believe we’ve found one such group.

One element of my research process consists of ‘spending a year’ with a company early on in my due diligence. This involves examining how the business results unfold over time, and what a typical year might look like from start to finish. In the case of Currency Exchange, I spent a few. Typical with microcaps, few seem to be paying attention, but CURN’s efforts began long before our involvement as shareholders. While toiling away in obscurity for the past decade, management’s clear strategic vision about what they wanted to accomplish has started to unfold and to date CURN has nailed every operational and strategic target they’ve laid out. For a business somewhat tied to international travel, COVID provided a large step back, but the business emerged stronger than ever and in my view is at a major inflection point as of this year. The Currency Exchange business model has a few moving pieces, which in my view is partly why the mispricing exists.

Currency Exchange is a provider of foreign currency exchange services in North America, with several adjacent business lines in addition to their core. Currency exchange ‘provider’ comprises several things, but the majority of revenue today comes from selling foreign banknotes. Selling banknotes takes place through the company’s retail and wholesale channels, and there is also an international payments business, an online FX service for home currency delivery, and a retail business within airports that CURN has entered into via agency agreements with existing providers. For those less familiar, think of CURN’s banknotes business as the exchange of US dollars for foreign banknotes (or vice versa), where customers pay a small fee to undergo the transaction. The payments business also offers transaction-based check cashing, wire transfers and FX forward transactions, mainly for import/export activity.

Revenue segments are currently broken out into Commission Revenue and Fee Income, but I believe it makes more sense to look at CURN through their Banknotes segment and Payments segment. Banknotes comprises retail and wholesale transactions, the airport agency business, and Online FX, while Payments consists of the company’s international payments business with financial institution customers.

Within banknotes, as mentioned, there are two main customer types, retail and wholesale. On the retail side CXI operates 36 storefronts in high tourist traffic locations like New York City and shopping malls in parts of Florida. The wholesale business supplies banks and third-party FX retailers with currency to sell through their branch locations. Retail transactions involve the individual customer, where CURN serves as a net buyer of foreign currency, making a decent margin on each transaction. Wholesale transactions involve CURN acting as a net seller of currency to meet the physical FX demands for bulk banknote trading. While the retail business sports higher margins, the wholesale business has much greater scale, higher transaction volumes and can be expanded at a greater pace. CURN earns a profit on the spread between the spot purchase price of the currency and their final sale price. CURN also competes on things like service and compliance, two areas in which they excel.

An examination of historical financials wouldn’t reveal much to get excited about, especially as EBITDA and margins have failed to increase along with revenue growth. This is both misleading and intentional. Instead of issues relating to an unprofitable business model or competitive dynamics, CURN spent the past decade building out their banknotes, payments, and software infrastructure, while navigating the regulatory environment on their way to becoming a stronger, more profitable business. Today, CURN has a competitively advantaged and proprietary software platform, a Schedule 1 Canadian bank charter and a number of adjacent revenue generating opportunities that are inflecting as we speak.

While CURN is somewhat levered to international travel as well as economic activity through their payments segment, efforts to diversify the business away from banknotes have been largely successful and proven beneficial as payments revenue GREW during the pandemic while payments revenues as a percentage of total revenues grew from 7% in 2019 to over 20% today. With relatively low fixed costs, ‘scale’ in the payments business is said to be above $10m in annual revenues, the current run rate, where incremental EBIT margins come in at 30-40%. Payments have been growing in excess of 30% for the past few years. Inherent in this business in both banknotes and payments is an incredible amount of operating leverage which has just begun to reveal itself following years of the aforementioned reinvestment in building out core and additional services and navigating the regulatory environment.

That last point is important, as the most significant part of this story took place in 2012, when Currency Exchange applied for a Canadian bank charter through their Exchange Bank of Canada (ECB) subsidiary in order to become a ‘banker’s bank’. The importance of being granted a Schedule 1 bank charter cannot be overstated, as it affords the company numerous advantages, including being able to bank with central banks (through the Federal Reserve Foreign Bank International Cash Services Program) in order to source US dollar cost effectively, reducing collateral obligations and enhancing existing bank relationships. Furthermore, the charter being granted serves as a huge competitive barrier (CURN is one of now three banks approved for international distribution through the Fed program) and will ignite the operating leverage within the business. With the costs to obtain this license along with the required infrastructure behind them, I expect CURN to both win much larger customers and experience significant cost savings moving forward. It’s estimated that incremental banknotes revenues from here should provide 50% EBIT contribution margins. Normalized international travel, combined with CURN’s other initiatives means it wouldn’t be hard to see the banknotes business significantly exceeding pre-COVID levels this year and beyond.

The management team has roots in foreign exchange dating back to the late ’80s, when current CEO Randolph Pinna founded Foreign Currency Exchange (FCE), the predecessor to CURN. Foreign Currency Exchange was eventually acquired by the Bank of Ireland, where Mr. Pinna continued growing the business until 2007. The Bank of Ireland, under stress from the financial crisis, started selling off assets, at which point Mr. Pinna bought back a number of forex retail locations and established the current version of Currency Exchange International. During the subsequent few years, the early version of CURN developed a proprietary software platform called CEIFX, used to enhance the trading of currencies and other travel related aids for both retail locations and bank branches. In addition to their bank charter, this is one of CURN’s most significant competitive differentiators and an asset for which I don’t believe they are getting credit, given its built-in and difficult-to-replicate compliance system. CURN’s compliance verification system (CVS) has allowed them to win a large number of bank customers as heavily regulated financial institutions feel safer working with all compliance checks in place and a company with a history of strong compliance practices. The software can be plugged directly into most banks enterprise resource planning systems (ERPs), leading to faster, more secure and more efficient foreign currency management. This has led to significant growth in financial institution customers, and during 2019 and 2021 CURN entered into partnership agreements to integrate their software with Fiserv and Jack Henry’s core bank processing systems. These integrations significantly increase the addressable market for CURN by over 1,000 potential bank customers.

The North American foreign exchange market has two major entities, Bank of America and Wells Fargo, and until recently, two lesser players, Travelex and Currency Exchange. As Travelex recently filed for bankruptcy while exiting the Americas, the door has been opened for CURN to capture a significant amount of market share on the retail side and continue growing their agency relationships at high traffic airports, something that should prove massively profitable over time…