October 24, 2023 - 12:40am EST by
2023 2024
Price: 16.13 EPS 3.57 3.50
Shares Out. (in M): 11 P/E 4.6 5.0
Market Cap (in $M): 189 P/FCF 5.6 6.0
Net Debt (in $M): 273 EBIT 84 75
TEV (in $M): 462 TEV/EBIT 5.5 6.5

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CPI Card Group is a good example of a decent business generating healthy cash flow that has been punished in the smallcap downturn over the past few months. The current valuation level is attractive, and I expect the stock to revalue higher when market sentiment returns to a more risk-on mood. 

Business and valuation:
CPI Card manufactures debit and credit cards in the United States. The company has generated $100m of EBITDA and $42m of net income in the last twelve months. Its cash flow from operations less capex has been $33m, not too far off from GAAP net income. It has paid $27m of cash interest, implying unlevered free cash flow of ~$51m. Yet the company has a market cap of $180m and an enterprise value of approximately $453m. So it’s trading at a 20% free cash flow yield to the equity, and 4.6x EV/EBITDA, a very cheap multiple given the company’s modest capex requirements. It trades at 5x 2023 P/E. Cash has generally been going to pay down debt, a reasonable use of cash flow given the 8.625% rate the company is currently paying on its bonds. We’ll see in the coming earnings report if the company has taken advantage of the weak share price over the past few months to buy back shares. The company’s debt-to-ebitda ratio is under 3x.

Based on our diligence, there are 4-6 manufacturers of cards in the United States, with the top 4 being CPI, and three European companies: Thales, Idemia, and Giesecke & Devrient GmbH. There are smaller players such as Perfect Plastics, but for larger clients, the manufacturers to choose from should typically be CPI, Idemia, G&D and Thales.

By most accounts we’ve heard, CPI has been gaining market share. In terms of customer service and attention, CPI has ranked highly in terms of responsiveness, reliability and overall service, developing a favorable reputation in the card manufacturing industry. Price is a factor in this market as well, which is why I’d characterize the overall industry as a fair, as opposed to great, industry, but the current valuation reflects this. At times historically, CPI has won clients based on favorable pricing relative to peers, particularly Idemia, which I believe has been a share loser. I expect there to be continued consolidation in this industry, and, most recently, G&D acquired the U.S. operations of Valid S.A., a South American card manufacturer.

Q1 Guidance Revision
In May, the stock crashed more than -30% after Q1 earnings due to management striking a more cautious tone during the call. The company didn’t revise guidance but did note softness in its end market, ascribing the softness to the regional banking crises earlier this year. Specifically, management commented the following in its earnings call:

Today we are affirming the financial outlook we provided in March. We believe continued strong performance from contactless cards, additional sales of end-to-end solutions, and further penetration of instant issuance will drive sales growth for the full year. However, there is more risk and uncertainty in the market. The banking industry stress that emerged following the collapse of Silicon Valley Bank in March has contributed to more cautious spending environment among issuers. Although we do not have any significant direct exposure to the three major banks that have failed, we have recently seen softening customer demand in our debit and credit segment, and consequently, do not expect second-quarter results to be as strong as the first quarter. Near term, it's difficult to project the extent of the banking industry stress or how long it will continue to impact us. However, given the uncertainty, we have implemented various new initiatives to drive sales and manage expenses more tightly in 2023.

So while PMTS maintained its full-year guidance, management's tepid commentary spooked the market. However, the stock is now down -62% since the Q1 report, and that’s after a Q2 earnings report that wasn’t alarming at all, and after which the stock spiked. Specifically, the company beat guidance in the 2nd quarter by posting revenue growth, and grew EBITDA 14% yoy. The company is on track for $100m EBITDA for 2023 and $3.50 EPS. Even if the company misses those numbers by a bit, the current valuation provides plenty of cushion to still justify owning PMTS at these levels. 

CEO Change

CEO Scott Scheirman announced on June 5 that he would be stepping down effective February 28, 2024. The stock has steadily declined since then, except for a weird one-day spoke after Q2 earnings in early August. On June 15, CPI’s chairman Bradley Seaman also stepped down – Seaman is chairman of Parallel49 Equity, the private equity firm that owns 57% of CPI. But Parallel49 still has another representative on the board, Nicholas Peters, who is a managing director at and the CFO of Parallel49. So the PE firm still has a presence on the board.

Management has attributed the CEO’s departure to the fact that his wife has become ill, and I have no way of knowing whether that’s the genuine reason or a cover for something more adverse that has changed at the business. But my diligence calls and the company’s Q2 results haven’t indicated that anything is amiss or has changed materially in the company’s operations.

Potential Sale of Company

A potential sale of the company remains one path for an attractive exit for equity holders. Given the company is controlled by a PE firm, the decision to sell and at what price is up to Parallel49. The company has been a holding for the fund for a very long time now, and I anticipate that the PE firm would love to exit the investment at an attractive price. When shares spiked into the $30s/$40s in August/September 2021, the company filed a shelf offering to sell shares on behalf of Parallel49 (aka Tricor). But in the end, no offering was consummated and shares have declined significantly since.

As such, my expectation is that the sponsor isn’t interested in selling at the current low prices, and will await a recovery in market sentiment and the company’s share price in hopes of exiting above $30, if not higher.

Given the company’s healthy free cash flow, a sale to private equity is a possibility. However, with rates elevated, the likelihood of a take-private via LBO might be more realistic if rates begin declining again. In terms of a sale to a strategic, it’s possible that Thales or G+D could acquire CPI to further grow their market share and U.S. footprint. Idemia itself is up for sale, and the ultimate acquirer of Idemia is another potential suitor for CPI. Additionally, CPI is also a potential target for an Asian card manufacturer looking to enter the U.S. market. FIS and Fiserv are also potential buyers, as the card manufacturing business is synergistic with their own card services operations. FIS and Fiserv are “aggregators” in that they aggregate numerous small bank issuers, and Fiserv is believed to be CPI’s largest customer. At the currently low valuation, CPI would be an attractive acquisition to numerous buyers since the purchase could be significantly accretive.

Card Transitions

A key bull case to the thesis is that eco cards potentially represent a new growth trajectory in card manufacturing. A brief discussion of the history of card manufacturing would be helpful here. While CPI notes that 90% of new card issuance is driven by replacement cards due to card expirations, lost cards and customers switching banks, the sector has historically been marked by new technological advancements that result in the issuance of a new type of card that replaces legacy cards, over several years by most financial institutions. This results in a sort of boom-bust cycle in card manufacturing, though significantly more muted in our opinion than some investors think. In 2014-2016, debit and credit cards transitioned from magnetic stripes to EMV chip cards, which led to strong growth for CPI in 2014 and 2015, followed by significant revenue declines in 2016 and 2017, as customers had overstocked on EMV cards and were issuing that inventory to customers in 2016 and 2017, leading to reduced orders from CPI. Similarly, over the past five years, contactless cards have broadly replaced chip cards, fueling a new period of growth, or cyclical upturn in card orders.

I’d note that market shares can shift during these new card introductions, depending on which manufacturers are more advanced in capitalizing on the initial batch of orders for the new card types. We had several industry experts explain to us that part of what exacerbated CPI’s troubles in the mid 2010s was that it was a laggard in EMV technology relative to the European players, partly because Europe introduced chip cards earlier than U.S. institutions, and thus CPI lost market share during that period.

Today, contactless cards are reaching market penetration, and a bear thesis against CPI is that the maturation of the transition to contactless cards will result in a revenue decline. I counter that the shift from chip cards to contactless has been more gradual than the shift from magnetic stripes to chip cards and much of the shift occurred in 2019 to 2021 (and yet 2022 witnessed strong growth for CPI). So I don’t expect the same magnitude of fall-off for CPI in 2023 to 2024 due to the maturation of contactless as we saw after the EMV card boom in 2016-2018.

Furthermore, the -56% decline in the stock price YTD has now provided a discounted valuation affording buyers a margin of safety even if a slowdown does occur due to the maturation of contactless issuance.

The Rise of Eco Cards

An upside scenario to the CPI story relates to eco friendly cards. Our best guess as to the next shift in debit / credit cards is that traditional plastic cards will be replaced by eco friendly cards using a higher proportion of recycled or otherwise environmentally friendly plastic materials. We heard this consistently throughout our channel checks, including from a key decision maker at a major national U.S. bank.

Naturally, eco friendly cards are, in my opinion at least, mostly a marketing gimmick – my personal debit and credit card probably amounts to less than .01% of my annual plastics usage. But with Visa and Mastercard at the helm of one of the world’s most profitable toll roads, and perpetually looking for ways to defend their public image in the wake of the periodic outcries against their parasitic relationship with the global economy, mandating cards to be made from more environmentally friendly plastics is a no brainer publicity stunt.

In advance of a formal mandate from card networks, some banks have already begun purchasing eco friendly cards, and CPI has actually seen a decline year-over-year in eco friendly card orders because of some large orders last year. But overall, I think debit and credit cards will transition to eco friendly cards over the next 5 years, driving continued growth for the card manufacturing sector.

A few articles on the recently announced mandate from Mastercard for eco-friendly cards, as well as certain major banks switching entirely to eco friendly cards:

We think Visa will make a similar announcement soon, and over time, most banks will follow in the footsteps of the largest banks in transitioning to eco friendly cards.

Therefore, CPI is an ESG play! If you’re feeling as guilty as I am about all my offshore driller and Canadian E&P investments, fear not – CPI Card is helping Americans across the country switch from cards made of first-use PVC plastics to recycled or bio-sourced plastics. Indeed, in an upside case, the growth in eco cards could prove to be a catalyst triggering the next growth cycle in card manufacturing, and could catapult CPI to $60+. Maybe at some point, CPI becomes a meme reddit darling hailed as an ESG play and unscrupulous discord chat rooms pump the thinly traded microcap to new highs! Or who knows, maybe some mean short activist gets sick of CPI trading at a 20% FCF yield and blasts out a bullish report highlighting CPI’s ESG merits to all his twitter trolls! But at the least, I believe that the transition to eco cards will provide enough industry tailwinds to counterbalance declines owing to contactless card maturation, and will help justify an investment in the stock at the current 20% FCF yield valuation.

Of particular importance, our channel checks have indicated that CPI has been an early mover in eco cards, and has done a better job marketing their eco card offering relative to Thales, Idemia and G+D. I ascribe that to the same reasons CPI has been winning market share based on customer service and responsiveness over the past 5+ years – card manufacturing is CPI’s sole business, and it is singularly focused on executing well in this industry, whereas card manufacturing is just one vertical for Thales, Idemia and G+D, which are much larger global conglomerates with multiple business lines and areas of focus. 

CPI’s eco-focused solutions include its “Second Wave” and “Earthwise” cards. Second Wave payment cards feature a core made with recovered ocean-bound plastic, and Earthwise cards are made with re-used plastic waste (including recovered ocean-bound plastic as well as recycled PVC and recycled PET-G), also known as “upcycled” plastic. Its eco-focused cards were launched in 2019.

While our channel checks demonstrate that CPI has developed a favorable reputation among customers for its eco friendly offerings, ultimately I believe all the card manufacturers will have viable eco friendly offerings, and this will not be a space like the metal card space where Composecure has developed somewhat of a moat around its specific card manufacturing and cost structure. However, CPI’s head start will certainly incrementally help it win or maintain market share. For instance, it’s a good sign that on Visa’s own site on ESG initiatives, Visa singles out CPI with respect to its moves in eco friendly cards: https://usa.visa.com/about-visa/esg/planet.html

Nature of the Industry

I characterize the industry as a fair one, and while I wouldn’t recommend a card manufacturer at 25x P/E, I think it’s a decent enough industry structure to own one of its leading players when it's trading at 1x revenue and 5x P/E.

Management has previously mentioned that credit and debit cards can be expected to grow in the mid single digits range, and I don’t think that trend will change anytime soon. Customers continue to open up multiple bank accounts and credit cards and switch banking / credit providers, and physical cards remain a cheap form of advertisement for financial institutions. FinTech and neobanks continue to grow, and issuing cards is a key way for them to establish a physical connection with customers.

As a final point, I’m happy about the presence of a private equity owner controlling the company’s destiny as the company’s majority shareholder, as well as the presence of Steamboat as a major shareholder. Steamboat has written activist letters to the company previously, and has acted as a healthy check on management and the board to ensure they don’t do anything stupid, which to me, at this point, would be a boneheaded M&A transaction. At current prices, CPI should focus on executing on its business, potentially buy back shares, and wait until market sentiment shifts to more of a risk-on mode, at which time I’d expect beaten down smallcaps like PMTS to rally.

Finally, several posts have already been written on CPI and I encourage readers to read those writeups and Q&A as well for further background on CPI.

Additional Risk Factor

The chip shortage during COVID led some clients to stock up on cards, and management has discussed a buildup of inventory during the pandemic that may be worked off this year. However, we are now more than a year since supply chain constraints have been eased, and 1H 2023 numbers were fine.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


- Q3 earnings coming in fine, and company meeting its 2023 guidance, or not missing it by too much
- Energy investors buying PMTS to reduce their portfolios' carbon footprints

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