Our slide presentation explaining our short thesis on Cardtronics, Inc. is available here [1] and our 41-page report is available here [2].
We are short shares of Cardtronics (CATM), the largest non-bank owner and operator of ATMs, primarily in the US and UK. CATM’s core business is installing ATMs inside brick-and-mortar retailers like 7-Eleven and CVS, where high foot traffic generates withdrawals that in turn generate surcharge fees (paid by consumers) and interchange fees (paid by card-issuing banks). In addition, banks sometimes pay CATM to put their brands on its devices or to offer surcharge-free withdrawals to their customers.
Despite its exclusive focus on the secularly declining ATM market, CATM trades at the rich valuation of a high-growth firm, with trailing and forward P/E ratios of 37x and 26x, respectively, 53% higher than the S&P 500 median. Moreover, we believe that CATM has inflated its earnings via aggressive accounting. It depreciates its ATMs over much longer periods than its competitors do – more than eight years rather than five years – thereby understating expenses. Applying a five-year average life to CATM’s assets would have reduced EPS in 2013 from $0.86 to just $0.19.
While CATM’s press releases paint an optimistic picture of organic growth, its SEC filings show that domestic same-store transaction growth has slowed markedly, from 3.8% in Q1 2012 to just 0.4% in Q1 2014. A recently released Federal Reserve study [3] confirms that total ATM withdrawals in the US are already declining. Essentially, CATM is a concentrated bet on paper currency and retail foot traffic – stunningly at odds with the direction in which the world is moving. CATM management has distracted investors from these relentless secular trends through an aggressive roll-up strategy that has consumed more than 100% of its free cash flow over the past three years. But diminishing returns have pushed RoA from 8.9% in 2010 to 4.3% in 2013, and new ATMs have come on at 41% lower per-unit gross profitability than legacy ATMs.
Making matters worse, CATM also faces an existential threat as its largest merchant relationship, 7-Eleven – which we estimate accounts for ~40% of its earnings – comes up for renewal in 2017. A sister company of 7-Eleven’s that operates all of the chain’s ATMs in Japan is rapidly expanding in the US and openly pursuing the contract. If it succeeds, it would be catastrophic for CATM.
In light of its numerous risks, and based on comparable firms’ far lower valuations along with our DCF analysis, we believe that CATM’s fair value is only $9-$19 per share, or 40-70% below the current stock price.
Investment Highlights
- Roll-up strategy yields declining returns on capital while organic growth deteriorates. After a three-year hiatus, CATM has re-embarked on an acquisition spree, gobbling up 13 companies in the last three years. From 2011 to 2013, CATM spent more than 100% of its free cash flow on acquisitions. Meanwhile, “same-store” transaction volume at its US ATMs has slowed drastically to 0.4%, net growth in ATMs (excluding acquired units) turned negative in 2013, and average revenue per withdrawal fell three years in a row. In its 2013 Q1 10-Q [4], management guided to a “more normal range of 3-5%” same-store transaction growth. In reality, growth was -1.0%, 2.7%, 1.7%, 1.7%, and 0.4% over the past five quarters, never even reaching the low end of the range. CATM has deflected investors away from these weak organic numbers by promoting its aggressive roll-up strategy. However, this strategy has generated diminishing returns: CATM’s return on invested capital dropped from 14.5% in 2010 to 9.1% in 2013, and its return on assets fell from 8.9% to 4.3%, representing declines of 37% and 52%.
- Aggressive accounting overstates true earnings power. Despite the simplicity of its business, CATM management and sell-side analysts focus on “adjusted” earnings rather than GAAP. But the spread between GAAP and “adjusted” has grown wider with every passing year: while adjusted EPS grew 93% from 2010 to 2013, GAAP EPS fell 10%, from $0.96 to $0.86, even after adding back a UK tax charge. “Adjusted” numbers that exclude transaction expenses, stock-based compensation, and amortization costs let management off the hook for the real costs of its M&A-driven strategy. Furthermore, we believe that CATM’s capital expenditures are dominated by maintenance and replacement costs, not growth investments. Yet CATM appears to be exaggerating its earnings by aggressively assuming long average lives for its ATMs. If CATM assumed a five-year life, in line with its peers’ accounting, then depreciation in 2013 would be $44 million higher, cutting GAAP EPS from $0.86 to just $0.19. Reinforcing the case against CATM’s inadequate depreciation are the facts that (1) it consistently sells used machines for less than their carrying values, and (2) it repeatedly underestimates near-term capital-expenditure requirements.
- ATM usage is declining at an accelerating pace – a secular trend that is only getting started. Though CATM management and sell-side analysts pour scorn on the straw-man argument that cash will vanish overnight, the utility of ATMs need not go to zero for CATM’s value to be dramatically impaired. In the US, Federal Reserve data confirm that declining ATM usage is already a reality, not some far-off forecast: cash withdrawals grew at a 0.3% CAGR from 2003 to 2009 but fell at a 1.1% CAGR from 2009 to 2012. Given population growth, this implies that per-capita withdrawals have been declining since at least 2003, and the decline is now accelerating. It’s no wonder, then, that independent ATM deployers, CATM’s competitors, rate [5] “declining transactions” and “ATM saturation” as their top two concerns. Overseas trends are similar: ATM withdrawals are declining in the eurozone, countries like Sweden and Australia are increasingly becoming cashless, and groups like the Gates Foundation are pushing for the rapid adoption of electronic payments in developing nations. Despite CATM’s valiant attempts to use M&A to paper over these trends, CATM is a concentrated bet on paper currency and retail foot traffic. We view CATM’s aggressive shift toward M&A as a tacit admission that it faces secular decline in its existing operations and hopes to escape the inevitable by paying up for growth.
- Upcoming contract expiration puts largest customer – and 24% of revenue – at risk. In 2007, CATM acquired 7-Eleven’s US ATM fleet in a transformational deal that made the convenience-store chain CATM’s largest customer. Since then, however, the Japanese ATM operator Seven Bank – almost 50% owned by 7-Eleven’s Japanese parent company, Seven & i Holdings – has entered the US market by outbidding CATM on two acquisitions, with a clear long-term goal of replacing CATM as 7-Eleven’s ATM partner. Seven Bank already serves in this role in Japan. Given CATM’s outsized exposure to this single merchant, constituting 24% of its 2013 pro forma revenue and, by our estimates, 40% of earnings, the loss of 7-Eleven would be devastating. Even if CATM manages to extend the contract in 2017, the genie is out of the bottle: over the long term, Seven & i wants to bring the ATM business back into the fold, and CATM is at its mercy.
- Premium valuation unwarranted given enormous near-term and long-term risk. Adjusted for capital structure, CATM trades at a massive premium to DirectCash, its leading Canadian competitor, as well as to firms like NCR and Deluxe that are similarly exposed to the secular decline in paper-based payments (but are seeking to diversify instead of doubling down like CATM). DirectCash trades at 8.2x EV/EBITA, while CATM trades at a lofty 13.4x – 64% higher. Averaging together a wider peer group suggests that CATM should be valued at 9.3x EV/EBITA, implying a share price of $19, 41% lower than the current price. From a longer-term perspective, our bottoms-up DCF, which extrapolates CATM’s profit drivers in a world with modestly declining per-ATM transaction volumes, produces a fair value of just $9 per share, 72% below the current stock price. Thus CATM’s stock appears to price in many years of rapid growth while completely neglecting the risks of deteriorating profitability, client attrition, overstated earnings, and long-term obsolescence.