Business Breakdowns
· Matt Reustle
[00:00:00] S0: It's easy for me to look at the metal card and think about the vanity play of the noise it makes when it drops on the table. But there is obviously a lot of actual innovation going into the chip and what would attract them to the banks on the other side of this. I want to get into that SPAC era now because they had this premium metal card business, but I know they introduced another growth engine. Very much a sign of the times and we'll see where it goes. But can you talk a little bit about, beyond just being baby thrown out with the bathwater in terms of SPAC up and SPAC down, what was fueling some of the excitement over Compo? That was another piece of the business that we can introduce now.
· Parsa Kiai
[00:00:00] S1: The SPAC era was interesting because there was just some real unrealistic expectations about everything—digital assets and a lot of other things. But they actually do have a business called Arculus which focuses on two things. One is a digital cold wallet for storing, transacting, and trading digital assets. But its larger use case, in my view, is really on the security and authentication side. And it's here where I think there's potentially a lot of value, and it really shows the next step in the innovation and growth of the company. When they came public via the SPAC, you had this very good core payments business, and it was almost overlooked as an afterthought because they're like, all right, well we have this business, it's profitable and it's growing. But really look at this Arculus business. And the expectations there initially were too high. If you think about what Arculus does from security and authentication, it has a lot of incredible use cases that we have not yet seen monetized. So their services can be combined between the payments and the authentication. It makes your premium metal card into a security token, into an authentication token, and it can be combined to have a lot of different use cases for different banks, fintechs, and all sorts of payment transactions. For example, you can use this for passwordless login on a variety of different financial apps or banking apps. So you can combine it with your biometric, fingerprint, or face recognition. You can tap your Arculus-enabled metal card on your phone, and this reduces the need for passwords, reduces fraud risk, and it simplifies your access while maintaining a lot of high security. I think it also can be used in certain high-value false declines in online purchases. So if you make a potential transaction that needs verification from your bank without having to call in or text to confirm, you can tap your Arculus card and it minimizes friction, it boosts the approval rate, cuts down on fraud. So it's really a win for the cardholder and the issuer. There are a lot of other use cases, including high-value transactions in gaming, in-store approvals, in more unusual locations, call center efficiency, customer verification. Beyond just saying it's a crypto cold wallet, it has a lot of applications, and it was a big portion of the excitement of the company.
· Parsa Kiai, Matt Reustle
A couple years after the SPAC, it almost became a bit of a liability because its revenues had not materialized. It was generating about a $20 million operating loss, and it went from being the shiny toy to a liability. And that was our involvement in the company, saying we've got this incredible niche core payments business that is growing organically, has a long runway for growth, is valued at a fraction of what it's worth, and we have this incredible nascent technology that is not yet generating a lot of revenues, but it has incredible use cases, an incredible team, and is the next leg of innovation and growth for this company. [00:00:00] S0: As a consumer, I've heard of your credit card with a Bloomberg B-unit for those that use Bloomberg attached in it being a one-stop shop to reduce a lot of the frictions. But then you can obviously understand from the opposite side of the equation, whether it's banks or whoever who have to deal with all of the costs associated with the challenges of security. And it's only getting more and more intense. So that's an interesting one where the expectations were so high and at times you could see these dislocations, but it will be interesting to see how that evolves. I wanted to tap into a little bit about those relationships they have. They seem so core. Can you just talk about what drives that beyond some of what you just mentioned and what the competitive set looks like in terms of others that might be trying to do the same thing and where Compo really ranks against the rest of the peer group?
· Parsa Kiai
[00:00:00] S1: When you think about the relationships that they have with their issuers, the two biggest customers are American Express and Chase. And if you're in the premium metal card business, it's only natural that those are going to be your two biggest clients given their size and scale. But in the industry, if you focus on those two first, you see how long and valuable that partnership has been. And even though it's a contractual business—one, two, three year contracts—the number of times that those contracts have been renewed and have been increased in tenure really speaks to how important that relationship is. Initially when we looked at the business, we had some concerns about customer concentration. But the more we learned about how symbiotic this relationship is, we became a lot more comfortable with that. So if you think about what they provide, this is really all about the pursuit of the high-end credit card customer. Research shows that 10% of cardholders are responsible for nearly 50% of all consumer spending. So if you are a Chase, American Express, now Citibank, Capital One, you really want to go after that high-end customer because they spend on average—cardholders with credit cards that have an annual fee greater than $500—they spend something like $3,000 per month on their credit cards. Those with cards with below that as an annual fee spend only $1,000. The difference between that $2,000 a month is $24,000 in annual spending. And that is a huge prize for credit card issuers, not only because of the interchange revenue that it brings, but all the ancillary service fees and cross-selling opportunities to this high-end cohort. These are also a much more loyal customer base with lower churn. And given their higher income stature, they generally don't carry balances. So you have lower credit loss provisions. And you're seeing this now with the increase in annual fees and the increase in rewards for the new American Express Platinum cards, the new Chase Sapphire cards. It really is a battle to win the top-of-wallet status. When you open your wallet, you want to be that heavy metal card that you throw on the dinner table at a restaurant and it clanks. It really is trying to find those. What CompoSecure does is it really helps facilitate that.
· Parsa Kiai
Because when you think about the unit economics of this business, you can think about it on a per card basis and then you could think about it in aggregate. If we take an American Express cardholder or a Chase Sapphire cardholder, these cardholders will spend anywhere between 30 to 60 thousand dollars per year on some of that spend. That interchange is as high as 2.5%. So the card issuer can get $750 or $1,500 annually in interchange revenue. On top of that, they provide these rewards to the customers. So they have to give something about half of the interchange back to these customers. And they're happy to do that because it makes and retains, it grows these customer relationships. So you spend about $375 or $750 on your rewards costs. These cards typically have very, very low credit losses. And then you add on top your annual fee for this and you're looking at something like a $1,200 or $1,600 annual profit. And the cost to the issuers for this CompoSecure card is $12 per card. So you're looking at something like 100 times return on your investment. This is really the only physical COGS that an American Express or Chase has. There's a lot of other things that are variable costs. And if that metal card, that premium feel is that important, we think it's very important to have that quality card so that you're not going to switch to go to a new upstart competitor to save a dollar per card when you're making something like $1,000 or $1,500 in annual profit. And now you compare that to your generic plastic card, even that one that has no fee. It costs less than a tenth of a premium metal card. It costs $1.25 per card. But given how much less a customer spends and generally the higher cost for credit provisions and churn, we estimate that the return on investment on a generic plastic card is less than a fifth of what it is on a premium metal card. That is why we think that this symbiotic relationship exists. And that is why even as the company has become public and its high gross margins, its high EBITDA margins, and its average selling price has become public disclosure, you have not seen customer attrition, you've not seen market share losses because it is such an incredibly valuable tool for their issuers to go after those high-end credit cards.
· Parsa Kiai, Matt Reustle
If you look at a business like American Express, American Express does something like $75 billion of annual revenues. And the largest component of that, about $40 billion, is interchange fees. Another $18 billion is net interest income. About $10 billion is your card fees and $8 billion is service fees. So on the $75 billion, American Express makes about $20 billion of pre-tax and pre-provision profits. The biggest cost structure is about $18, $19 billion in card member rewards. This $20 billion of pre-tax, pre-provision profit is really facilitated by providing that valuable customer experience and a $10 card. That cost of goods sold is 0.2% of their cost base. And we think this is a really interesting business that you provide such an experience to such a big company, facilitating such a large scale, and you are such a small part of that cost. And that's really why we think these relationships exist and grow, and why other people want to get into the game. [00:00:00] S0: You mentioned they have this market share. Do you have any sense in terms of numbers of what that market share looks like in this segment?