The following segment was excerpted from this fund letter.
In our third quarter 2021 letter we profiled BM Technologies (NYSE:BMTX) a fintech company. Almost immediately after we purchased the shares, the price jumped by 40%. We trimmed the position. Soon after the price began declining.
To refresh your memory, BMTX was originally part of Customers Bancorp (CUBI). It was sold to Megalith Financial Acquisition Corp., a SPAC. BMTX has developed a fintech banking platform which provides digital banking and disbursement services to consumers and students in the United States. It facilitates deposits and banking products and services between customers and partner banks. The company provides access to a suite of banking products, including checking, savings, personal loans, credit cards, and student refinancing. They are not a traditional bank. It is a white label platform for other companies such as T-Mobile (TMUS).
Approximately half of BMTX’s revenue is from payments by Customers Bancorp for roughly $2 billion of deposits, and technically a sharing of the net interest margin Customers expected to earn. (It looks like it was a sweetheart deal. The CEO of BMTX, Luvleen Sidhu, is the daughter of the CEO of Customers, Jay Sidhu). Customers essentially has been paying BMTX just over 2.75% for their deposits.
Late in 2021 Customers informed BMTX that it would not be continuing the relationship after the end of 2022. In a near zero interest rate environment, BMTX had a problem. They were going to see earnings drop precipitously in 2023 as it was highly unlikely they would receive nearly 3% for deposits. Trailing adjusted EBITDA was $2.40 per share. If they only earned 1% on the deposits, EBITDA would be breakeven or slightly negative.
BMTX’s solution was to purchase a small bank and bring the deposits in house. They agreed to buy First Sound Bank (OTCPK:FSWA) for $25 million. The problem is the level of deposits would far exceed the bank’s capital necessitating a large capital raise, which would significantly dilute shareholders. At best net income would hold steady but the share count would double or possibly triple, meaning earnings per share would decline by 1/2 to 1/3. And that assumes they rapidly built up a lending team and loan portfolio, which does not happen overnight.
Another issue also came up at the beginning of the year. BMTX had to restate their financials due to how they treated some stock compensation. Previously the cost had been borne by Customers Bancorp, but auditors decided BMTX should have amortized it over calendar 2021 and 2022. BMTX made the adjustment, filed its annual report, and then dismissed its auditors.
Just one of the major issues BMTX faced – needing a capital raise when you are seen as desperate, are associated with a former SPAC, have had an accounting issue that led to changing auditors, and being in the midst of a sharply declining market – would be a challenge. Facing all was a perfect storm. Buyers were waiting for a bottom. Then inflation kicked up, pushing interest rates up. BMTX went from the likelihood of having the 2.75% service revenue on its deposits declining to less than 1%, to potentially having no drop at all.
One-year CD rates are now 3% and have been trending higher. BMTX can broker the deposits out to numerous banks and replace the relationship with Customers. Today, they may be buying a bank they don’t actually need, but that is a much better problem than what they faced six months ago.
The strange thing is that the market has not made an adjustment. The stock has languished at $6 per share, which is just 2.5 times trailing adjusted EBITDA of $2.40 per share. BMTX has no debt and we estimate end of June 2022 cash levels to be close to $35 million, or nearly $3 per share. While $25 million will go to buying First Sound, they will still have a solid balance sheet. BMTX announced hiring KPMG as auditors this week, and we expect them to be current in their filings by mid-September.
The risks are that rates decrease. Despite what the current administration says, we are technically in a recession – two successive quarters of negative GDP. Are we likely to return to zero interest rate policy? Probably not, but that does not mean rates won’t be lower a year from now. The inverted yield curve also implies rates in the future will be lower. Having spoken with BMTX’s CFO, we think BMTX has a proper understanding of the situation and will act rationally.
Our hope is that BMTX is able to stay a fintech company and not turn completely into a bank that is subject to regulatory capital requirements. As a fintech they can earn much higher returns on equity and will not need to keep all that equity in the business.
For the moment, we think the current valuation of just over one times EBITDA, net of cash is absurdly low. Assuming the bank purchase closes, the valuation is two times EBITDA net of cash, plus the value of the bank. Barring a drastic change in the other parts of the business, the downside scenario is the company functioning at breakeven. If that occurred two years from now cash would equal the current value of the company.
Thus, we think the downside is very minimal, and the upside substantial. In addition, they are still working on gaining additional white label partners, and were successful in the first quarter, and deposits are still growing.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.