This article sets out to explain why to a wider audience.
Originally, we bought CASH because of the following thesis:
- It traded at bank-like valuations, but the underlying business wasn't really bank-like, it was better.
- One of the reasons for the business being better was tied to CASH being a large issuer of prepaid cards and those cards holding cash balances. The cash balances don't earn any interest, so the company can put this cash to work on safe assets and earn an interesting spread/carry. Moreover, the nature of this cash means Meta is also a large beneficiary of any possible increase in interest rates (as the balances would keep on earning zero interest).
- Another reason was tied to the fee income CASH earned from its prepaid card customers. This income is intrinsically stable and grows with the card base. Past experience and other competitors showed us that it was possible to milk the card base much more intensively than CASH was doing. Some of the moves the company was making indicated that it indeed expected to earn higher fees. Thus, we had both the expectation of a larger card base, and one that would be paying more fees per user. This could supercharge card fees.
- Other agreements and developments (acquisitions) made for a good short-term probability of seeing continued earnings growth.
What Changed, Then?
It was against this thesis backdrop that I went over CASH's latest earnings report.
Two developments then jumped out at me as being inconsistent with the original thesis. These might change in the future, but with CASH being held at a reasonable to high valuation after the share price increase, there wasn't much room for doubts.
These were the developments:
- CASH had a higher reliance on other sources of funding.
- It saw a large sequential decline in non-interest income.
Let's go over each of these.
Higher Reliance On Other Sources Of Funding
The thesis was that CASH would mostly use the interest-free proceeds from prepaid cards, and perhaps a bit from deposits, to invest in low-risk assets and earn a nice spread. However, between Q3 FY2016 and Q4 FY2016, there was a large ~$631 million increase in "other borrowings" away from deposits (red emphasis is mine).
Although the company explains this growth partially through the positioning of the balance sheet to explore possible future opportunities, in my view, it can represent something else. It can represent an effort to pad NIM (Net Interest Margin) by doing arbitrage with other-than-free financing. This is then relevant as it shows a lack of trust in the ability to grow both interest-free deposits and card fees fast enough.
Moreover, the company alerts that it might have an impact to its interest-free base as a related program expires soon. This is also consistent with the previous interpretation.
The Company anticipates some potential near-term volatility in the growth rate of its MPS-related non-interest bearing deposits as a one-time program expires and the timing of new programs begins to accelerate, though long-term growth rates are expected to remain strong.
Indeed, it might be that the large accumulation of cash in the balance sheet could already be tied to the ending of such program - though there's no obvious indication of this.
Large Sequential Decline In Non-Interest Income
Last year, there was no observable seasonality in non-interest income between Q3 FY2016 and Q4 FY2016. This year, non-interest income dropped nearly 20% sequentially. This of course put pressure on the company's profitability (red emphasis is mine).
This (large) sequential drop went against our expectations of continued growth. Since we see no seasonality in the prior year, we have to assume something might be weaker, even if we don't yet know what it is.
The two developments I described aren't that serious per se.
However, they ran counter to key aspects of the long thesis, namely the (mostly exclusive) use of interest-free sources for supercharging NIM and the continued acceleration in card fee income. As such, what we might otherwise let pass in this case led to us close the position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.