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Aggressive Accounting and Secular Decline in ATM Market May Not Bode Well for Cardtronics


Cardtronics could lose 7-Eleven as a customer after 2017, which would prove catastrophic to the ATM owner/operator.

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At my firm, Kerrisdale Capital Management, we're short shares of Cardtronics (NASDAQ:CATM), the largest nonbank owner and operator of ATMs, primarily in the US and UK. You can often find its ATMs inside brick-and-mortar retailers such as 7-Eleven and CVS (NYSE:CVS), where Cardtronics makes money off of charging surcharge fees to consumers and interchange fees to card-issuing banks. In addition, banks sometimes pay Cardtronics to put its brands on its devices or to offer surcharge-free withdrawals to its customers.

Despite its exclusive focus on the secularly declining ATM market, Cardtronics 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 (INDEXSP:.INX) median. Moreover, I believe that Cardtronics has inflated its earnings via aggressive accounting. It depreciates its ATMs over much longer periods than its competitors -- more than eight years, rather than five years -- thereby understating expenses.

While Cardtronics' 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 confirms that total ATM withdrawals in the US are already declining. Essentially, Cardtronics is a concentrated bet on paper currency and retail foot traffic, stunningly at odds with the direction in which the world is moving. Cardtronics' 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 return on assets from 8.9% in 2010 to 4.3% in 2013, and new ATMs have come in at 41% lower per-unit gross profitability than legacy ATMs.

Making matters worse, Cardtronics also faces a threat as its largest merchant relationship, with 7-Eleven (which I estimate accounts for approximately 40% of its earnings), comes up for renewal in 2017. A sister company of 7-Eleven that operates all of the chain's ATMs in Japan is rapidly expanding in the US and openly pursuing the contract. If that effort succeeds, it would be catastrophic for Cardtronics.

In light of its numerous risks and based on comparable firms' far lower valuations, along with my discounted cash-flow analysis, I believe that Cardtronics' fair value is only $9 to $19 per share, or 40% to 70% below the current stock price.

My firm's slide presentation on Cardtronics can be viewed here; the full report on the stock can be viewed here.
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