Warrants and Spin-Offs and SPACs, Oh My!

Former SPAC, Change of Control, Confusing Balance Sheet...Heavy Insider Buys?

Sorry for the title. I was going for something like the Wizard of Oz “Lions and Tigers and Bears, Oh My!” I tried my best. Part of what I was trying to convey with the title is there is a lot going on with this company. For a young simpleton such as myself, this analysis is pushing the limits of my brain power. But it’s time to get into it: CompoSecure $CMPO.

INTRO

CompoSecure is a New Jersey based manufacturer of metallic payment cards. They provide cards for 8 of the top 10 issuers in the United States, most notably Chase and American Express. If you have a metallic Amex or Chase Sapphire card, you’re using their product. They take the metal, make it into a card, put the tech in it, and send it off to someone else to put the finishing designs on before getting it to the issuers. They created this niche back in 2003, introducing the first metallic payment cards. Since then, they’ve been a market leader, being ranked as the top metallic card manufacturer and top innovator by third party research companies such as API Research. More recently, they were the first to produce tap-to-pay metallic cards in 2017, and are currently rolling out new tech like dynamic CVV, biometrics, and their new authentication tech, Arculus, which I’ll talk more about later.

The company went public via SPAC in 2020 at $10. And naturally, it’s done nothing for over 4 years, sitting at $10.79 today. Revenues have been growing, but margins were struggling. The company actually had a $80 million loss on its income statement in 2024. The company has had a worrying balance sheet too, full of liabilities leftover from going public via SPAC, hundreds of million in debt on the balance sheet, with a large percentage being in convertible notes. It also had a confusing ownership structure. The stock price was actually underwater from its “IPO” until last June when some interesting things started happening.

Last June, there was a change of control. A man named David Cote stepped in and, through his family fund Resolute Holdings, purchased a controlling share in the company. This was followed by Cote and some other names personally purchasing millions of dollars more in $CMPO stock, including a United States congressman. Cote named himself Executive Chairman, and over the next couple of months the company simplified the ownership structure, freeing up $20 million in cash flow according to management (not sure how that works exactly but I’ll take their word), turning half the debt on the balance sheet into equity by converting all the convertible notes, and in February of this year, spun off a company called Resolute Holdings (sound familiar?). What is going on here? Who is David Cote? Why is a congressman buying the stock? What is this spinoff? And why do I think the stock looks interesting?

Key Players

Let’s start with David Cote and come of the buddies he brought along to help him. David Cote was CEO of Honeywell ($HON) from 2002 until his retirement in 2017. He popped back onto the scene in 2020, when he took control and named himself Executive Chairman of a company called Vertiv ($VRT). He’s also an author, having published a couple of books on operating businesses and leadership that have done well.

So let’s look at his track record. Over his tenure as CEO of Honeywell, the shares increased 6x. Not bad. Over the past 4 years at Vertiv, the shares have increased more than 8x. Alright then. You know Honeywell is a legit business but just to show Vertiv isn’t a scam, when he took control of Vertiv in 2020, the company was losing over $300 million a year. Since then, revenues have doubled and net income is over $650 million. Cote has proven himself to be an adept operator and capital allocator with both a business that are a bit more traditional such as Honeywell, and newer tech company such as Vertiv.

Thomas Knott is someone else heavily involved in the CompoSecure takeover. He was high up at Goldman Sachs and was involved in Vertiv with Cote. He is now involved with CompoSecure, having purchased millions of dollars in $CMPO, and is CEO of the newly spun-off business. His brother, Brad Knott is a United States congressman, which explains why a congressman was seen buying $CMPO shares. Both were personally purchasing shares around $15 per share.

Resolute Holdings ($RHLD) is the spinco. Cote is also the Executive Chairman, and Knott is the CEO. What was weird about this company is that when it was spun-off, it had the same name as Cote’s original fund, and its balance sheet was blank. It’s important to note that the publicly traded spinoff is a different entity from the original investment vehicle. The fund is now called Resolute CompoSecure Holdings Llc, the spinoff is Resolute Holdings Management Inc. and is publicly traded. Basically, Resolute is going to serve as the capital allocator and asset manager for CompoSecure, for a percentage of EBITDA as a fee.

Now Resolute could warrant its own deep dive, but the main thing to know for now is that $RHLD, run by Cote and Knott, will be in charge of the M&A for $CMPO, as well as all the capital allocation decisions. It’s a strange structure, but $RHLD has made it clear they plan to manage other companies similarly in the future. In all honesty, I still haven’t fully wrapped my mind around what exactly $RHLD is. I’m guessing Cote and Co. feel they are skilled capital allocators and think small cap companies may find it valuable to outsource some of those decisions to a third party for a fee. Maybe there’s an opportunity there too, but that’s for another time. Back to $CMPO.

CompoSecure

Alright. Time to dive into the company. The wonderful thing about this company is it’s pretty simple. They really have two products worth talking about. Their main line of business, and where almost all revenue and profits come from, is manufacturing metallic cards. There’s not much to say about it. They created the niche in the early 2000s and have been the market leader for two decades.

While I don’t think it’s impenetrable, I think they do have a moat. If you’re a market leader for two decades, there’s gotta be some sort of moat, right?

What is keeping large plastic card manufacturers from jumping right in and taking market share? I’ve been assured by the few people in the space I’ve talked to, as well as what I’ve been able to look up, that the manufacturing process for putting the required tech in a plastic cards vs. metallic card is vastly different, and CompoSecure has some of the leading expertise, as well as over 60 patents protecting their process.

Second, I think part of their moat comes from their relationships. Their two biggest customers are Amex and Chase. They have been Amex’s provider of metallic cards for over 20 years, and Chase’s for almost a decade. While I don’t know about switching costs or anything, I’m sure these relationships are worth something.

Third, they have been the top innovator in the space. First metallic cards, first tap-to-pay in metallic cards, etc. Which brings us to the new tech that management seems most excited about: Arculus.

To be brief, Arculus is a card that uses Near Field Communication (NFC), like your tap-to-pay, to authenticate your identity. From my understanding, it began as a cold storage key for cryptocurrency. Management quickly saw that it could be applied elsewhere. Their goal now is to have the technology in your metallic payment card. Need to make a large transaction? You put in your password, as well as tap your card on your phone for added security. It seems interesting, and it is seeing some initial success.

It’s been a few years in the making, but management says Arculus made its first positive contributions to the company’s bottom line in Q4 of ‘24, and management expects to contribute positively from here moving forward. Revenue from Arculus in ‘23 was about $1 million vs. $10 million in ‘24. There hasn’t been any forward guidance for Arculus, but management seems quite bullish on it. The product currently boasts 80% gross margins, so if it is able to grow and scale up, the potential upside could be significant.

Alright, you know the products. Now the numbers. Since the company’s SPAC merger in 2020, revenue growth has been solid, with it nearly doubling over that span. Last year, revenue grew 8% and management has said they see it growing mid single digits in ‘25. They have great return on capital, with the lowest ROIC figure I could find being around 25%. Gross margins have been steady, with them sitting at 52% currently. The area of concern has been operating margins, which have fallen from 35% to 25% during that time. I have a hunch some of that decline has been due to investment in Arculus. Some may be from competition, although gross margins have held steady over that same span, but I’m sure some of it has been some mismanagement as well. Successfully, and sustainably, improving operating margins has been where Cote has had success at previous companies, and I’d expect that would explain some of his interest in CompoSecure.

Now, if you look at the company’s 2024 income statement, what jumps out to you is a $83 million net income loss. How does a company that has $110 million in operating profit have a $80 million loss? That takes us to the balance sheet.

At first glance, this thing is ugly. $470 million in assets vs $617 in liabilities. Yikes. Well, while it isn’t a pristine balance sheet, it isn’t quite as bad as it looks. There’s really only $180 million in true long term debt, and with nearly $80 million in cash and healthy cash flows, debt really isn’t an issue. Most of the liabilities are in the form of Tax Receivables Agreements, Earnout Liabilities, and Warrants, all of which come from the SPAC merger. Like I said, it’s still not pretty. The stock is facing some solid dilution over the next couple years, but it is very unlikely to face any liquidity issues.

So how does this relate to the income statement? Well the earnout and warrants are carried as liabilities based on their fair value. The earnouts are triggered at certain stock price thresholds and as of the beginning of 2024, the warrants, expiring Dec ‘26, were convertible at around $15. So, when the stock was at $6, the fair value of these liabilities were carried at nearly $0. Then Cote took over, and the stock skyrocketed to $16 triggering half the earnout and getting the warrants above the conversion price, making them worth a whole lot more than nothing. As of last quarter these liabilities were now worth $170 million more than before, which was then expensed on the income statement. That’s how you go from $110 million in operating income to -$80 million in net income.

Some good and bad about that.

The good: The company is much more profitable than the income statement would initially show. The company's operations produced $120 million in FCF last year. With the current market cap of just over $1 billion, that means you’re getting a 12% FCF yield on a growing, stable business!

The bad: Significant dilution is coming. One weird aspect of the change of control and spinoff is the conversion price of the warrants was knocked down to $8, so I am assuming they will be converted. I am going to assume the full earnout liability is hit as well, just to be conservative.

So what does dilution look like? There are currently 100 million shares outstanding. Adding up the warrants, earnout, and equity compensation that will be issued over the next couple of years, you get close to 28 million additional shares. Like I said, not good. Now, the company recently approved a $100 million share buyback program, which will help, but I’ll be conservative and not account for that.

Valuation

So let’s value the stock assuming all of those additional shares are currently outstanding and the share price stays the same.

128 million x 10.79 share price = $1.38 billion market cap.

1,380 million market cap / 120 million FCF = 11.5x FCF.

Let’s round it up to 12x FCF, or an 8% FCF yield. Still not expensive, but I wouldn’t call it a dirt cheap multiple either.

Here’s my view. You are buying a growing market leader earning high returns on capital and proven leadership for a low teens FCF multiple. The new regime has tons of skin in the game, in the form of millions of dollars worth of $CMPO ownership, and they have proven to be high quality capital allocators. The premium metallic card market is expected to grow at a mid to high teens CAGR through 2030, which means they will face competition, but there will be opportunities to reinvest profits, hopefully at high rates of return. The company emphasized M&A as part of their strategy, another area Cote has had wonderful success in at previous stops. Arculus is no longer a drag on the bottom line, and it is actually contributing to profitability.

I think my base case is that everything looks the same moving forward. I think you could expect a high single digits return from continued modest growth and returnings capital to shareholders.

In my conservative bull case, you get back to high single digits or low double digits topline growth, modest margin recovery, Arculus growth, and buybacks. Even before any inorganic growth, I think $170 million in FCF is very reasonable in the next 5 years. Put a 15x FCF multiple on it, not much higher than it is currently, factoring in dilution, you can get a high teens return.

With a cleaner balance sheet after warrants and earnouts are gone, along with no more earnings drag from their revaluations, as well as a stable business, no liquidity issues, and strong leadership, I think this company could warrant a higher multiple than it currently gets. And that valuation leaves out the possibility of stellar acquisitions or Arculus being a home run. I like the risk reward setup on this stock.

I’ve made it a position in my portfolio, but before I make it a bigger position, I would like to see the story play out a little bit more. His previous stops have taken some time. Honeywell played out over the span of sixteen years. You could’ve bought Vertiv for $10 up until mid 2022, or two and half years after he took control at $10 per share. With Vertiv currently at $80+ per share, in both scenarios, your returns would’ve been stellar even if you hadn’t waited, but again, I would like some confirmation.

This is just my opinion. This is not investment advice. Do your own research.