Goldmoney: A Full Reserve Gold-Backed Bank In A Fractional Reserve World (OTCMKTS:XAUMF) (2024)

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Executive Summary

Investment Thesis

Goldmoney (TSE:XAU and OTCPK:XAUMF) is the only publicly-listed full reserve gold custodian bank in the world allowing customers to open allocated deposit accounts fully backed by gold. In the recently published 2020 shareholder letter, CEO Roy Sebag mentions that gold allows customers to accumulate wealth outside the banking system given the amount of risks in the global financial system due to national currency debasem*nts. Using a DCF valuation model, the intrinsic value of its custodian banking and gold coin brokerage businesses is estimated to be at least $2.9 per share (CAD) under the assumption that gold prices will continue to rise by 10% per annum and that the company continues to improve its core operations.

Using historical data from the World Gold Council, gold prices have appreciated by 13.8% per annum the last 3 years between July 14, 2017, and July 8, 2020, in US dollar terms. Since August 18, 1971, after the Nixon Shock allowed gold prices to float and became market determined, gold has compounded at 8% per year until July 8, 2020, in dollar terms. The 10% assumption lies in between these benchmarks. If we factor in the 37% ownership stake in Mene, a highly disruptive jewellery business that grew 64.8% YoY in 2019, the estimated intrinsic value is even higher at $3.4 per share (CAD). The company has virtually no debt on its balance sheet and is still relatively unknown amongst gold equity investors.

As of July 13, management has taken notice of its undervaluation initiating a share purchase agreement to repurchase for cancellation of a total of 3,000,000 common shares. This increases the target price from $3.4 to $3.5 per share (CAD).

Business Analysis

Share Price History

Source: Wall Street Journal

BitGold, which was one of the earliest ventures for creating a decentralized digital currency that began in 2005, acquired Goldmoney in 2015 for $51.9M (CAD). BitGold had settlement and payment technology while Goldmoney had over $1.2B in customer assets under vault management backed by gold and over 135,000 customer sign-ups since 2006. Eventually, Goldmoney exited completely from the cryptocurrency space becoming purely focused on gold, platinum, and silver.

Industry Economics of Gold Custodian Banks

Unlike fractional reserve commercial banks that rely on maturity transformation of deposit liabilities into loan assets to generate an interest spread for its bottom line, a full reserve custodian bank creates its profits primarily through the spread between its storage fees and the cost of sales to third-party vault operators. A full reserve bank has no counterparty risk making it substantially less risky than a commercial bank, but with much lower margins. Therefore, the gold custodian banking business is a high volume, low margin business model that requires a significant scale. From a customer point of view, an allocated gold account can be thought of as savings account with a negative interest rate that is offset by the appreciation of gold prices.

Unallocated gold account providers are not direct competitors of Goldmoney. The primary direct competitor within the allocated gold custodian industry is BullionVault, which was founded in 200 with over 75,000 clients and about $2B in customer assets. It charges 12 basis points per year on gold with a monthly minimum of $4 for insurance, storage, and use of its platform. Goldmoney recently changed its pricing model to converge with BullionVault's standards, charging between 12 and 21 basis points per year (depending on the vault operator), with a minimum $10 monthly storage fee. Goldmoney charges a slightly higher premium for a superior platform while BullionVault focuses on operational excellence and customer service. Additionally, BullionVault is backed by the World Gold Council while Goldmoney is backed by a well-known thought leader, James Turk and the Soros family office.

There are some customer switching inconvenience costs because of the time and administrative work required to open an account, which is similar to a commercial bank with best practices related to KYC compliance. The gold custodian banking market is a duopoly denominated by BullionVault and Goldmoney, but many small, new entrants have emerged (GoldCore, GoldRepublic, Voima). However, the barriers to entry are fairly high given the razor-thin margins that require significant cumulative losses to gain sufficient scale to break even and catch up. Additionally, apart from the regulatory compliance costs, auditing, platform development, and relationships with both vault operators and, more importantly, gold suppliers, this is a fairly difficult space to compete in.

Customer Experience

If we look at the customer reviews of Goldmoney on Trustpilot, it is far below that of BullionVault, reflecting the customer-oriented operations of BullionVault.

Source: Trustpilot

A typical customer complaint appears to be related to the unresponsiveness of its customer service and its lack of communication regarding account transfer procedures. This is a key area of concern for the business that could potentially end up with a litigation case in the future if Goldmoney does not address these customer complaints.

However, the fact that Goldmoney has increased its payroll from $3.8M (CAD) to $6.3M YoY while reducing all its other expenses shows its commitment to spending more on improving its customer service operations which is a key weakness of the company. Additionally, its gold jewelry business, which is also managed by Roy Sebag, has achieved excellent customer reviews indicating that it is capable of improving customer feedback.

Source: Trustpilot

Management and Ownership Structure

CEO Roy Sebag was previously a hedge fund manager at Essentia Equity focused on distressed value investing. However, he appears to have no educational credentials. He is a visionary that has until now neglected the strategy of pursuing optimal operating efficiency as he was refining the business model.

In the most recent shareholder letter that was just published in the end of June 2020, he disclosed transparently for the first time material changes in the strategy of the business to focus more on improving core operations. He enacted changes to the pricing model to improve its profitability profile while increasing spending on customer service operations, indicating a commitment to improve its reputation for unresponsive customer service.

Compared to the CEO Paul Tustain of BullionVault, Roy Sebag has historically been much less transparent. Tustain has also been critical of Roy Sebag's strategy in the past:

This is why payments to other people are disallowed by BullionVault. Money (or gold) exiting a BullionVault account can only go back to the funding source, which means if someone finds out your password and breaks in (which will trigger the burglar alarm on your phone) the worst they can do is sell your gold at the current market price, and send the money straight back to the source. (Paul Tustain)

Source: Bitcoin, BitGold, Goldmoney - and BullionVault

While Goldmoney is owned primarily by insiders, aligning shareholders to management, it was not always shareholder-friendly in the past in terms of more transparent communication. Based on its shareholder letter, this appears to have improved. Additionally, Goldmoney retains 36.92% ownership of Class B shares in Mene, its gold jewellery spinoff. Currently, it is also working on launching a new business related to gold covered digital storage drives.

Core Operations and Strategy

Roy Sebag has a volatile track record of changing the business strategy frequently indicating the firm's struggle with finding a clear, focused long-term strategy. In the latest shareholder letter published, he disclosed for the first time several clear objectives:

1. Cash and expense optimization: minimize excess fiat cash to 1 year of operating expenditures
2. Transparent investment portfolio: 70% gold, 20% silver, 5% platinum, 5% palladium precious metal bullion investment allocation of excess cash
3. Exiting the fiat lending business and only accepting collateralized loans backed by precious metals

The CEO diverts our attention to the improved performance of its core operations. The company has surpassed several historical records, achieving in its reporting currency $459M in annual IFRS revenues (63% YoY), record $22.3M gross profits (80% YoY, 45 basis point growth), record annual fee revenue of $4.4M (87% YoY), while reducing its operating expenses by $3.5M.

Source: 2020 Goldmoney Shareholder Letter

Source: March 31, 2020, Goldmoney Consolidated Financial Statements

Unfortunately, the CEO does not mention anything about its negative earnings which was mainly attributed to its loss on investments. There is no transparency or additional footnotes that breaks down its historical investment portfolio prior to liquidation that resulted in a one-time, non-recurring loss of $6.8M (CAD), but it does disclose its new investment portfolio in line with its new strategy comprised of $39.7M (CAD) focused entirely on precious metals. Clearly, the problems of its investment portfolio have been corrected, offering shareholders direct exposure to its gold holdings in line with its customer accounts.

Source: March 31, 2020, Goldmoney Consolidated Financial Statements

The CEO also never explicitly admitted fault to its shareholders for its flawed pricing strategy which has been simply too low to support its business. It is always better to start at a high price point and work it down over time, rather than starting from a low price and increasing it subsequently after capturing new accounts. Charging higher prices in a commoditized space can cause consternation and even anger, which may explain its poor standing amongst customers after the increase in pricing to its current $10 per month and 0.5% holding fee that covers transaction, storage, and insurance costs. Regardless, the pricing is more competitive and in line with BullionVault, improving the sales profile of Goldmoney.

Interestingly, Roy Sebag once criticized the minimum storage fee pricing strategy in a 2015 response to the CEO of BullionVault which appears to have been taken down off Roy Sebag's Seeking Alpha blog post:

Our service at BitGold is significantly less expensive than BullionVault. They charge a minimum storage fee of $4 per month for gold and $8 for silver. That means if you own $1000 worth of each metal you are paying 4% and 9.6% per annum respectively just for storage! That same $1,000 worth of metal would carry no storage fees at BitGold and between 0.12%-0.39% fees through GoldMoney. (Roy Sebag)

Source: Goldmoney merging BitGold

Earnings Quality

Overall, the core businesses of Goldmoney, the custodian bank, and gold coin businesses (Schiff Gold) have achieved consistent YoY top-line growth and stable gross margins around 2%. In 2019, Goldmoney achieved an annual IFRS revenue of $458.9 million (CAD), an increase of $177.3 million or 63% YoY. One significant driver behind the top-line performance was the introduction of a minimum monthly storage fee and optimized fee schedule to capture the full value of service.

Source: Goldmoney Financial Statements

Expense Management

The company has continuously improved its core net income margins by reducing its expense base. As it is still in a growth phase, its advertising and promo spend will remain important as its growth investment. In 2018, its operating expenses represented almost 9% of its sales, but, by 2019, it was able to reduce its operating expenditures to only 3% to 4% of sales. As mentioned above, almost all of its expenses have been cut except its payroll to provide better customer service. This trend is likely to continue as management focuses increasingly on optimizing its core operations.

Source: Goldmoney Financial Statements

Balance Sheet

The company has a clean balance sheet with no debt and with a debt to equity ratio of 7%. It does not provide disclosure on its one-off short-term investment losses which led to negative earnings to the 2019 calendar year, but this seems to be the catalyst for clarifying its new transparent investment allocation strategy towards precious metal bullion. This will allow shareholders to gain direct exposure to gold through Goldmoney's balance sheet.

Financial Forecast

• The financial model does not normalize the recent financial restatements and prior period adjustments
• Stock-based compensation is ignored in the financial model as well as one-off items (FX gains)

Source: Goldmoney Financial Statements and Author's Pro-Forma Projections

To build a clearer picture through simplicity, discretionary, and non-core one-off costs such as FX revaluations are ignored in the analysis. Improvements in core operating costs are already seen year over year, but it is difficult to forecast precisely how much operational improvement through cost discipline we can expect management to target as the business matures.

Source: Goldmoney Financial Statements and Author's Pro-Forma Projections

Pro Forma Financial Statements

Source: Goldmoney Financial Statements and Author's Pro-Forma Projections

Conclusion

Goldmoney is the only publicly-traded gold bullion bank in the world that very few investors know about, despite overseeing $2 billion in vaulted assets under management which is held off its balance sheet. Compared to a commercial bank, this would classify it as a small community bank. The management has evolved to focus on a commitment to improving its core operations as an efficient gold bank operator.

Going forward, investors should closely monitor whether management will be able to deliver on providing bottom line results. It has optimized its top-line and its core operating expenses. The only question remaining is its ability to preserve shareholder wealth by preventing further losses on its short-term investment portfolio, which has explicitly been reallocated towards outright purchases of precious metals.

The CEO appears to have shown a renewed focus towards maximizing investor visibility implying increased spending on marketing and investor relations activities. However, a key risk to also be aware of is the ongoing matrimonial matters for the CEO. In an interesting paper called Love or Money by Professor Jordan Neyland at George Mason University, the author concludes that divorces lower equity risk during the year of the divorce after analyzing a collected sample of 79 CEO divorces to measure its impact on firm performance. Apart from the loss of focus and productivity, the wealth loss from a divorce reduces risk due to absence of the CEO. Roy Sebag appears to have a hyperactive mind that constantly requires new and exciting ventures to pursue. This may be a blessing in disguise, providing an opportunity for Goldmoney to slow down and pursue a more stable path focused on operating efficiently without new distractions.

Finally, the third wildcard to pay close attention to is the price of gold. Gold has the potential to increase substantially if geopolitical developments escalate as a catalyst to restructure sovereign debt loads in the western world. This could take the form of another Bretton Woods Conference requiring countries to reset the monetary system by reintroducing gold as a fixed monetary anchor. For example, the Dutch Central Bank has already publicly announced on its website a new precedent amongst monetary authorities declaring the importance of gold in rebuilding the architecture of the financial system if it were to collapse. If there were ever to be a monetary reset of gold prices to reverse the Nixon Shock of 1971 and end fiat currency debasem*nt, Goldmoney would offer significant additional optionality to the upside.

Value investor providing investment ideas across boom bust cycles with a focus on smaller cap securities around the world with significant margins of safety. Unlike other value investors, a tactical view of the credit cycle is combined with rigorous, bottom up fundamental analysis. Prior work experience as an Analyst at the Federal Reserve and several hedge funds.-Boom Bust Value is an investment newsletter and research blog that provides unique bottom up research ideas using a tactical framework based on the applied principles from the Austrian Economics. More specifically, investment risk and opportunities are identified by analyzing the monetary distortions of central planners on banking systems and the financial markets.