dLocal (NASDAQ: DLO)

A South American fintech compounder?

dLocal (NASDAQ: DLO) is an Uruguayan fintech company that went public in June of 2021. Per p. 1 of the businesses’ prospectus, dLocal is, “focused on making the complex simple, redefining the online payments experience in emerging markets. Through one direct API, one technology platform, and one contract, which we collectively refer to as the One dLocal model, we enable global enterprise merchants to get paid (pay-in) and to make payments (pay-out) online in a safe and efficient manner. Merchants on our platform consistently benefit from improving acceptance and conversion rates, reduced friction, and improved fraud prevention, leading to enhanced potential interaction with nearly 2 billion combined internet users in the countries we serve (excluding China).” The company’s headquarters are in the mean streets of Montevideo, Uruguay with other offices in São Paulo, San Francisco, London, Tel Aviv and Shenzhen. dLocal has the distinction of being the first “tech unicorn” from Uruguay. Per the most recent investor presentation (Q3 2021), dLocal had $69 million in revenues, 123% in year-over-year revenue growth, a net revenue retention rate of 185% and an “adjusted EBITDA” margin of 38%.

Why dLocal Might Not Be for You

Operates solely in emerging markets – I believe the term “emerging markets” is kind of nebulous because a lot of these countries have been “emerging” for my entire life, but that’s a conversation for another time. Per slide 13 of the Q3 2021 Investor Presentation and as of the publishing date of this writeup, the business operates in the countries shown below.

dLocal operates in some interesting geographies and must deal with unique circumstances like Argentina’s hyperinflation, Brazil’s current head of state, the Chinese government and its relationship with private businesses, the size and scale of both the Indian and Indonesian melting pots, rapid growth of their West African markets, etc. Dealing with all these dynamics would be a lot for any business, but there’s also the possibility of the occasional and sometimes rapid change in governments or geopolitical situations in the markets they serve. The potential issues in these emerging markets are certainly major risks for the business. For the record, I think operating in emerging markets is somewhat of an advantage because dLocal is staying away from competitors like Stripe and Adyen who focus on “developed markets”.

The business is run by a duo of young bucks – As of the June 2, 2021, publishing date of dLocal’s prospectus, Jacobo Singer, dLocal’s President, was 31. Sebastián Kanovich, the CEO, was also 31. These two, along with a few other investors, control the company, but I will discuss that more in the next section.

Two classes of common shares – Per p. 172 of the prospectus under the “Share Capital” subsection, “The Articles of Association authorize two classes of common shares: Class A common shares, which are entitled to one vote per share and Class B common shares, which are entitled to five votes per share and to maintain a proportional ownership interest in the event that additional Class A common shares are issued. Any holder of Class B common shares may convert his or her shares at any time into Class A common shares on a share-for-share basis.” Another thing that potential investors should be aware of is who controls the B shares. Per the “Two classes of common shares” subsection on pp. 181-182, “The Class B common shares of dLocal are entitled to five votes per share, while the Class A common shares are entitled to one vote per share. Since certain of our existing shareholders, Andres Bzurovski Bay (directly and indirectly through Emerald Bay 24 LLC), IZBA SA, Aqua Crystal Investments, Sebastián Kanovich (indirectly through Ledlife SA) and Jacobo Singer, own 100.0% of the Class B common shares. Andres Bzurovski Bay, Sergio Enrique Fogel Kaplan, Alberto Eduardo Azar, Sebastián Kanovich and Jacobo Singer, acting together, currently have the ability to elect a majority of the directors and to determine the outcome of most matters submitted for a vote of shareholders. So long as Andres Bzurovski Bay, IZBA SA, Aqua Crystal Investments, Sebastián Kanovich and Jacobo Singer have the ability to determine the outcome of most matters submitted to a vote of shareholders as well as the overall management and direction of dLocal, third parties may be deterred in their willingness to make an unsolicited merger, takeover, or other change of control proposal, or to engage in a proxy contest for the election of directors. As a result, the fact that dLocal has two classes of common shares may have the effect of depriving holders of Class A common shares of an opportunity to sell their Class A common shares at a premium over prevailing market prices and make it more difficult to replace the directors and management of dLocal.”

Eyewatering valuation – As of the publishing date of this writeup, dLocal has a market capitalization of approximately $8.5 - $9.0 billion. 2020 revenues were just north of $104 million. I’ll be generous and assume that dLocal managed to more than double their revenues last year to $250 million. This would mean that the business trades at a multiple of 34-36x revenues. Everything, and I mean everything, has to work out in the future to justify a valuation like that.

The ”adjusted EBITDA” game – dLocal, like many other publicly traded businesses, plays the “adjusted EBITDA” game and prominently posts these results throughout its prospectus and quarterly reports. It even includes “adjusted EBITDA” and “adjusted EBITDA margin” as two of its four “Key Business Metrics” found throughout the prospectus. I don’t think this is the best metric to look at in terms of valuation or profitability for a company.

Cayman Islands company – For full transparency, I wanted to make an Island Boys reference or joke in this section but couldn’t think of something clever enough. dLocal is a Cayman Islands company. Shareholder rights and the responsibilities of the Board of Directors are different than what we have here in the United States. I will discuss this in further detail in the “Cayman Islands Corporate Law” section of this writeup.

dLocal History

The business started out as a division of AstroPay, a South American fintech/payment solution company and was spun out in August of 2018. It should be noted that the same controlling shareholders of dLocal also control AstroPay and that Sebastián Kanovich was also previously CEO of AstroPay. I was not able to fully untangle the connections between AstroPay and dLocal. I’m not sure if there are any related transactions other than the fact that Mr. Kanovich still held a 1% interest in Astropay as of the publishing date of the dLocal prospectus. The prospectus goes on to state that dLocal is completely distinct from AstroPay at this point. Per p. 13 of the prospectus, dLocal started with a single product to support cross border payments in Brazil and has since expanded their product line to support local payments, pay-ins and pay-outs. It is also worth noting that dLocal has always been focused on “global enterprise merchants” which means large, global businesses. Per company filings, “global enterprise merchants” are defined as those which have at least $6 million of Total Payment Volume (TPV) on the dLocal platform. These merchants include Amazon, Netflix, Microsoft, Mailchimp, Dropbox, Uber and Spotify. The massive size of these merchants would explain why they currently have less than 400 of them on their platform. Well known investors in the business include General Atlantic and Mastercard.

Executive Officers

There are five listed executive officers at dLocal. Jacobo Singer, the President of the business, was previously its Chief Technology Officer and worked on building the first version of dLocal’s payment platform. He previously worked in tech product and engineering roles at AstroPay before dLocal was spun out. Per the prospectus, Mr. Singer owned zero A shares and 2.3% of the company’s B shares after the offering and the full exercise of the underwriters’ option.  Next up is Sebastián Kanovich who is the CEO. He has worked at dLocal since its inception back in 2016 and was previously the CEO of AstroPay.  Per the prospectus, Mr. Kanovich owned zero A shares and just under 5% of the company’s B shares after the offering the full exercise of the underwriters’ option. Third on the list is Sumita Pandit, the Chief Operating Officer. She previously was a Managing Director and the Global Head of Fintech Investment Banking at JP Morgan. She has an undergrad degree in electrical engineering and an MBA from Wharton. This is a hell of a get for business. Diego Cabrera Canay is the Chief Financial Officer. He was previously the Finance Vice President at Mercado Libre and before that worked at PricewaterhouseCoopers. Hernan Di Chello is the Chief Technology Officer and was previously a Vice President of Product Development at Mercado Libre where he led development efforts for Mercado Pago, their online payment solution. Ms. Pandit, Mr. Cabrera Canay and Mr. Di Chello did not own any shares in the company as of the publishing date of the prospectus.

Management Compensation

Per the “Compensation of Directors and Officers” section on p. 165 of the prospectus, “Under Cayman Islands law, we are not required to disclose compensation paid to our senior management on an individual basis and we have not otherwise publicly disclosed this information elsewhere. Historically, our directors have not been paid separate compensation and have received only dividends in respect of their ownership of our common shares. For the years ended December 31, 2020 and 2019, our directors did not receive any ownership in our common shares as compensation for their services. During 2021, we issued an aggregate of 11 of our Class A common shares to certain of our directors as compensation for their services. In addition, in 2021, we approved aggregate annual compensation for our directors in the amount of US$48,500. For the years ended December 31, 2020 and 2019, the aggregate compensation expense for our executive officers for services in all capacities was US$8.1 and US$2.8 million, respectively, which includes both benefits paid in kind and monetary compensation.” I didn’t find anything else in the prospectus or either of the two subsequent quarterly presentations or press releases that discussed management compensation further. I have no idea how management compensation is considered or what benchmarks are used to issue cash bonuses and/or stock awards. To be honest, this is a red flag 🚩. It’s not detrimental to my opinion of the business though. However, not knowing how management is compensated isn’t something I’m comfortable with.

What does dLocal do and why is it unique?

As stated above in the introductory paragraph, dLocal is “focused on making the complex simple, redefining the online payments experience in emerging markets.” Put more simply, there are hundreds, possibly thousands of alternative payment methods throughout the globe. dLocal allows their merchants to connect with more than 600 (that is not a typo) kinds of alternative payment methods in the markets they serve. You may be wondering how this has come to be. How can there be so many payment methods? It kind of goes without saying but paying for things in emerging markets is different than in the United States. This is partly due to the low penetration rate of international/cross border credit cards and partially due cultural/societal norms. Being American, I didn’t understand why people around the globe weren’t using credit cards to purchase items. Also being American, I didn’t realize the nuances in how financial transactions are done internationally. Not being aware of the low penetration rate of credit cards and the nuances of financial transactions in emerging markets made me skeptical of dLocal before researching the business. Luckily for me, dLocal posted a fascinating video titled “LATAM payments landscape: mastering the most used alternative payment methods” discussing the intricacies of how payments are conducted in Latin America on the YouTube channel back in August of 2019. It’s 45 minutes long, but well worth it. There is a lot to be learned about how payments work in Latin America.

Link to the video is here:

I will discuss a couple of interesting takeaways in this section that helped me understand the payment landscape in emerging markets. The first takeaway is that the use of installment payments was and still is a popular payment method throughout Latin America. Per the video, 69% of Colombians chose to use installment payments. In Brazil, 54% of online purchases were sold through installments. Installment payments made up 40-50% of online sales in Mexico, Argentina, Peru and Uruguay. Per the explanation by Michel Golffed (dLocal’s VP of Growth at the time) in the video, the reason that installment payments work is due to inflation in these countries often being higher than the interest rate on the installment loan. A second interesting takeaway from the video is that paying with cash in Latin America is still very popular. One specific country that is highlighted regarding cash payments is Brazil. Brazilians use a cash voucher called Boleto Bancário. Per the video, Brazilians use Boleto to pay for just about any daily/monthly recurring expense or online order. There’s over 200,000+ payment locations in Brazil that accept Boleto. The customer can choose to pay for whatever they’re paying for online through their regular banking site/app or at one of these payment locations. Per the explanation by Federico Mazzoli (a Product Manager at dLocal), a Boleto payment works like this: The customer purchases an item à they are then redirected to an automatically generated Boleto voucher à the customer decides to pay at one of the 200,000+ payment locations or through online banking à the merchant whom the customer bought the item from receives a payment notification. Per the video again, these kinds of payments made up 21% of the e-commerce payment mix in Brazil as of mid-2019. These are only two payment methods that dLocal offers on their platform throughout a portion of Latin America. You can imagine how accepting 600+ more types of payment methods would be extremely complicated and complex, but very useful for their merchants. I would urge you to go to their website and click on the “Countries” tab and go through a few of them and see how many payment options there are. Hopefully you can see what’s so beneficial about dLocal’s platform on the payment side. It simply integrates these payment methods into its platform. This is the first important function that dLocal performs. If you think the data I’m referencing are outdated then click on the link below which takes you to an industry report by America Market Intelligence on behalf of dLocal titled “The Ultimate Guide to Unlocking E-Commerce Growth in Markets across LATAM, APAC and EMEA”. It provides updated figures from April 2021 on payment methods in the markets that were discussed above plus many more. The report, like the video linked above, will take a while to get through, but is worth it.

Link is here: https://investor.dlocal.com/wp-content/uploads/reports/2021/Q2/the-ultimate-guide-to-unlocking-e-commerce-growth.pdf

dLocal addresses the inherent complexity in the payment industry in their prospectus on p. 14. “The payments industry is complex, cumbersome, and varies in structure in each country. In many instances the interaction between parties varies substantially from jurisdiction to jurisdiction. For example, a payments service provider, or PSP, may compete with other providers in one market and collaborate in another (under a sub-acquirer relationship or otherwise). This results in different unit economics for PSPs in each market largely depending on the services offered and the role that they play in the payments value chain. This complexity has created the demand for next-gen providers that integrate directly with global merchants and act as a single point of interaction that can engage with a large ecosystem of participants, offer them integrated solutions, and thus limit disintermediation.”

There is a second and equally important function that dLocal performs which is related to the quote in paragraph above. Per p. 19 of the prospectus, “dLocal combines payment processing and FX management with compliance, tax, and fraud management capabilities into one intuitive, fully integrated platform. We provide global merchants increased transparency and valuable insight into their cross-border and local-to-local payments flows, enabling them to provide an enhanced user experience for their end users. The features that power dLocal’s platform enhance the processing systems in each of the emerging markets we serve, while at the same time standardizing payments offerings across multiple countries. Our dynamic routing feature leverages the full breadth of dLocal’s connections with our more than 350 acquiring company partners to maximize approval rates. Our fraud prevention module helps our merchants to detect risky patterns and prevent fraud. Our security features are very relevant to our merchants as we handle highly sensitive transaction and user information. Refund and dispute management, currency exchange management, reporting and reconciliation for automatic settlements of funds, among other capabilities, round out our comprehensive suite of solutions.” Something that went over my head when I first read paragraph above and the preceding seven sentences is that dLocal does all the back-end work in each market they operate in. Knowing the ins and outs of each market is highly beneficial to their global merchant customers. Can you imagine how much time would be spent by global merchants if they had to figure out all this backend work on their own? dLocal does it all for them. This backend management is the second important function that dLocal performs. The backend management combined with the plethora of payment options is what makes dLocal a unique business.

At this point you may be wondering how the business makes money. Per p. 12 of the prospectus, “dLocal earns revenue from fees charged to our merchants in connection with payment processing services for cross-border and local payment transactions in emerging markets. These fees are primarily generated on a per approved transaction basis as either a fixed fee per transaction or fixed percentage per transaction. The fees include a Merchant Discount Rate, or MDR, to compensate us for our services, as well as an FX service fee earned on payments involving conversion and expatriation of funds to and from various currencies, including the U.S. dollar and the Euro.” The business makes money every time there is a business gets paid (pay-in) or every time a business has to make a payment (pay-out) on their platform. Per p. 268 of the prospectus, the business also makes “other revenues” which are “mainly composed of minor fees, such as an initial setup fee, installment fee, minimum monthly fee, charge backs fee, refunds fee and small transfer fees. Other revenues are recognized at a point in time when the respective performance obligation is satisfied.”

Cayman Islands Corporate Law

Pp. 183-190 of dLocal’s prospectus detail the differences between Cayman Islands and U.S. corporate law. I will only discuss a couple of differences that caught my attention while reading through this section. In case you’re wondering, this section in the prospectus covers such topics as mergers and similar arrangements, squeeze-out provisions, shareholders’ suits, corporate governance, borrowing powers, directors’ fiduciary duties, shareholders proposals, cumulative voting, removal of directors, transactions with interested shareholders, winding up the businesses, variations of rights of shares, amendments of governing documents, rights of non-resident or foreign shareholders, and the handling of mail. The first difference that caught my attention was in the “Corporate Governance” subsection on pp. 185-186. Per Cayman Islands law, dLocal is not required to have a majority of the members of their board of directors be independent, have a nomination committee be comprised solely of independent directors or have a compensation committee composed of a majority of independent directors.

The second difference that caught my attention was in the directors’ fiduciary duties subsection on pp. 186-187. Taken directly from p. 187, “In addition to the above, under Cayman Islands law, directors also owe a duty of care which is not fiduciary in nature. This duty has been defined as a requirement to act as a reasonably diligent person having both the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company and the general knowledge skill and experience which that director has. As set out above, directors have a duty not to put themselves in a position of conflict and this includes a duty not to engage in self-dealing, or to otherwise benefit as a result of their position. However, in some instances what would otherwise be a breach of this duty can be forgiven and/or authorized in advance by the shareholders provided that there is full disclosure by the directors. This can be done by way of permission granted in the memorandum and articles of association or alternatively by shareholder approval at general meetings. Accordingly, as a result of multiple business affiliations, our officers and directors may have similar legal obligations relating to presenting business opportunities meeting the above-listed criteria to multiple entities. In addition, conflicts of interest may arise when our board evaluates a particular business opportunity with respect to the abovementioned criteria. We cannot assure you that any of the above-mentioned conflicts will be resolved in our favor. Furthermore, each of our officers and directors may have pre-existing fiduciary obligations to other businesses of which they are officers or directors.” There are two interesting takeaways from this paragraph. Firstly, what’s the point in having a “duty of care” if it’s not fiduciary in nature?  Second, regarding the “position of conflict” and self-dealing, it seems like this can be forgiven if the director is transparent about it and gets shareholder approval. The lack of fiduciary responsibility in the duty of care and the permissible self-dealing are both red flags 🚩🚩. Like my opinion on management compensation, these two additional red flags are not detrimental to my thoughts on the business as whole. However, they are things I’m concerned about and not necessarily comfortable with that deserve more analysis if I were to ever buy the stock.

***** One thing that isn’t a red flag is a subscription to my Substack. Please subscribe if you like what you’re reading :D *****

Back to our regularly scheduled programming.

Valuation

There is not a cash flow statement in the prospectus for some reason, but luckily, I have TIKR so I used the cash flow statement that was provided there. The screencap below shows the cash flow statement since 2019 for dLocal.

I subtract stock-based compensation from operating cash flow to arrive at what I call “real cash flow”. “Real cash flow” for 2019 and 2020 were $25.67 million and $81.19 million respectively. Free cash flow, defined as “real cash flow” minus capital expenditures, in 2019 was $25.52 million and in 2020 was $80.31 million. Let’s assume that free cash flow in 2021 more than doubled and was to $200 million for the year. Remember that the company currently has a market cap of $8.5-$9.0 billion as of the writing of this document. That means it trades at a 42.5-45x valuation of free cash flow which is line with its revenue multiple. As I said before, everything must work out for the company at that kind of multiple.

What are the returns on invested capital (ROIC)? Well, there’s only two years of data, but it looks good. As I stated in my writeup of Best of the Best, I calculate it two ways using NOPAT (calculated as Operating Income – Income Tax Expense) in one method and Net Income in the other. I first use NOPAT / (Total Equity + Total Debt - Goodwill). My second ROIC formula uses Net Income instead of NOPAT in the numerator. Using NOPAT as the numerator gives more of a pure calculation of what ROIC is while the Net Income should be reasonably close to the NOPAT calculation. Any large deviation would mean that there’s an exceptional income or expense item on the income statement that must be investigated further to see if it is truly an “exceptional”, one off event or if they seem to be more normal than that. The results are shown below.

As you can see, dLocal is achieving very high returns on capital. Please remember that ROIC is most likely materially higher as I do not back out “excess cash” from invested capital. I am going to hold off on calculating returns on incremental invested capital (ROIIC) for now as there is only two years’ worth of data. I would ideally like to calculate ROIIC over a 5–10-year time frame. The company is set to announce their fourth quarter and full year results in mid-March so I may update the spreadsheet at that time.

One last interesting thing about dLocal is that it is already profitable and does not spend a lot of money on sales and marketing like most other startups/tech unicorns. Net income (in thousands of dollars) for 2019 was $15,602 on $55,289 of revenue. Net income for 2020 was $28,187 on $104,143 of revenue. Sales and marketing expense (in thousands of dollars) for 2019 and 2020 was $2,057 and $2,852, respectively. This indicates to me that their business model does well on its own and doesn’t need to take over the world to start making money.

Outlook

The outlook for dLocal really depends on what you think about emerging markets and how alternative payment methods are going to evolve over time. I tried researching the global alternative payment landscape via the EBSCOhost. Big shoutout to the New York Public Library for providing free access to this via my library card. I found something called “Global Alternative Payment Methods 2021 Post COVID-19” during my search. This is exactly what I was looking for. I went to the website that provides the full text of the document and found out that it cost $5,700 to access. So, that didn’t happen. I did find something interesting though when I was browsing through the “The Ultimate Guide to Unlocking E-Commerce Growth in Markets across LATAM, APAC and EMEA” paper that I referenced above. Per p. 14 of the report, “In total, the global e-commerce market reached $5.5 trillion in 2020, 74% of which comes from emerging markets ($2.3 trillion and 40% when excluding China). This highlights the importance of local payment methods. While in the United States and Europe, credit and debit cards are widely owned and used online, this is not the case in global emerging markets, where banking penetration can fall below 20% of the adult population and cash-based payments methods, local digital wallets and bank transfers are prevalent. All in all, local payment methods represent 83% of total e-commerce expenditure in the 14 core markets analyzed in this report. Extrapolated to the global level, local payment methods represent an estimated 61% of all global e-commerce spend, an estimated $3.4 trillion. Given this, it is imperative for global merchants venturing beyond the US and Western Europe to develop a global and comprehensive local payment strategy.” This should obviously be taken with a grain of salt as this report was commissioned and published for dLocal, but the fact remains that large swaths of the world remain unbanked, underbanked or don’t have access to credit cards, but still want to consume goods from global merchants via alternative payment methods. Credit cards will undoubtedly take some share in markets that shed their “emerging” label, but that will take some time. This will be somewhat offset as the size of e-commerce pie grows as more and more people come online meaning more people who will use alternative payment methods.

Final Comments

Does dLocal have the attributes of a compunder? Yes, but not at the current valuation. My overall opinion is that what they’re doing is clearly working. They wouldn’t be profitable and have merchants like Amazon, Netflix, Microsoft, Mailchimp, Dropbox, Uber and Spotify using their platform if it wasn’t delivering results. I know I said this twice already, but it’s priced at a level where everything must work out to justify it and that usually doesn’t happen in financial markets. I also have concerns about management compensation and its status as a Cayman Islands corporation which require further analysis and judgement if I ever decide to buy the stock. With that being said, the business is asset light, has high returns on capital and focuses on its niche by providing an all-in-one solution to global merchants who are looking to accept alternative payment methods in emerging markets. Thanks again as always for reading. Please feel free to like, comment, provide feedback or subscribe. You may also email me at possiblevalueresearch@gmail.com with any further inquiries.

Disclosure: I do not own shares in this company.