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Want to know the scariest thing about Theranos? No, it wasn’t Elizabeth Holmes’ gravelly voice, or the way she stared into the depths of your soul with those piercing Manson lamps. It was the fact that some of the world’s most astute institutional investors were so easily duped. If someone like Tim Draper couldn’t see Theranos for the vaporware that it was, then how are you – doing a few hours of due diligence in your underwear on a Saturday afternoon – going to avoid the next Bind Therapeutics?
It comes down to this. As a rule, we tend to trust the world’s most sophisticated institutional investors will do better due diligence than we ever could. So, when a short report gets put out on a fintech firm that does business with some of the world’s biggest companies, we want to watch closely how their customers and investors react. That’s precisely the approach we took for the Muddy Waters Capital short report on dLocal (DLO). From our November 2022 piece titled, dLocal Stock Demolished by Short Report:
dLocal is now having to do damage control for two groups of stakeholders – customers and investors. If they lose one or more key customers, it’s likely the grave accusations in the report have merit. If institutional investors use this opportunity to add to their positions, that’s a vote of confidence that suggests otherwise.
Credit: Nanalyze
So, when dLocal traded down 26% in yesterday’s trading session, we decided it’s a good time to see why, starting with the aftermath of that short report.
The Short Report Aftermath
While rather terse, dLocal’s same day response to the short report was encouraging to see, and as we suspected, they took some time to digest the accusations and respond to them. Just over a month later, they published a press release that responded to the major accusations made by the short report in a concise fashion (you can read it here). That followed two separate reviews conducted regarding the allegations which were as thorough as we would have expected and included “an independent global expert services and forensic accounting advisory firm.” Large institutional investors would have demanded nothing less. Following the reviews, the three top shareholders, including the company itself, decided to buy shares at the – presumably – discounted prices they were trading at following the short report.
Reuters tells us, “top shareholders General Atlantic, Tiger, and Fidelity all bolstered their holdings in the company in the quarter,” and a look at the SEC filings confirms this. The largest shareholder by far, General Atlantic, initiated a 10b5-1 Plan (a topic we covered in our recent piece titled Should You Worry About Insider Selling?) which saw them purchase shares at fixed intervals from January through May. The total plan was authorized to purchase up to $100 million worth of shares, but that number needs to be put into perspective. Assuming a price of $15 a share, that planned purchase would represent 6,666,666 shares or an increase of about 10% over the 57,660,766 shares General Atlantic held at the beginning of this year. It’s not a large increase, but still a meaningful vote of confidence from one of the largest private equity funds in the world that currently owns 38% of dLocal.
Yesterday’s Q4-2022 earnings call eluded to the “unwarranted attack” the company was under, though we’d argue that short reports aren’t necessarily a bad thing. In this case, investors in dLocal can be assured that nothing suspicious is happening with the Uruguayan company they’ve invested in, unless of course we have another Elizabeth Holmes pulling the strings, which is statistically unlikely. Psychopaths duping sophisticated investors is the exception, not the rule. But the best part is the opportunity to purchase shares of a quality company at a discount. That’s a good segue into the 26% drop in share price we saw last trading session.
Why dLocal Shares Were Punished
We invest in companies, not stocks, so when a stock drops significantly, we’re primarily concerned with what may have fundamentally changed with the business. Most pundits pointed to missed earnings in Q4-2022 which appears to be a temporary setback. Says Reuters:
dlocal’s fourth-quarter profit of $19.4 million was down 18% year-over-year as the company saw higher operating expenses, including trapped deposits in bankrupt cryptocurrency exchange FTX and $2 million in costs related to a short-seller report.
Credit: Reuters
Investigating the short report’s serious allegations is money well spent, not to mention a one-time occurrence. So is the exposure to FTX (says dLocal), which shows what a bad idea it is to start accepting cryptocurrency on any payments platform (crypto represents just 0.2% of dLocal’s total payments volume). Reuters says dLocal has “yet to issue a detailed written response to Muddy Waters’ claims,” but we found the December 2022 press release sufficiently addressed the key concerns. Two external investigations, along with support from key shareholders, provides enough closure from where we’re sitting. What might be more of a concern was the language in the earnings call around “gross profit margin” vs “gross profit dollars” which also could have contributed to the rapid decline in share price.
Revisiting dLocal’s Business Model
dLocal’s simple business model is one reason we find the company to be so appealing. They enter emerging markets and establish relationships with native payments providers. Then, they enable access to these payments providers using a single application programming interface (API). So if you’re Facebook (err.. .Meta), and you want to sell things in Kenya, you’ll find a culture where just 6% of payments are made with credit cards and 60% made with mobile phones. Meta can go about creating their own relationships in the bureaucratic swamp of East African telecom providers, or they can plug into the dLocal API and immediately access 2 billion consumers across 40 emerging market countries via 900+ payment methods. That’s what Meta did, and they’ve been working with dLocal for four years now including this exact use case which was highlighted in the Q4-2022 earnings call.
We traditionally look at gross margin as an indicator of how profitable a company can be in the future. dLocal suggests that analyst not focus on gross margin for a number of reasons, the biggest being that platform volume – even with extremely tight margins – will eventually resort in a windfall. Therefore, they want analysts to focus on “gross profit dollars.” This was reiterated over and over in the call, while analysts seemed to be generally uncomfortable with the idea based on the volume of questions asked around the topic.
Our Thoughts on dLocal
Companies increase earnings per share by either increasing profitability or revenues. dLocal believes that continuing strong revenue growth will be a bigger driver than a focus on increasing profitability. After achieving 77% growth for 2022 with revenues of $419 million, they’re guiding to at least $620 million for this year, a growth rate of 48%. Moreover, this is a company that’s profitable, and they’re expecting to grow their cash stockpile of $248 million as the year goes on.
Going back to dLocal’s business model, the total amount of payments transacted on their global platform is aptly titled “total payment volume,” and the percentage of that they capture is referred to as the “take rate.” The short report challenged dLocal’s high take rates, and the company admits that they’ll be declining over time. The implication seems to be that they’re using cheaper transaction fees to capture more market share as competitors struggle to gain a foothold (they specifically point to new deals with larger companies, not renegotiation of existing contracts). Analysts leveled question after question trying to understand why profitability wasn’t growing to their expectations, while management pointed to their revenue growth momentum and ability to expand market share in countries where competitors are pulling back.
After reading through the earnings transcript several times, it appears that analysts are perhaps still gun shy from the short report and want to uncover as much detail as possible. Management seems to be less focused on short terms details and more on the bigger picture – to grow the platform as quick as possible. Our belief is that once the world’s biggest companies become heavily reliant on the platform, switching costs will increase while alternatives will decrease, and this will provide dLocal with a great deal of leverage. What’s most important right now is making sure the platform scales without any issues and that total payments volume continues to grow.
Looking at a geographic breakdown of revenues for dLocal shows a good spread across LATAM countries with Africa/Asia emerging to become more than a fifth of total revenues this last quarter.
With a simple valuation ratio of 7, dLocal would appear fairly priced when compared to an average of 6 across the 192 tech stocks in our tech stock catalog we calculate this value for.
Conclusion
It’s coming up on four months since the Muddy Waters short report was published and dLocal seems to have allayed our concerns. Two independent investigations concluded, their biggest shareholders increased their holdings, and growth seems to continue unabated. Unless there’s a serious Elizabeth Homes stunt being played out before everyone’s eyes, dLocal seems to have emerged unscathed, though their stock wasn’t able to dodge the short report bullet. Muddy Waters likely profited from their trade, while long term investors should be grateful for the opportunity to add shares of a quality company at a more reasonable valuation. Should we decide to add shares of dLocal, a trade alert will be sent out to paying subscribers.
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