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DLocal: What Investors Need to Know

By Asit Sharma – Aug 19, 2021 at 11:54AM

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Discussing DLocal, its S-1 filing, and its aim of conquering the highly competitive payment processing market.

DLocal (DLO 3.31%) is one of the newest global payment processors to excite investors with its public offering. But does DLocal have the chops to succeed in an increasingly competitive space? In this episode of Industry Focus: Consumer Goods, join Motley Fool analysts Asit Sharma and Emily Flippen as they discuss if the company's risks outweigh its returns. 

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Aug. 10, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, Aug. 10, and I'm your host, Emily Flippen. Today, I'm joined by Motley Fool senior analyst Asit Sharma as we talk about DLocal. It's a business that is attempting to streamline the online payment processing systems for emerging markets across the world. Asit, thank you so much for joining, as always.

Asit Sharma: Emily, thank you so much for having me, and I am d-lighted to talk about DLocal today. 

Flippen: It's a name that I've seen fly across my desk periodically over the past couple of months.

Sharma: Sure.

Flippen: But I do say, I think it's the name that has been putting me off of studying this business, but I finally got around to looking through its S-1 earlier last week. I was like, wow, this is interesting. We should slot it in for an episode of Industry Focus, give us an opportunity to chat about it. I know the payment processing space has been not only a really interesting place to invest but a really lucrative place to invest for many people. So I thought maybe this slides right in. I will say, as I got deeper and deeper into this business, I was surprised. Like many businesses, this did send me down a little bit of a rabbit hole in terms of management, their backgrounds, but we'll get to that.

Sharma: Yes. I want to point out that the name doesn't really roll off the tongue and I had seen this come across my screens as well. In fact, I think I mentioned to you that I have seen the ticker, but that's about it. Sometimes you see a ticker and a name and just by the name, you want to research and explore it, but there must be something to the subliminal turn-off a bit. We should point out though, as we'll learn together, that DLocal does describe the business pretty well and I believe in this payment space overall. But I know that not every fintech that focuses on the payment space turns out to be, let's say, a PayPal or a MercadoLibre, which of course is also a marketplace, but increasingly known as a payments business. We can delve into that as we unpack exactly what this business does and its opportunities. I will say at the outset, Emily, just to tease a little bit, I'm not sure what I make of this company.

Flippen: Me neither. I can paint two very different pictures for this business' performance, and I find myself teetering on the fence, I can fall in either direction. But the business itself is interesting. Their cloud-based payments platform that gives the opportunity for international merchants to reach emerging-market shoppers and sellers across the world. The idea is that it's challenging for even some of the largest retailers to get into new markets because it requires so much niche knowledge, so partnering with local payment providers or financial institutions, navigating things like local regulations and foreign exchange management or even fraud detection.So it plays into this aspect. I've heard a lot of people refer to DLocal as almost a similar business to Adyen and I can see that connection made. But what immediately came to my mind was actually Avalara, which may sound strange, their tax payments, a tax software provider. But Avalara made a name for itself in the tax space because when the Wayfair supreme court case was passed, suddenly, everybody needed a lot of expert knowledge about things like local and state taxes for their online shopping needs, and Avalara had this specialized niche knowledge, and they were a plug-and-play solution for some of the big providers and in tax software. I could see the same argument being made with DLocal here. They are plug-and-play solutions to help big businesses manage their cross-border transactions, something that's becoming increasingly important in a more globalized world.

Sharma: It's interesting, this seems to be a year of companies that have a little bit of a compliance niche going public. We saw LegalZoom, which is consumer-facing, recently go public, and also a company called Entap, which is also in the legal community. They help large enterprises with operationalizing the partner-led model of business. I did an Industry Focus with our friend Nick Sciple discussing these two companies, and so your thought on Avalara resonates with me because it's very easy to ignore markets that are complex from a tax or a regulatory standpoint, but there is good money to be made there if you have the holding power to do so, you've got the financial resources and a team that's very, very patient. This does seem to be a characteristic of this company as we look into the narrative that's in the prospectus. They've all evolved over time by having a very slow approach with the various markets that they operate in with this focus on Latin America. I can see that angle. The thing that always gives me pause in businesses like this is that once the pioneers carve out the space, they open a path for the bigger companies to come in and take market share. Could this be all that DLocal is doing? I think Avalara as a stock has performed pretty well. If that's any indication, maybe there is a long-term path here for this company. But Emily, why don't we talk a little bit about what makes DLocal unique and why they have chosen to play in a really specialized space. You had some interesting use cases that you were looking at for this business.

Flippen: Yes, I love that you called out the competition because this stood out to me when I was reading through their S-1. My biggest thought was, well, why would a big company even need DLocal to begin with? I guess my concern was less about them carving a space for bigger competitors, which I think could happen. And more just about do companies really need this? Based on the use cases they've laid out on their S-1, I guess the answer is resoundingly yes. They work with some big businesses. For instance, they help with Microsoft to sell their products in Nigeria. DiDi, which is the Chinese ride-hailing app, they use that to help make payments in Argentina, so just a couple of their notable volumes. I will say there's a lot of concentration. 

While they have, these big consumers or customers, I should say, [unclear] and other Chinese customers, they have a lot of big customers, but there's a lot of concentration within these customers themselves. But for the customers that are doing at least $6 million in total payment volume through their platform, that average customer is using it to sell into six different countries, over 44 different payment methods. The idea is that once they bring a customer into their ecosystem, they say, look how easy it is for you to run your product. Through our system, we can have all these local payments that expand the take rate or the conversion rate that you'll get from that average customer, resulting in more money to you, so pay us. Right now, businesses, at least in, in some niches, Argentina and Nigeria, at least in some niches, are paying DLocal for that.

Sharma: I think a phrase you just used is key for me: payment methods. You mentioned the average customer selling into six different companies using 44 different payment methods. DLocal is a specialist in something called APM, alternative payment methods. As you were mentioning, it can be hard for us to conceive why a really large multinational payments company like a MasterCard or Visa or a PayPal wouldn't dominate a local emerging market and just provide this complete end-to-end solution for merchants who want to participate. There is a good reason for this. Often, the markets that are ripe for this type of platform actually have a high percentage of unbanked customers in their countries. Brazil is a really keen example. There are about 55 million Brazilians who don't have a bank account, yet they're able to shop online using a local system that was developed in the early 1990s, I think it was 1993. This is called, and excuse my Portuguese here for those of you who are native speakers, Boleto Bancario, or simply Boleto, and this means ticket in Portuguese. How this works is, if you're in Brazil and you are shopping with no bank account to your name, you can have a Boleto generated by a merchant at the point-of-sale. This can be online or offline. That Boleto will stipulate both the transaction amount and the date by which the ticket has to be paid. There are thousands of locations in Brazil where people can just walk in and pay cash for their purchases using the system, from ATMs to banks to supermarkets. The Boleto has migrated over the past couple of decades into a system that is pretty mobile-friendly, but it's still a little bit of a cumbersome process to have the Boleto filled out. 

The bottom line here is that this local payment method, alternative payment method, which works basically to facilitate an online transaction for a cash-paying customer, is embedded in the Brazilian economy. Now, imagine that you are this big global merchant that wants to crack the Brazilian market. You come with all of your whole spread of extended payment methods from bank-to-bank, peer-to-peer, Visa, Mastercard, you name it, you've got a whole suite of products, but the local merchants are dealing in a few of those, mostly the Boleto system, you will lose out on millions of potential customers. We just mentioned 55 million of them. One of DLocal's first and most successful innovations was to provide access to Boleto on its platform. They advertise its platform, Emily, as being one API, one application programming interface, just very easy to glue into from the merchant side. If any of you who are listening are familiar with global unbanked solutions, if you've traveled at all from these countries, there's UPI in India which enables bank-to-bank transfers between merchants and actual consumers. There's also M-Pesa in Kenya. That's one that came to mind for me, which I was curious about. This is a system that is similar to the Boleto, but it's totally mobile based. It was originated just for mobile devices. DLocal added these methods onto its platform. 

This gives us a little bit more of a purview in where management wants to go, but their ambition is a little bit larger. In their prospectus, they say that they want to be the first mover in these markets, but they also want to expand a little bit beyond this, and I think compete more with traditional payments in fintech companies.

Flippen: I actually had no idea about how that Boleto system worked in Brazil and across what seems to be a lot of South America and it explains by nearly 90% of their revenue and over 90% of their total payment volume actually comes out through Latin America, which is largely led by Brazil, Uruguay, Argentina. That is really interesting. I will say the advantage in addition to allowing that transaction to happen with the consumer that wouldn't have otherwise made the purchase actually extends to the merchants as well. Things like refunds, recurring payments, split payments, paying in installments, which seem to be a very exciting consumer trend here in the United States. Those are all the things that have been enabled by using the DLocal system with merchants who otherwise wouldn't have been able to offer those to consumers. Then you add on top of all the things that we already mentioned, like fraud detection, regulation management, foreign currency settlement, all of these things, I can see it making a really compelling value proposition if I am a merchant.

Sharma: Absolutely. Emily, before we move on, I have to interrupt here with a commercial for our witty producer, Tim Sparks, who has just turned up in the chat. I think he is asking what the symbol is, but he's also making a joke. He's written to us DLO, which I just find very funny because of [unclear] JLo and a whole bunch of other Los. I will admit that I don't have the symbol on my fingertips, do you by any chance? Yes, it is DLO?

Flippen: It is DLO, yeah.

Sharma: DLO. Well, Tim, guess what? Yes, indeed, the symbol is DLO. 

Flippen: Maybe they can be half as successful as JLo.

Sharma: Exactly. Let us resume to our normal programming. Apologize for that interruption.

Flippen: No worries. Let's think about the market opportunity. Up to this point, I think, we've been largely focused on merchants that are trying to reach the emerging market customer, but they actually have their transaction fee structure, which again results in very high-margin revenue. But they have to pay in transaction, which is again that of international merchants, which is getting paid by a customer first service that's making a purchase. But they also offer what they call pay out transactions, so these are local sellers, so sellers in the emerging markets are getting paid by the international business. When you talk about DiDi, for instance, you can think about it again as a Chinese Uber. They have to pay the drivers in Argentina, and that is a payout transaction, that is DiDi that is making a payment to a local emerging market, I guess you can call it a seller at that point, an independent contractor. As you think about the need for all of these cross-currency transactions, you can understand how complicated it gets in and out. DLocal offering both of those services could be an advantage.

Sharma: Yes. I think so. I wanted to point out here that one of the competitive moats, although it's a slim one, is the company's ability to negotiate these really complex markets. It's a slim but solid advantage to begin in Latin America. There is no end to fintechs that are working on local payment solutions in developed markets, especially in Europe. In Europe, you've got so many countries with their own currencies, but of course they are on the euro system, and there is a lot of market share to be had for companies that have a position in this. Adyen, I think that's how you pronounce it, is a company that many viewers will be familiar with. Euronet Worldwide, which has been around for a long time, is also a company that has been focusing on localized payment innovation within Europe. But in Latin America, it's a little less fierce competition. This is due partly to sometimes team regulatory hurdles that exist from country to country. I think that it's good that this management team is very patient. They're willing to wait years for clearance in each individual country that they are trying to crack. Central bank financial regulators are notoriously suspect of any kind of solution that wants to provide the glue between global commerce and a local payments infrastructure. I think maybe that's because of an inherent fear that the local payment methodology will eventually be replaced with the ease of doing these global payments, that you'll just be able to eventually translate let's say a Visa, or Mastercard, or PayPal structure into a local market. 

This is typically an unfounded fear, which is why a company like DLocal exists. I found it interesting that the CEO, Sebastian Kanovich himself is from Uruguay, which is a country which is very small, very advanced, but at the same time has a localized payment system. He describes in various interviews the difficulty he's had in shopping as he was growing up, and even spoke about having to lend his mother his own credit card when she traveled, just because it is so difficult in Uruguay to participate in the global economy online. I want to quote from a recent interview that he gave:

We'll go to the country for the first time, we hear no. We go back a second time, we hear no. For those who decide to go to emerging markets, they're going to be interacting with people who have no idea what you're talking about. You have to be very patient and a very good communicator about these are the merchants I bring in, these are the controls we have, the education has to be there. Eventually, you get a small door in and that is what you work through.

You're convincing these regulators that you're not trying to end the system, and that you understand the localized system. This goes back to a point that you made at the beginning of the hour, Emily: You also have to demonstrate that you've got really great fraud controls in place, that's a big concern on regulators' part. For the time being, it's worked really well for this company, as we'll see, because we're about to talk about their financials.

Flippen: Yes. The financials here I think are probably the unexpected strong suit for DLocal. A lot of the numbers we're going to talk about are really impressive. Nearly 60% gross margins, 47% operating margins, and over 40% net income margins. Yes, that means they're profitable all over the last three months, they have no long-term debt on their balance sheet. At first glance, this asset-light business model looks like it's succeeding pretty well, that you've been tracking net revenue retention rate for their customers, which was nearly 160% over the last 12 months. Impressive metrics off the bat. I will say I'm a little bit, not skeptical is not the word, but when we talk about asset-light business models and software models in particular, I think there's an association with this infinite margin expansion that can happen. We see 60% gross margins, we think they have a single API that can plug and play. Therefore, they should be able to expand their margin 70%, maybe even 80% over time, like all of these great software businesses. But just because they're asset-light, it doesn't mean that their only costs are this platform. 

Because they're dealing in such a highly regulated environment as you mentioned, they still have a ton of labor costs that go into expansion. They have to hire expertise directly in the countries where they're trying to expand to, where they're operating, expansion isn't as easy as you just mentioned. It isn't as easy as just coming to a new country, plugging your platform, and hitting play. There's a lot of hoops that need to be jumped through. But even with these hoops, this is a business that has been profitable sustainably, impressive growth behind it. They had 60% year-over-year growth in their total payment volume last year. They actually track that by cohort, which again, I love seeing it, it reminds me of Chewy tracking their customers by cohorts, and it has grown consistently since 2018, which was the first year they started tracking.

Sharma: I think that's a great point that you bring up here. You have to watch both lines when you look at a fast growing company. You have to look at that gross margin line, what is the associated cost of sales? But you also have to look at the bottom line. Sometimes costs that one business associates or places up in its cost of sales, will be the cost that another company puts below the line in its overhead. In this case, what you're forecasting, Emily, is really a heavier operating drag as the company gets a little bigger. Right now they don't have that, they're skating off of this really tremendous acceleration in their total payments volume. You were just mentioning they did $1 billion in TPV, total payments volumes. I should pause here and say that's the total amount of dollars transacted over their platform, not their revenue or their profit, but just the amount of dollars that cross over the platform and they take a slice. So $1 billion in TPV in the last three months and $2 billion in 2020, so you can see the acceleration and where that total payments volume is headed. In just a bit I'll talk about why I think they might be bumping up against some limitations. But you have to pay attention to these numbers right now. It's pure operating leverage, they're profitable, they've got great bottom-line margins. 

But as they grow and as they have to fend off competition, you're very correct to point out that might not express itself in capital investment, it will express itself in something very similar. If you take a company's people spend, which isn't always obvious from the financials, oftentimes it's buried in other line items. But if you could see that spend and you forecast that out for 10 years, there is a little exercise for those of you who are accounting geeks can try, which is to try to amortize that particular cost over 10 years. If you know the business very well, let's say you've got a consulting business which hires a lot of labor also, it's possible to see how the bottom-line might deteriorate over time. What you just said, Emily, reminds me of that kind of exercise and that's something that I would probably follow-up if I continue to follow this company is to look at maybe R&D expense, because that's where we'll see an expression about labor costs and some other line items. But tell me about these cohorts. You shared a graph which we can't show on the podcast, but from the prospectus, you focused on a graph that you really liked that tracks total payments volumes by cohort.

Flippen: This is essentially looking at the customers that the business brought in in 2018, 2019, and 2020. For the customers that have retained over those years, how their behavior using DLocal has changed. At that TPV, that total payment volume for the 2018 cohort has nearly over seven-fold, I think has gone from $104 to over $760 million since over the past two years. Again, increasing the amount of payments that they're flowing through on that system, as well as the number of countries in which they are existing. This is interesting because the idea is that if you can partner with a company to get their foot in the door into one international markets that they've been trying to expand into or expand their operations say if it's Brazil, and they have a good exposure or good experience with DLocal, then they'll come back to DLocal and say, "OK, let's do the same thing in Uruguay, let's do the same thing in Chile, or Argentina, or Venezuela." You can look at the countries by cohort. In 2018, the average number of countries that their customers were in was just over three, now it's just over five. Over the past two years, it has expanded the number of countries in which they're operating services. The argument that management is trying to make with this graph is that there's an opportunity to better monetize and upsell customers that do stick with the cohort over time. Again, going back to that revenue retention rate over 150%, that does point to those same metrics. I will say we don't get a clear picture of what churn looks like. I can't imagine it would be high, I think there are bigger challenges convincing a customer to come onto their platform in the first place, but definitely something to keep an eye on.

Sharma: It's interesting that net retention rate, and I don't have the latest figure, I think you're correct, it's around 150%. They did 170% in the 12 months that ended Dec. 31 of 2020. That is basically the manifestation of this total payment volume by cohort rising so much. When you look at that customer concentration, they've got about 10 customers that make up the majority of their business. You can build a picture here that they have managed to gain some really deep relationships with some great clients, and they show in their prospectus an image at the very beginning of their presentation of really great clients that they've got in their roster. I'm trying to find it here, so we've got DiDi you mentioned, Wix. Again, it's [inaudible] Emily I'm I right?

Flippen: [inaudible 04:18:43]

Sharma: Amazon, Spotify, Microsoft, MailChimp, Wikimedia. I'm not trying to say here that these are those 10 customers. Presumably, I'm going to guess that Microsoft might be one of those top 10 customers. But this gives you an idea of how the company is growing at a very concentrated form. It's expanding its addressable markets through these customers. They say that their model is ripe for diversification and they point to a future in which they're not as reliant on a few big names. But here, I'm a little ambivalent. I see those numbers and I also see potential for a slowdown in that total payments volume if one of these customers decides to also use another worthy vendor. The reason that I hesitate here is because there are some more robust customers that are coming online in Latin America. Yes, I sound like I'm contradicting myself because I just said a little while ago that they're in this space that's relatively not as fierce as European competition. But I have noticed a couple of interesting movements. Adyen, the European payments company, which has relationships with eBay, they actually recently rolled out their own Boleto solution for customers that want to do business in Latin America. There's a company called Xoom, which is a remittance company that's spelled with an X, not to be confused with Zoom Video. Xoom, it's owned by PayPal. They have recently rolled out a solution for the Indian market for peer-to-peer remittances, which utilizes one of the most popular systems in India called UPI. I mentioned this earlier, which is also on the platform. Now, that is a consumer-facing application, but PayPal owns the technology, so they can also port that over to a merchant solution. 

Also, we haven't really mentioned the big elephant in the room when you look at South America, we mentioned at once, but that's MercadoLibre. They, of course, are creating a lot of innovation in this space through their own payment solutions, which allow everything from bar codes to peer-to-peer cash payments. These are small merchants that are transacting with one another using cash-only. I see that maybe this great total payments volume, as nice as it looks, could slow down a bit as this space, which is being carved out among just a few fintechs, becomes more of a lucrative opportunity for the big giants that are looking in. I want to hold both thoughts in equal measure that you can be playing without a lot of challenge but it won't be forever. Any thoughts on that, Emily, before we move on to risks?

Flippen: Just that it's a perfect segue into, I guess, the concerns that I have with this business. I think to this point, we've done a good job of presenting the positives of which there are a lot. I think DLocal has proven, you don't do $2 billion of payment volumes if you're not doing something right, but asking ourselves why DLocal succeeds over competitors, I think, is where I find myself getting a little bit hung up because the payment processing space is getting crowded, to put it nicely, and the exposure that they do have with some of their core customers does make me a little bit nervous. For instance, partnership with Microsoft feels very limited. We're talking about one country, Nigeria, at which they are offering those services. You could say the same thing for DiDi and Argentina, it feels more one-off than it does a fully integrated partner. When you think about the risks, I have a host of risks. I think if you look at our outline, I think there's a 50% take rate from the risks section in comparison to the other comments that we had. But what stands out to you?

Sharma: I want to say, first, your notes -- so Emily, did the outline for this episode and I filled in with a little bit of color. But her notes remind me of the Robinhood S-1, the relationship of risks per competitive advantages, explanation of the business model, etc. But sometimes you need to focus on that. A model looks really persuasive, but you have to think in terms of being an owner who is going to stick around. If we're only talking about a couple of years and you had a strong feeling that DLocal was going to realize a lot of value in its publicly traded shares in two years, you can ignore the risks. But for any sensible, rational shareholder, I think these cut into the thesis a bit. Let me begin with one that you mentioned, which is globalization. This whole movement to make it easy to transact commerce across borders, to do cross-border payments, to take anything that's localized and be able to port it and sell it in other areas of the world is not a recent phenomenon. 

Although small fintechs like DLocal get a lot of attention, this movement has been decades in the making. From Visa and Mastercard, who I mentioned, to other networks, the Discover network. We've mentioned companies like PayPal, but we shouldn't forget all the international marketplace platforms that work on these same issues. MercadoLibre is a good example. We've been talking about the payment space, but they have an international marketplace which forces management to focus on how merchants and consumers are going to interact. Same with eBay, which ended up basically funding a company called Adyen, which itself has been very successful. This was the reason that PayPal came into being. It was basically the payments arm of eBay. We have companies like Etsy which are pouring capital into understanding and making this happen. Globalization could eventually evolve into a best-case scenario that it's just seamless to buy something from a merchant, a neighbor, or someone from across the world or business across the world. And when you flip that over, it becomes seamless for a merchant to then be able to offer his or her services to anyone across the globe. So why would we need these systems? If you think even further ahead as those 55 million Brazilians become banked, what's the need for a Boleto? That itself is going to just evolve into something that looks very much like a bar-code payment, which PayPal is putting into its own system. 

Almost everything you can visualize in the payment space is being worked on from multiple angles. Every time I think about this space, I am befuddled until I get a little more granular on why another company couldn't do the same thing. Viewers, you can put this in the comments or those of you who are watching today on live. Tell me if you haven't had this experience, it's just awfully confusing. Every payments company seems to be doing the exact same thing. If you read their summary of their business, "we make payment seamless across borders" or some expression of that. I think this globalization risk that you mentioned is important. Although, Emily, as you pointed out to me, the fact that they are focusing on the regulatory side and taking time to play where no one else really wants to play yet. Everyone else is like, you go ahead and you can have that market share for now. That is an advance, I called it a slim competitive moat, but it is a competitive moat in the near-term. What else have you got, Emily? This is like a scroll. It's like someone just dropped a scroll and it's hit the floor. What's your next risk?

Flippen: I'll try to go through some of my thoughts quickly. I will say concentration risk is a big one, both in terms of their customers and their geography. In terms of customers, over 60% of revenue comes from their top 10 biggest customers, one of them accounting for more than 10% of revenue. Those contracts are not only extremely flexible, both in terms of their duration as well as the payment rates. But they're also nonexclusive, which I think heightens that concentration risk a bit more because any one of those customers could cancel at any point. They do go on to say that most of their customers do use more than one local payment processor. Which means that I think DLocal is probably a bit more dependent on their customers than their customers are on them if there are other compatible solutions. The flip side of that concentration risk is the geographic concentration. 

As I mentioned, nearly 90% of revenue coming from South America, and countries that they're serving have historically had very volatile exchange rates. It's something to watch that I think investors may be a little bit surprised by the impact it has on this business. I think a lot of investors focus on the translation adjustments that happen whenever the business will translate their financial results into USD. I have no doubt that as DLocal starts to report earnings, again, this is a newly public company. But as they start to report earnings they'll give all these adjusted figures, saying withholding for all of the currency issues with the devaluation that certain countries experienced, here's what our results would've been. But I think the risk is a bit bigger than just translating financial statements to USD, because they essentially provide what can be seen as short-term financing for a lot of the margins that they're serving. They're taking payments and making payments and they hold on to that currency for a certain period of time. That delay from accepting to conversion can result in them actually experiencing some operating result changes as a result of short-term currency movements. Typically it's not big enough with any business to really mention it, but with this case in particular, I definitely think it's something to keep an eye on given the heightened concentration risk from the countries in which they're serving.

Sharma: Two comments on that: To your first point. I very much agree on that revenue concentration. The best-in-class companies will actually use a revenue concentration to grow and to then branch out. One of my favorite companies that's based in Latin America, I alluded to before, operating on a consulting basis, is Globant. They have a big concentration in their top 10 customers as well. But gradually, they're building out of that. I think it's maybe a little more difficult in this space to grow out of those revenue concentrations than it is in a business like consulting. This is definitely one to watch on the exchange rates, too. 

Emily, you mentioned the fact that the company is going to have some investment in future years that has a labor component, so not as visible on the income statement and balance sheet. It's not capital expenditure, but it's not broken out in the financials either. That too is subject to currency devaluation, because if you are paying localized salaries on the ground in places like Uruguay and Argentina and Brazil then you are having a long-term exposure to currency risk. I think investors have been trained to accept this because we see the same thing going on with MercadoLibre. But again, that may provide a false sense of security. I wouldn't hang your hat on that because there are few companies that can match MercadoLibre's results. If you look at MercadoLibre's revenue and earnings trajectory and just soften that up a little bit over the past several years, say they weren't as great, what you'd see is a company that has much more exposure from foreign currency translation on its bottom line, and the gradual devaluation of currencies in markets they were heavily in early on, such as Venezuela, which is, its own basket case of investment in the global economy. I am really tuned in to that exchange rate risk. Although it would seem on the surface of it, they are just taking from these transactions. What's the big risk? I think you're onto something there that over time, could eat into their profits.

Flippen: The last big risk I had that did send me down that rabbit hole I mentioned was the management team. It's a proxy nightmare looking through their S-1 a bit. This is a business that has a lot of the tail-tail red flags of a questionable management team. One of them being the fact that there's a decent amount of insider transactions. Essentially the company making deals with other businesses for which the insiders, whether that be directors or management, have a financial stake. Nearly 5% of the total payment volume that DLocal committed to last year, did go through local processors, for which directors had an ownership stake. Theoretically, if they don't have strong controls in their audit committee, then the directors could potentially pay more to funnel more money through their own processors to enrich themselves as opposed to DLocal or their shareholders. A practice that's made all the much easier when you consider that management and directors owned nearly, I think, over 50% of this business. It is a company controlled by the management team and the entire management team, which I don't even know what to make of this. Maybe you can break it down better than I've managed. But virtually, the entire management team comes from a separate business called AstroPay, that they also founded out of Uruguay. AstroPay is a payment processing service, theoretically competitive, but they are really focused on serving industries that in the jurisdictions in which they're operating are questionable at best and are legal at worst. These include online gambling and adult entertainment. They own controlling stakes in both of these competitive businesses, but it almost feels that they just carved out the legal part of AstroPay's business and turned it into DLocal to try to separate the two. I'm not quite sure what to make of it.

Sharma: It's so funny, Emily, because those really aren't your words. You're nearly quoting from the prospectus in calling these at worst illegal businesses. The company says, hey, AstroPay, they operate in online gambling, adult entertainment, and these businesses could be illegal, which to me was so curious. Maybe you have the correct analysis there that they took the unquestionably illegal part of the business, carved it out because there is that risk in the site, the reputational risk that could hit DLocal since the companies come from a commonwealth of ownership, that's a risk. I also see competitive risk here. The two companies, as part of this carve-out agreement, has basically it's one big non-compete agreement in 2018 that expires sometime this year. DLocal cites this exploration as a competition risk. You have to ask yourself, why would controlling ownership of both companies allow them to compete in the same markets if they carve these two businesses out? I'm thinking it's because the two of them can capture more market share if they both go after the same market. Picture a future in which AstroPay decides that we've gotten pinged a bit in the online gambling business or we see some regulation coming down the pipe. Why don't we take this technology that's been here anyway and now go ahead and just focus it under a new brand in adjacent markets to DLocal? Not the exact same markets, but markets that DLocal would eventually turn to itself. This benefits the shareholders of both companies. It's a way for them to salvage the economic machine that is AstroPay. It doesn't benefit DLocal because it's taking what's probably future market share away. Sometimes it might be a head-to-head competition. And it doesn't benefit you if you're a shareholder who only owns DLocal, it only benefits the person who can own both companies. 

Two companies going after the same or similar market share in a non-contiguous fashion, non-contiguous geographically, non-contiguous in terms of time, I should say non-synchronous. This happens in other industries. It's almost like they're setting that up here as just an ingenious scheme. We separate out the legal business. We have a three-year non-compete, and then we have both businesses able to hit the same legal markets if we need to, so we can't lose, buddies, pass the beer. Unfortunately, you're not sitting at the table with them. This was something that, boy, gave me pause. I like this business. There's a lot I like about it, but of the risks you isolated, the AstroPay risks seemed to me particularly one to pay attention to going forward.

Flippen: I completely agree and it's enough for me to want to sit on the sidelines for this business. There's a host of risks that I think, in my opinion, outweigh a lot of the admittedly very large potential rewards that exist with a business like DLocal. Speaking for myself personally, I have a lot of payment processor exposure in my portfolios that I think I can pass up on this one with the awareness that DLocal probably has a better chance to 10X or 5X than my PayPal shares can possibly do.

Sharma: Yeah. We should say here that the company, going back to what Emily outlined earlier, is debt free. I always look at the use-of-proceeds sections. It's actually the first or second thing I do if I know nothing else about a company, go straight to that use-of-proceeds section in the prospectus, raising money for the right reasons. They say that we want to use our proceeds to invest in technology, accelerating our operations. This is a company outside of the risks that seems to have a bright future in the near term. But yet you have to think about risks. And  I will say this wouldn't be an episode of Industry Focus if we didn't talk about either one of two things; Brand power, which wasn't as relevant here, or Emily Flippen's focus on material weaknesses with new issues.

Flippen: I feel so bad even calling it out because it's almost a foregone conclusion at this point. But again, it is a business that has material weaknesses all over the place. I will say they did catch material weaknesses and restated their prior financial statements, I believe from 2019 prior to going public. At least they caught it before they put it in front of shareholders, but they're still attempting to remediate these weaknesses. This is a business that like so many we've seen rush to go public, they just don't have the facilities in place to make up for these concerns and it's especially concerning because we're talking about a business that does operations all over the world. It's largely centralized in South America, but all over the world. It has such different regulatory frameworks, it can be challenging to remediate these. Definitely something I will continue to watch over the next couple of years probably.

Sharma: Sure. Just my last thought on that is that a company that is so good with regulatory risks and compliance in its offering should be a little bit better at compliance with its financials and its internal controls.

Flippen: I love that. Asit, thank you so much for joining.

Sharma: Thanks for having me, Emily. It was fun, as always.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say "Hi," you can always shoot us an email at [email protected] or tweet at us @MFindustryfocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Emily Flippen owns shares of Chewy, Inc., MercadoLibre, and PayPal Holdings. The Motley Fool owns shares of and recommends Adyen N.V., Amazon, Avalara Inc, Etsy, Globant, Mastercard, MercadoLibre, Microsoft, PayPal Holdings, Spotify Technology, Visa, and Wix.com. The Motley Fool recommends Adyen, Chewy, Inc., Uber Technologies, and eBay and recommends the following options: long January 2022 $1,920 calls on Amazon, long January 2022 $75 calls on PayPal Holdings, short January 2022 $1,940 calls on Amazon, and short October 2021 $70 calls on eBay. The Motley Fool has a disclosure policy.

Stocks Mentioned

DLocal Limited Stock Quote
DLocal Limited
DLO
$12.80 (3.31%) $0.41
MercadoLibre Stock Quote
MercadoLibre
MELI
$945.07 (0.43%) $4.06

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