Nu Holdings (NU 2.01%), a leading fintech in Latin America, is one of the most exciting companies to go public lately thanks to its high-profile financial backers. These includes Warren Buffett's Berkshire Hathaway, Sequoia Capital, Tencent, DST, and Tiger Global.
But before we get too excited and buy the stock, let's take a step back and learn more about the company.
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A disrupter of the banking industry
Since it introduced its first product, Nu Credit Card, in 2014, Nubank has evolved into a diversified financial-services company. Based in Sao Paulo, it offers products that help customers spend, save, borrow, and invest. It operates mainly in Brazil, Mexico, and Colombia, serving 47 million individual customers and 1.1 million small and medium-sized enterprises (SMEs).
Nubank's mission is to make banking services easy to use and accessible to average folks. Historically, banks in Brazil, Mexico, and Columbia -- which as a group hold between 70% and 85% of all loans and deposits in this region -- have charged very high fees. In the company's initial public offering (IPO) prospectus, the founder shared his experience in opening his first Brazilian bank account. The process took him four months with long hours in queues, calls to the customer-service center, multiple trips to a branch office, and an annual fee. He might have been one of the lucky ones because many in the region remained unbanked.
Nubank aims to change that. The fintech leverages its mobile and digital-first banking platform to simplify the banking process and improve accessibility. The start-up focuses on providing customers with its easy-to-use application and adding new services, such as personal lending, insurance, and investment products. The company also relies on data science to improve its decision making, reduce risk, and enhance customer experience.
While still early days, there are signs that customers like Nubank's approach. According to its prospectus, the company has acquired 80% to 90% of its customers organically, meaning no spending on direct marketing was necessary. It received a Net Promoter Score (NPS) of 90 in Brazil and 94 in Mexico -- which it believes far exceeds incumbent banks and other local fintech companies. The NPS is a quantitative score that measures a company's customer-service quality and the likelihood that customers will recommend the service to their friends. Usually, a score of above 70 indicates a company has top-notch customer service. Besides, Nubank also has a low complaint rate, receiving 269 complaints per 1 million customers while the incumbents logged between 755 and 5,488 complaints. These factors helped explain Nubank's rapid total customer growth -- a 13-fold increase from 3.7 million in the first quarter of 2018 to 48.1 million in the third quarter of 2021.
Opportunities and risks
Nubank's revenue has grown rapidly, rising from $319 million in 2018 to $737 million in 2020. In the first nine months of 2021, revenue increased by 99% to $1.1 billion. Fifty-seven percent of the fintech's revenue was from interest-related income, and the rest came from fees and commission income.
Although these numbers are impressive, there are good reasons to believe the company is just getting started. According to its IPO prospectus, Nubank's total market potential was $99 billion in 2020 and could grow to $126 billion by 2025. Based on its revenue for the 12 months ended in September, Nubank accounted for just above 1 % of the opportunity in 2020.
There are many ways for Nubank to grow. As a start, it can continue acquiring new customers; there are 652 million people in Latin America, and only 47 million people have an individual banking relationship with Nubank. It can also grow alongside its customers, more than 70% of whom are under age 40. A young customer can start with a free basic account and slowly move into other fee-generating products such as credit cards, personal loans, and insurance products. On top of that, Nubank can enter new regions or adjacent sectors (such as e-commerce) to expand its reach.
Still, investors should be aware of some potential downsides. As a start-up, the digital bank has a short operating history, and it is too early to say whether it can hold up during an economic slowdown. This is especially true since it derives more than half of its income from credit cards and personal loans. Borrowers may face financial difficulties during a recession. When that happens, Nubank could incur higher-than-expected credit losses. Moreover, it has yet to turn a profit and may lose money for years to come as it invests aggressively to expand. An unprofitable digital bank with a short operating history is not for the faint-hearted, even if its prospects seem promising.
A word on valuation
By now, it is clear that Nubank has a lot going for it. Not only has it executed well so far, but it is also well positioned to grow in years to come. Hence, it is not surprising that the company is trading at a sky-high valuation of about 62 times price-to-sales (PS) ratio. For perspective, StoneCo (STNE 2.85%) -- another Brazillian fintech -- has a PS ratio of about 7.
Although the bulls might be willing to pay up for the stock, conservative investors might be better off waiting for a while to monitor Nubank's performance in the coming quarters, which will aid their understanding of this newly public company. After all, there might be hidden risks that only surface with a bit of time. It is better safe than sorry.
