On Nov. 16, Muddy Waters Capital disclosed a short position in dLocal (DLO +1.93%). When you short a stock, you're betting against it, and you make money when the stock price falls. When a firm like Muddy Waters makes its position known, many investors get out quickly, which can cause the price to drop.
And drop it did. dLocal shares fell more than 50% the day the report was released. Is this overreaction? Or is there something to Muddy Waters' position? Let's find out.
Muddy Waters' track record is up and down
dLocal is a payment processing company that focuses on emerging market countries. Its platform lets its clients take local payments and issue branded credit cards, while dLocal takes a slice of each transaction. dLocal's customers aren't fly by-night businesses; they include Amazon, Nike, Uber, and Booking.com. It also has an app on the Shopify store, allowing smaller businesses to get in on emerging markets. With this clientele, it's hard to imagine dLocal being an outright fraud.
But Muddy Waters says it's found evidence that dLocal's accounting is "highly likely fraudulent." Among the accusations are inflated total payment volume and unrealistic take rates. dLocal responded quickly, stating the report is "inaccurate" and that short reports are often issued to manipulate the market and drive a stock down to make a quick buck. Additionally, dLocal will also rebut the allegations "in due course," showing management isn't backing down.
Muddy Waters would have seen an instant 50% gain after publishing its position, and short-sellers' ability to take advantage of big price moves this way has landed some of them (including Muddy Waters) in a U.S. Justice Department probe that came public earlier this year. However, Muddy Waters has also exposed true frauds like Luckin Coffee, so it has credibility too.
NASDAQ: DLO
Key Data Points
If you divide dLocal's $111.9 million third-quarter revenue by its $2.7 billion total payment volume (TPV), you get a take rate of 4.1%. Now, that may seem high, but remember, dLocal is dealing with remote geographies in markets that aren't fully developed. Because of this, a premium cut makes sense. If you're a retailer like Nike or Amazon, would you rather lose 4% of your sales to a local operator or develop a unique payment solution for Indonesia or Turkey? It's pretty simple -- the cost of building this infrastructure far outweighs its benefits, so dLocal's clients take what they can get in the form of increased sales. After all, some sales are better than no sales.
Compared to another online payment processor like Stripe, which has a take rate of 2.9% plus $0.30 and which charges an additional 1% fee for international transactions, dLocal's announced take rate seems very plausible, and Muddy Waters' take rate skepticism seems pretty baseless.
When a crucial part of a short argument falls apart, I question the rest. It's much harder to dissect whether total payment volume is falsified. Still, given that dLocal is in 39 countries, including massive markets like India, China, Brazil, and Argentina, when you think of all the Uber rides, Amazon orders, and vacation bookings its customers are making, crossing the multibillion threshold doesn't seem farfetched.However, we will likely get more clarity on TPV when dLocal issues its rebuttal.
Questionable timing
My last question about Muddy Waters' report is its timing. dLocal held its Q3 conference call before the market opened on Nov. 15, and Muddy Waters released its report on Nov. 16, effectively not allowing management to answer questions about the report. Muddy Waters didn't enter this position and generate research in a single day, and I doubt anything said in the Q3 earnings would have delayed this report.
Because of the timing and TPV and take rate accusations, I'm not inclined to believe the report's authenticity. Other investors are in the same boat, as the stock has risen almost 30% since Nov. 16.
With the business growing rapidly and cranking out solid profits (dLocal's earnings rose 64% over last year's to $0.10 per share), I think it's still a fantastic business -- if the Muddy Waters report turns out to be false. It even trades at just under 40 times earnings after its recent haircut.
Sometimes a business is too good to be true. Other times, people believe it can't be true, even though it is. I think dLocal is the latter, which is why I'm still a buyer, even after Muddy Waters' accusations. However, I'm keeping my position sizing small so that if it turns out to be accurate, I won't be severely affected.
