Why I'm Buying DLocal
Taking a Look at DLocal (DLO).
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Why DLO?
In the landscape of emerging markets, global corporations find both opportunity and challenge, particularly in navigating the complex and fragmented payment infrastructures. DLocal (DLO), a trailblazer in payment processing established in Uruguay in 2016, emerges as a key facilitator, enabling a seamless bridge between these dynamic markets and international merchants through its innovative platform.
Spanning 40 vibrant economies across APAC, the Middle East, Latin America, and Africa, DLO is on a dual mission: to simplify payment collections for international merchants ("pay in") and to ease disbursements to local suppliers and contractors ("pay out"). This strategic initiative has attracted a notable clientele, including industry giants such as Meta, Nike, and Didi, positioning DLO as both an asset-light and profitable enterprise poised for substantial growth. Originally conceived to address the challenges of operating within industries lacking clear regulatory guidelines, DLO has evolved to support over 600 merchants, including behemoths like Amazon and Microsoft. It achieves this by offering a unified contract and API that incorporates 900 different payment methods, thereby streamlining the payment process and ensuring transaction success across a multitude of payment landscapes.
DLO's business model extends beyond transaction facilitation. It employs a fee-based revenue structure, augmented by foreign exchange services, reflecting the lucrative dynamics of the payment industry characterized by significant operating leverage and a direct route to profitability. Remarkably, DLO's total payment volume (TPV) has surged from $1.3B in 2019 to over $17B in 2023, underscored by a solid gross take rate of 3.8%.
The strategic relevance of DLO's operations is further amplified when considering the vast, rapidly growing consumer base in emerging markets, which is often overlooked by many investors. Accounting for half of the global GDP and featuring a middle class expanding by 100M annually, the potential for digital financial inclusion and e-commerce is vast. Nations are increasingly focused on financial inclusion, fostering the rise of alternative payment systems like Brazil's Boleto and India's UPI, which sidestep traditional banking obstacles.
Additionally, the evolving regulatory framework in these markets seeks to harmonize innovation with consumer protection, positioning companies like DLO as vital in navigating these complexities for international businesses. The unique payment preferences and regulatory hurdles highlight the significant opportunity for DLO to simplify cross-border transactions, marking it as an attractive investment for tapping into the burgeoning e-commerce and digital payments sector within these dynamic economies.
DLO is solving a major issue in undeserved regions or emerging markets, which is indeed overlooked by many investors. This company is entering these markets and establishing a need for them, and DLO happens to be serving this need. According to their last investor day presentation, the company reiterates their stance on a $1.4T total addressable market. Looking at the big picture, the emerging markets offer a huge opportunity for growth. DLO has been expanding and executing its plans well in these areas, making what might seem like an ambitious number actually quite a reasonable forecast in my view. When you consider how much room there is for growth in these markets and DLO's track record, the projection makes a lot of sense.
Also, I’m of the view that DLO presents a compelling undervaluation case, given its potential for sustained growth. Reflecting on fiscal 2023, with a TPV of $17.7B, projecting a 35% compound annual growth rate over the next five years positions TPV at approximately $45B+ by 2028. Assuming the take rate adjusts to 3%, this scenario forecasts revenue reaching $1.4B. Further, with an anticipated EBITDA margin of 25%, we're looking at EBITDA around $350M. Applying a 20x multiple to this EBITDA suggests an enterprise value of over $6B, effectively doubling the investment over five years, which translates to an annual return of about 15%. Now, this projection is conservative, especially considering the 70% YoY TPV growth seen in 2023, and accounts for a potential deceleration in growth and margin compression.
Should DLO amplify its TPV significantly in the forthcoming half-decade, it's poised to cement its status as the premier payment processor in emerging markets. This achievement would not only affirm its dominance but also enhance its scale advantages and pricing power, establishing a robust competitive moat. Typically, firms with significant moats are rewarded with higher valuation premiums. So, DLO’s long-term return potential, makes it an attractive opportunity. Which is why I capitalized on this opportunity after the overreaction from Mr. Market.
What Should We Be Worried About?
This is obviously not all sunshine and rainbows for DLO, there are some notable risks. Muddy Waters casted a shadow over DLO with a short report a while back, igniting a flurry of skepticism around several key aspects of the company's operations:
The longevity and genuineness of DLO's TPV growth, with suspicions around the potential fabrication of sales.
Questions about the legitimacy of DLO's take rates, suggesting they may be artificially inflated through foreign exchange gains and fees.
Concerns regarding undisclosed transactions with related parties.
Doubts about the breadth of DLO's merchant base, suggesting a reliance on smaller, less-known customers rather than substantial, well-established merchants.
DLO has denied these allegations fully, and from my perspective, much of the critique seems to hinge on conjecture rather than irrefutable evidence. While the possibility of the claims being valid cannot be entirely dismissed, DLO's track record and disclosures offer a counter-narrative.
Indeed, DLO's transparency about its partnerships reveals a roster of significant merchants, evidenced by the fact that its top ten merchants contributed to over 50% of its 2023 revenue. This concentration underscores not only the company's appeal to leading global players but also underscores the revenue risk associated with this dependency. Furthermore, DLO's revenue distribution across key markets like Brazil, Argentina, Mexico, Nigeria, and Chile highlights its geographical diversity, which, while beneficial, also exposes the company to the varied economic climates and operational costs of these regions. Argentina being a major hinderance for the company at the moment.
The nature of the payment processing industry, known for its high customer retention due to the intricate integration of these systems, works in DLO's favor, suggesting a solid foundation for sustained merchant loyalty. This inherent stickiness is a double-edged sword; while it ensures consistent revenue from existing relationships, the pursuit of new, high-caliber clients can be a slow and rigorous process, often entangled in extensive proposal requests and negotiations.
Overall, the concerns raised by the recent short report and Argentina don't overly alarm me. However, vigilance in certain areas is essential to gauge DLO's ongoing health and growth trajectory effectively. Key areas to monitor include:
Total Payment Volume (TPV) Trends: Observing the TPV's movement is crucial. It serves as a direct indicator of DLO's market penetration and operational scale. An upward trend suggests growing merchant adoption and consumer trust in DLO's platform, while any stagnation or decline could signal underlying issues in market appeal or competitive positioning.
Gross and Net Take Rates: These rates are vital metrics for understanding DLO's revenue efficiency and pricing strategy's sustainability. The gross take rate offers insight into the company's top-line revenue before expenses, whereas the net take rate, accounting for costs, sheds light on the profitability of transactions processed. Fluctuations in these rates could indicate changes in business dynamics, competitive pressures, or shifts in merchant mix. Maintaining healthy and stable take rates is indicative of a balanced growth strategy that doesn't overly rely on price adjustments to attract volume.
Insider and Company Stock Activities: Transactions by insiders and the company itself can be telling of the leadership's confidence in the company's future. Insider buying can signal belief in the company's undervalued stock or future growth prospects, while significant selling might raise red flags about confidence levels within the company's core. Moreover, company-initiated stock buybacks or sales should be interpreted in the context of its capital allocation strategy, financial health, and outlook on value creation.