DLO - Part I
Payment Secular Tailwinds in LatAm
When I first thought of writing about dLocal (“DLO” or “dLocal”), the impression was that it was possible to do it in one post.
However, after careful consideration, I split the report into Part I and Part II. Even though the company hasn’t many complexities, the sector is demanding.
There is a few misunderstanding about the industry gear I wish to clarify in the post. Also, as promised previously, the idea is to avoid gigantic posts.
So, this first post will give a very (very) short overview of dLocal, and a profound analysis of the industry size, tailwinds, growth, and so on.
Next week, I’ll break down the entire value chain in dLocal’s take-rate and understand its future prospects, presenting my estimates, valuation, and why I don’t hold any stock.
The valuation (Xls) and the presentation (pdf) will be attached in the next week’s post. In my opinion, that would not make sense to break it down as well.
As a solo writer self-funding the entire research, any support is invaluable for maintaining the operations. To support my work, consider becoming a free or paid subscriber.
Credit Card Penetration
Share of Wallet
Estimating Addressable Market
DLO 0.00%↑ is a payment company focused on making the complex simple, redefining the online payments experience in emerging markets (ex-China).
The company enables global enterprise merchants to get paid (pay-in) and make payments (pay-out) online safely and efficiently through one direct API, one technology platform, and one contract.
Merchants on the platform consistently benefit from improving acceptance and conversion rates, reduced friction, and improved fraud prevention, leading to enhanced potential interaction with nearly 2 billion combined internet users in the countries we serve (excluding China).
dLocal’s proprietary, fully cloud-based platform can power cross-border and local-to-local transactions in 30+, mainly LatAm.
The solutions are built to be both payment method-agnostic and user-friendly, enabling global merchants to connect with over 600 local payment methods for emerging countries.
In the past decade, probably one of the industries that went through the most significant changes was payments.
Payments companies are using tech to digitize manual workflows and automate tasks to respond to customer demand, reduce expenses, and streamline legacy payment systems.
This includes deploying solutions that automate accounting processes and move money more quickly and efficiently, saving costs and proving profitability.
Cross-border payments & money transfer tech companies help businesses send funds to other businesses, often internationally.
Some technologies, like white-label digital wallets, help non-financial institutions customize their digital wallets to improve the customer experience.
Other tech solutions help financial institutions connect to real-time payments networks for faster payment processing.
According to multiple channel checks, we observed three key themes: customers are increasing their exposure to automated accounting, faster payment processing, and product personalization.
Companies in this space provide comprehensive payment processing solutions that allow businesses to accept payments through online, mobile, or in-store channels.
These platforms offer data integration across payments, marketing, and sales channels so that customers can shop and transact the same way online and offline, giving businesses a single view of the customer journey.
In the long-term, omnichannel payments startups help merchants integrate datasets to build personalized shopping experiences and drive customer value.
To understand the market trend, we selected leading payment processing firms, incumbents, and challengers and mapped all M&As they did.
For incumbents, it’s important to highlight they’re responsible for almost every payment processing firm acquisition.
Incumbents are global players. There are few incentives for them to expand and create a commercial relationship in smaller countries, so M&A is the cheapest alternative.
For challengers, though, except for one company, there is no acquisition of payment processing firms. Most challengers are born local, with their respective commercial relationships, so M&A between challengers' payment processing firms looks unlike.
If you’re interested in the exception, it was Valitor’s acquisition by Rapyd in 2021. Nevertheless, Arion Bank, Valitor’s previous owner, was actively looking for a buyer and leaving the business, so it was not Rapyd actively looking for new processing companies.
Nevertheless, challenger payment processing firms have been investing heavily in backoffice capabilities to support scalability, AP/AR, and POS to increase customer stickiness, as the payment processing is perceived as a commodity business.
We agree with them. Companies such as Stripe and $ADYEN, who transit from a payment processing firm to a Payment API & Infrastructure company, are likely to charge higher take rates with substantial stickiness to their clients.
Dealing with cross-border payments, we could split them up between B2B and B2C product bundles. In this post, we’ll focus exclusively on B2B, though B2C presents an exciting opportunity.
Today, establishing a commercial relationship with local partners is costly. For companies such as GOOG 0.00%↑ , MSFT 0.00%↑ , NFLX 0.00%↑ , and so on that operates globally, hiring cross-border companies is advantageous.
Even though take-rates are still high, global players have little interest in investing heavily in creating their own commercial network in regions with little importance to them.
For instance, if GOOGL 0.00%↑ didn’t hire any partner, it’d have to build 800+ commercial agreements with local partners to facilitate its receivables.
Even though we believe open banking will solve most of the puzzle, facilitating this connection will take years. Perhaps, decades.
In summary, cross-border companies make money transfer cheaper and faster by building various tech solutions:
Cross-border payments infrastructure that doesn’t run on traditional bank networks;
Platforms that allow clients to access legacy bank rails more easily;
Crypto-based payment solutions that run on blockchain technology.
The following years will be interesting for the sectors. In 2021, many companies emerged, backed by huge VCs. Take-rates will go down.
B2B money transfer tech is moving further into crypto & blockchain-based payments as emerging fintechs provide platforms, products, and services that leverage the blockchain network to transfer funds.
Bank incumbents still dominate the global money transfer market, although fintechs are gaining market share with SMB customers that tend to move smaller amounts of money across borders.
So, most cross-border players are focused on enterprise customers. We believe that it will take years for penetration in SMBs to increase, as the complexity is also greater.
Credit Card Penetration
eCommerce penetration, and adoption of electronic payment methods, credit and debit card penetration in emerging markets continues low relative to developed markets peers.
According to a study conducted by Morgan Stanley, the average card penetration of emerging countries is around 25% of PCE, almost 3x lower than the average for developed markets peers.
Lower penetration in a context of faster digitalization poses an attractive multiyear high growth opportunity for electronic payments in EM.
As highlighted in previous posts, we’ll always consider Brazil as our case study since the country is far ahead of any other in banking digitalization.
According to Rapyd, over 98% of Brazilians already use online banking and bank apps. Most (83%) are willing to migrate to fully digital banks, driven by their lower costs, 24-hour operations, and faster speed.
Consequently, credit card growth will be driven by product substitution due to higher product penetration and competition increasing in the past years.
LatAm eCommerce presented US$102bn in sales in 2021, while we forecast growth to US$250bn in 2026. In 2021, eCommerce volumes represented 13% of overall retail sales in LatAm (excluding autos, restaurants, and services).
While this was up notably from 5.9% in 2019, the secular shift toward online retail had been in place well before the Covid-driven acceleration.
Supported by our bottom-up company estimates and the top-down consensus expectations, we build to a cumulative US$250bn market opportunity by 2026, representing a 19% 5-year CAGR and a US$145bn incremental GMV opportunity.
Considering initial Covid impacts in 2020 and subsequent Covid-wave disruptions throughout 2021, growth accelerated to a 51% 2019-21 CAGR (69% in 2020, 35% in 2021); annual penetration gains were ~360bps over these two years.
Looking to 2021 figures, parts of the world had not fully normalized/reopened, likely benefiting the eCommerce channel. However, we also see structural and behavioral change, given the persistence of growth in 2021 on a historically tricky comparison.
Looking at 2021-26E, we forecast a 19% CAGR, with ~100bps of annual penetration gains, while the percentage growth rate is below pre-Covid levels, partly due to the more extensive base, penetration gains are more in-line with pre-2019 levels.
This is consistent with our view of a step-change in eCommerce demand, supporting the go-forward penetration curve in LatAm.
This depth and breadth support our conviction in a stronger-for-longer eCommerce growth outlook, even though we couldn’t estimate the penetration per category for LatAm.
Also, on a relative basis, forecast growth rates are higher for lower-penetrated regions (e.g., LatAm, ASEAN, Africa) and categories (e.g., grocery, personal care).
While there are headwinds (logistics and otherwise) in certain countries and verticals, we believe these barriers continue to come down; encouragingly, across the LatAm countries, we have yet to see a ceiling for eCommerce penetration.
At the country level, we estimate, on average, a five-year path from 12.5% to ~16.5% eCommerce penetration, supporting growth forecasts for markets in this phase of the eCommerce inflection.
The image below shows the eCommerce penetration curves for countries; we offer the overall penetration per country in LatAm.
Share of Wallet
We estimate that dLocal has been significantly increasing its share of wallet among its top ten clients. So even though we’ll talk specifically about dLocal next week, this is the only tangible illustration we have.
Regrettably, dLocal has not disclosed its top 10 merchants; however, our channel checks suggest that Google, Facebook, Netflix, Amazon, and Uber are included in the list.
We know that the top 10 merchants combined represented 56% of total revenues in 2021, but we do not know the revenue weight of each.
To estimate each client's wallet share and potential growth in existing clients, we took companies that provide greater granularity in their sales in LatAm.
For that, we consider the four companies offering better sales disclosure for their LatAm operations: Netflix, Facebook, Google, and Uber.
Initially, we had to assume participation as a percentage of sales. Considering that what really matters to us is the gain/loss of share of wallet, this is a very good proxy.
Considering the available evidence, we believe DLO 0.00%↑ has between 12% and 14% of the share of wallet for mature enterprise clients — we consider 13% in for our long-term market share.
Furthermore, with this information, we estimated the growth attribution for each new client cohort and the breakdown between the share of wallet and revenue growth.
This is super helpful for estimating new customers' sales growth since dLocal leverages it through gaining a share of the wallet, as we’ll see in the next post.
Estimating Addressable Market
Estimating dLocal’s TAM was tough. Since every market participant uses the same consultancy firm as the source, it’s hard to double-check the information.
Another problem is that the consultancy firm gives little disclosure in measuring the market size and how they estimate future growth.
Nevertheless, we’d like to highlight the market is considering their estimates in current FX, potentially overestimating the market size.
To simplify for clients, most consultancies present their estimates based on USD since it's the currency most clients forecast their PnLs.
The problem of estimating the TAM in USD, not in local currency, is that you exclude potential growth and inflation differentials that may affect the outcome.
For instance, the estimated inflation for the US in 2022 is 5.5%, while Argentina has an expected 57% inflation for the same period for similar real GDP growth.
Not taking this into consideration is a huge mistake. For that, we built our model in local currency for each country in LatAm, considering the inflation differential for the forecasting.
As usual, our proxy country is Brazil. Therefore, we considered its PCE and, through our top-down model for payment companies, estimated the online spending and the actual TAM for DLO 0.00%↑ .
Comparing our estimates to the consensus estimates, we point out that i) the consensus considers cash transactions, wire transfers, and wallet P2P in their market share composition.
By doing this, they’re overestimating the addressable market by almost 30%, which we consider an avoidable mistake.
Nevertheless, the general assumptions related to credit card penetration are overly conservative. On our side, we see an aggressive advance in digitalization in LatAm.
Finally, considering all the above, we present our estimate for dLocal’s TAM. Even though we’re significantly below the consensus, we thought that would be worse.
Since we know many people will come after us complaining about our TAM, we’ll go over most assumptions we’re considering for the TAM.
In our premisses, digital commerce covers all online purchases of goods and services, regardless of the device or payment method used – whether in retail, travel, or digital goods and services.
This includes purchases made with locally issued payment methods, cross-border purchases, B2C e-commerce, and B2B e-commerce that flows through a merchant’s online website and payment gateway.
In our premisses, we consider the following transactions:
Retail: related to physical goods, from departments to grocery stores and marketplaces. This was the “easiest” one. Since we already had a massive work building our top-down model for the credit card industry, we had to collect extra data from Central Banks and local regulators, but it was “quick.”
Digital goods: digital products and services such as music and video streaming, ride-hailing services, food delivery, and SaaS, as well as subscriptions and recurring payments made online.
Travel: all travel-related services, including airline and bus tickets, hotels and accommodations, car rentals, packages sold by travel agencies, etc. After Covid-19, collecting data from travel companies became much more accessible since every local regulator started to make it public.
Before moving on, though, we’ll recognize that we didn’t consider Argentina in our TAM. No kidding, it’s far more complex than most people estimate anything for a country running at a 50% annualized inflation.
Unfortunately, given the country's inflation, we weren’t smart enough to figure out all the distortions caused by our modeling. Therefore, we recognize our limitations and exclude the country from the sample.
SME businesses are going online for the first time, while global players are expanding to the region with an eye on LatAm. As a result, we expect eCommerce to grow 20% annually in this booming market through 2025.
Even though the travel industry is yet to recover after Covid-19, we don’t see the industry reaching previous levels as a percentage of online sales ever again.
The reason is relatively simple: retail and digital products and services are booming, primarily due to a disruption in many industries, such as cable TV versus streaming, B&M retail versus marketplaces, etc.
Still, our modeling points out that travel should yield superior growth through the following years, leading all categories growth.
Then, we have the digital products and services driven mainly by mobile apps, including all the applications that fall under the digital goods category, such as streaming services, gaming, finance, social, delivery apps, and ride-hailing services.
We believe that companies will keep pushing the app because they engage more, incentivize loyalty, and maximize engagement. So, we believe penetration should keep increasing in the following years.
Regarding the competition, Latin America has been remarkably flooded by new global participants. Last year, Disney+, Star+, HBO Max, Discovery, and Paramount Plus were some of the services that announced new operations in the region.
Slower subscriber growth in more mature markets, such as the US and Europe, helps to explain this movement. Recently, both Netflix and Disney+ seemed to have reached a saturation point in subscriptions in North America, with their number of paid users stalling.
Meanwhile, in Latin America, video streaming subscriptions are expected to reached 76mn by the end of 2021 – up from 53 million, a 43% growth YoY, according to Digital TV Research.
All of this is also leading to fierce competition in LatAm. Up to two years ago, Netflix was the absolute leader in video streaming services in the region, holding almost the entire market share alone.
However, in 2021, Netflix had a 50% market share in Latin America, followed by Disney+ (21%), HBO Max (19%), Amazon Prime Video (10%), and Viacom CBS (10%), according to Netscribes' primary research.
The same happens for different services, such as finance, audio streaming, etc. Consequently, we still estimate considerable growth for the category.
Finally, putting all the elements together, we find the TAM presented in the previous section of this post. We believe that our analysis considering all moving parts is reasonably conservative and within our circle of competence.
In the next week, we’ll consider the information presented this week as the primary assumptions for dLocal’s growth. We believe that explaining bit by bit of our findings will help investors digest our expectations for the company.
Thanks for reading. Cheers and a fantastic weekend, folks.