dLocal delivered yet another strong quarter. However, the analysts concern on the Argentina crisis and the rise in company’s operating expenses in Q3 seem to dampen the upside to the stock. The company’s revenue grew by 63% YoY and up 11% QoQ to $111.9 million. The company beat the analysts revenue estimates by 1.6% and the revenue growth is good in spite of the high comps of last year. The total payment volume (TPV) grew by 51% YoY and 12% QoQ to $2.7 billion.
The company’s net revenue retention rate came at 152% compared to 157% in the Q2 2022 and 185% in the same period last year. The NRR has decelerated, however it is within the management guidance of above 150% for the year 2022.
The company’s revenue from top 10 merchants accounted for 53% of the revenue. This is down from 51% in Q2 2022 and 57% in Q3 2021.
The company’s LatAm revenue grew by 39% and flat QoQ to $87.3 million. The LatAm revenue accounted for 78% of the total revenue. Excluding the Argentina’s cross border business, it grew 43% YoY and 7% QoQ in LatAm. Argentina’s central bank has imposed some limitations to access the foreign exchange market for the payment of certain imports of goods and services as the country faced a fall in foreign currency reserves. The management mentioned in the call that the situation has improved during the quarter. However, the analysts were not too impressed as they had concerns that these issues in Argentina could be recurring unless the situation in Argentina improves.
The company’s revenue in Asia and Africa grew by 312% YoY and 80% QoQ to $24.5 million. It accounted for 22% of the total revenue compared to 9% in the same period last year. The management is positive on the growth in these regions. The company’s single API has helped it to quickly ramp up in these regions.
The company’s President, Jacobo Singer said in the earnings call, “So I think, overall, it's taking what was saying, the fact that we have a single API we call — and we have. There are a lot of analogies between the services we have been providing Latin America and opportunities that are in Africa and in Asia, and we have been able to replicate our playbook in LatAm in those two continents. And the merchants, they value a lot the fact that, that playbook is constant on the same API and on the same agreement, allow them to test our service or in the region faster than doing any other solution before.”
The company’s gross profit grew by 56% YoY and 9% QoQ to $53.9 million with a gross profit margin of 48% compared to 49% in Q2 2022 and 50% in the same period last year. The management mentioned that the slight decrease was due to the country and product mix. Diego Canay, CFO of the company said in the earnings call, “Our cost of processing for the quarter represented 2.0% of our TPV, stable quarter-over-quarter and compared to 1.8% a year ago. The increase versus Q3 2021 was driven by business mix, particularly an increase in pay-ins, which have higher processing costs than payouts.”
The operating profit was $37.2 million compared to $21.6 million in the same period last year. The operating margin was 33% compared to 31% in the same period last year. There was a rise of operating expenses that was primarily due to the increase of headcount, marketing, and travel expenses.
Diego Canay said in the earnings call, “If we look at operating expenses for the quarter, we see that they have grown 26% year-over-year, as we saw an increase in salaries as we continued expanding our team with focus on sales, expansion and technology. In addition, we increased our travel and marketing expenses. We operate in a hyper growth business and want to keep investing in building the infrastructure and harvesting long term sustainable growth with a very disciplined and lean approach.”
The company’s net profit came at $32.5 million compared to $19.7 million in the same period last year with the net profit margin of 29% during both the periods. The company’s EPS came at $0.10 compared to $0.06 for the same period last year. The company missed the analysts EPS estimates by $0.01. The profits for the current quarter include net financial losses of $2.5 million which was mainly driven by higher cost of hedges due to the changes in FX regulations and higher interest rates. The management expects these financial costs to get normalized in the coming quarters.
Jacobo Singer said, “So regarding financial expenses and related to this particular change in regulation, yes, part of Q3, we have incurred into high cost of hedges because of the change in regulation. We see these being temporary changes, which we need to incur extraordinary in order to cover our position. As we have always been saying, we take a very conservative approach towards FX. We have never been in the business of taking corrective risk — so that's why we hedge non-dollar amount. If anything, we expect in the coming quarters this cost to get again normalized going forward.”
The adjusted EBITDA increased by 58% YoY and 9% QoQ to $42 million. The adjusted EBITDA margin was 37% compared to 38% in the last four quarters. The management has a given a guidance of 35% plus for the year 2022. To an analysts question for the guidance for Q4, Diego Canay replied, “Sure. So we give you annual guidance, so we're not giving guidance per quarter. As we mentioned, all the strengths continue in terms of growth. As I mentioned, we have an increase in OpEx in the third quarter, but we don't expect that type of increase in the coming quarter. So we expect operating leverage going forward. We will guide for a new EBITDA margin level in the next year, but these are the trends that we are seeing right now.”
The company has a cash and marketable securities of $542.3 million which includes $320 million of own funds and $222 million of merchant funds. The company has debt of $14.8 million. The company generated a free cash flow of $121 million in the past year.
Fintech companies are disrupting the global economy with new and innovative products. Technological advancements have led to considerable investments in this sector and traditional finance companies have not been able to efficiently cater to changing business needs. Of the recent fintech quarterly earnings, D-Local stood out for its strong bottom line. The company’s cloud-based payment platform is popular in the emerging markets of Latin America, including Brazil, Argentina, Mexico, Colombia, Uruguay, and Chile. It allows international enterprises to operate in the emerging markets by using the company’s payment platform to receive and make payments, and comply with local regulations, taxes, foreign exchange, and fraud management. The payment service is used by companies such as Amazon, Microsoft, Didi, Mailchimp, Wix, Shopify, Wikimedia, etc.
DLocal released its Q1 2022 results last month. The company’s revenues grew by 117% year-over-year to $87.5 million. It beat the Wall Street revenue estimates by 5.9%. The company also reported a 30% net profit margin in the recent quarter. The solid top-line growth, earnings beat, and good profits sent the stock soaring 15% the following day of the announcement of the results.
Below, we discuss the market opportunity, the company’s background and a full financial picture on this hot fintech stock.
Market Opportunity
According to Vantage Market Research, the fintech market is expected to reach $332.5 billion by 2028 from $112.5 billion in 2021, growing at a compound annual growth rate (CAGR) of 20% from 2022 to 2028.
KPMG published a Pulse of Fintech H2’21 report suggests that the investment in the fintech sector was strong in 2021, and the trend is expected to continue in 2022. According to the report, the global fintech investment reached $210 billion in 2021. The payments category drew a record in venture capital funding. The report also highlights the record investment in emerging markets like Latin America and Africa.
Mike Louw, Partner, Head of M&A KPMG South Africa, said, “The northern hemisphere is a crowded marketplace and multiples are at an all-time high. This makes Africa an attractive alternative. Global PE firms and investors are seeing the opportunity. It’s put the continent on the fintech map.”
Ricardo Anhesini, Head of Financial Services, LATAM KPMG Brazil said, “The growth of fintech in Latin America is a classic example of ‘leapfrogging’ — fintechs have leveraged the need for financial inclusion amongst large swathes of the population to move straight to a new generation of services.”
Company Overview and product niche
The company was founded in 2016 in Uruguay. The shares were listed on the Nasdaq stock exchange in June 2021. Through its single API, technology platform, and a single contract, the company helps global enterprise merchants to be paid (pay-in) and make payments (pay-out) in the countries it operates. The company’s cloud-based platform can make cross borders and local payments in 37 countries while enabling global merchants to connect to over 700 local payment methods.
The company’s Marketplace payments solutions allow its sellers to receive payments in the local payment methods through credit or debit cards, bank transfers, and cash. The company makes it easier for global enterprises to operate in the region by partnering with a local payment platform by saving the hassle of complex regulations and solving difficulties that arise due to the lack of efficient banking facilities in these countries.
The company’s tie-up with alternative payment methods (APM) providers plays a role in the unbanked population. In Brazil alone, there were 34 million unbanked adults, according to a study by Instituto Locomotiva conducted in January 2021.
The company also cited in the F-1 the research from Americas Market Intelligence (AMI). In Brazil, domestic credit cards constituted 55% of the total e-commerce payment volumes, followed by alternative payment methods at 21%, cash at 14%, and the rest 10% of international credit cards. It highlights why the company has been popular in emerging markets and can easily bridge a gap in places with a high percentage of cash transactions and consumers using local payment providers.
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For example, one of Brazil’s popular alternative payment methods is Boleto Bancario. Boleto means a ticket with a due date and the amount to be paid. Previously, it was only cash, and now the payment can also be made through bank accounts or in various branches, post offices, and ATMs to use the goods and services. Boleto payments were typically confirmed in 2-3 days, however, this time is reduced to a few minutes through the company’s API’s. This shows how the company’s tie-ups with APM providers are successful.
The company has been a boon to global enterprises by solving the problem of dealing with tough regulations, tax complications, and fraud detection. The emerging markets are witnessing rapid e-commerce growth. Due to the under penetration of the digital economy, emerging markets are the hot spot for fintech companies.
Pay-In
The company’s pay-in solution helps merchants to offer services and receive payments in various payment methods like international and local cards, bank transfers, cash, and other alternative payment methods. Examples include: Microsoft sells its products in Nigeria and can accept payments from local payment providers. Due to the company’s single API they can easily expand to all countries where DLocal operates.
Pay-Out
The company’s pay-out solution facilities global companies to make payments in the countries in which DLocal operates. The company ensures that the payments are to the registered bank accounts of the users in accordance to the regulatory requirements. For example, Ride-hailing companies can make secure payments to their drivers in the emerging markets through the DLocal platform.
Marketplaces
Marketplaces allow sellers to sell internationally and receive money in their local currency. For example, in many cases, international sellers will not be able to sell in emerging markets since they will not have local bank accounts to collect payments. In this case, the marketplace onboards the sellers as they need to comply with local regulations and DLocal will facilitate receiving the payment in the local country and then send money to the international sellers.
Financials
The company has delivered strong top-line growth with good profit margins. In the recent Q1 2022 results, revenue grew by 117% YoY to $87.5 million. It was the fifth consecutive quarter of triple-digit growth. While the triple-digit growth rate is not sustainable into the future, Wall Street analysts still expect strong revenue growth to continue as they forecast revenue to grow 74% in the next quarter, followed by 58% in Q3 and 59% in Q4.
For the full year 2021, revenue grew by 134% YoY to $244 million. Wall Street analysts expect revenue to grow 73% YoY to $422 million in 2022 and 52% YoY to $640 million in 2023.
Source: YCharts
The company earns revenues from fees charged to the merchants for payment processing services. The company’s total payment value (TPV) accelerated by 127% to $2.1 billion. The take rate was 4.2% in Q1 2022 quarter compared to 4.1% in Q4 2021 and 4.3% in Q1 2021. The formula for take rate is revenues/ total payment volume.
The company’s business is not dependent on a single industry and has a diversified base of more than ten business verticals. The company is also geographically diversified to over 37 countries which is positive.
The LatAm region revenue grew by 116% YoY to $78 million and accounted for 89% of the Q1 2022 revenue. The Asia Africa region’s revenue grew by 127% YoY to $10 million and accounted for the remaining 11%. The company expects the revenue share from Asia and the African region to gradually increase over a period of time as the company cross-sells to merchants that originally began their relationships in the Latin American area.
The company has been able to grow its revenues with its existing customers, which is demonstrated by the strong net retention rates (NRR). The NRR in the Q1 2022 was 190% compared to 198% in Q4 2021. The high NRR is not sustainable, and the management expects the NRR to be over 150% for the full year of 2022, which is still good.
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Sebastian Kanovich, CEO of the company said in the recent earnings call, “So we built the whole platform in local on the premise that it's one API, one contract and one platform for everything we do. So it's extremely simple for merchants to expand with us. That's the key driver behind our NRR. Merchants start with us in one geography, and they continue to move into other products and geographies without any friction. That's why you see us continue expanding geographically. We want to make sure we have more attachment.”
The company’s gross profits grew by 87% YoY to $43.6 million, with a gross profit margin of 49.8%. The company’s CFO, Diego Canay, said in the earnings call, “We continue to expand our gross profit and EBITDA. Starting with our gross profit, as we have mentioned in the past, our commercial focus is to increase our gross profit dollars per merchant. As a result, our gross profit continues to grow at a healthy rate.”
The company’s CEO also echoed a similar tone. He said, “When we ask our commercial teams and the way we incentivize them, it's purely on gross profit dollars to make sure that we are adding more dollars to [our] P&L.”
Source: YCharts
The company’s net profit came in at $26.3 million compared to $16.9 million for the same period last year. The net profit margin was 30% in Q1 2022, which is at the same level as the H2 2021 and lower than the 42% in Q1 2021.
The adjusted EBITDA margin was 38% in Q1 2022 compared to 38% in Q4 2021 and 44% in Q1 2021. The adjusted EBITDA margin was partly lower due to the higher share-based compensation in the recent quarter. However, the management is guiding an above 35% EBITDA margin for the full year, which is positive.
Risks:
The company’s revenue growth is slowing down from the triple-digit growth in the past five quarters is a risk to consider. The company’s costs have increased due to the return of in-person marketing and travel expenses. Also, the stock is currently trading at a forward P/S ratio of 17. The high valuations are another risk to consider with rising interest rates and macro uncertainty.
Our firm tends to be wary of IPOs in general and we covered the risks associated to IPOs last year here. We are particularly sensitive to companies that go public with very high growth rates that decelerate quickly, in this case, DLocal will have decelerated by nearly 50% from 186% in Fiscal Q2 to 74%.
Conclusion
The company has demonstrated strong revenue growth with good profits. It has developed a niche in the fast-growing emerging markets. However, considering the current macro uncertainty and the risks mentioned above, we are not interested to buying the stock at the current levels.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund do not own DLocal at time of writing and have no plans to enter the stock in the next 72 hours.
We recently purchased Upstart as part of the momentum portfolio, and we plan to hold it into strength. The company is well known and had a breakout year in 2021. I provide a brief summary of the company’s business model, what we like about the business and key risks.
What does Upstart do?
Upstart is an artificial intelligence (AI) cloud platform that is used to facilitate loan originations. The company uses over 1500 variables in its AI models, which allows its platform to underwrite superior loans with higher approval rates, lower interest rates and lower default rates for consumers compared to legacy lending approaches.
Upstart was founded in 2012 by a Google technologist, Dave Girouard, who worked at Google in 2004, when the company was quickly scaling. Upstart originated its first loan in 2014 and its AI platform more accurately prices risk for unsecured consumer loans, and has now expanded into auto loans. In 2021, 69% of its loan were fully automated, which helps facilitate more loan volumes. Increasing loan volumes strengthen the company’s AI models, improving its competitive moat and giving it a larger lead relative to competitors. Being the first mover in tech is often the most important aspect of the story, and Upstart has a large advantage with its relatively long history of repayment data that will be difficult for competitors to replicate.
Lending is critical to the US economy, and between 2014 through 2021, commercial banks lent out over $16.5 trillion in loans. However, the pricing of these loans has largely relied on legacy methods invented before the emergence of cloud computing and modern data science. A study by Upstart found that four out of five Americans have never defaulted on a loan, yet less than half of them would qualify for the low rates that banks offer. Furthermore, there are enormous amounts of data points available for lending decisions, such as payment data, banking transactions, employment history and educational background. It is a natural progression for cloud computing, AI and machine learning to be applied to lending, given its massive scale and legacy approach.
Revenue model and opportunity
Upstart is a platform for loan originations, its not a bank. Furthermore, the company partners with banks, it does not compete with them like other Fintech companies. The company’s revenues come from fees from originating loans on its platforms that are paid by its banking partners. These fees accounted for 91% of revenues in 2021. Importantly, Upstart’s revenues are low risk and 94% of its sales have no exposure to credit risk.
Revenues are primarily usage-based, and rising loan volumes contribute to rising revenues. As shown below, 2021 was a breakout year for loan volumes, which increased to over $4 billion in Q4 2021. Volumes have primarily been from personal loans that are used to refinance high interest credit card debt for consumers. For example, in Q4, Upstart originated 495,000 loans for $4.1 billion, or $8,300 per loan, and the personal loan market is large, estimated at nearly $100 billion.
The company has fully scaled into personal loans and has now expanded into new markets, such as auto loans. In Q2, the company purchased Prodigy, which expanded its addressable market in auto loans. Management expects auto loans to grow through 2022, which will weigh on its contribution margin in the near term until the company reaches scale, which it expects to do faster than it did with personal loans since it now “has the playbook down”. Beyond auto loans, the company expects to expand into Mortgages in 2023, a massive market at nearly $5 trillion.
What we like about Upstart:
There are a few key aspects of Upstarts model that we find attractive:
– Flywheel effect: Upstart has first-mover advantage, which has allowed it to amass more repayment data and improve its AI models. Its models benefit from a flywheel effect as repayment data leads to improved accuracy of risk pricing, which results in higher approval rates and lower interest rates, which leads to increased volumes and more repayment data. Upstart’s conversion rate, or the number of loans improved per inquiry, increased to 24% in 2021, up from 15% and 13% in 2020 and 2019, respectively. As its AI models improve, its conversion rate should also ramp, increasing volumes and giving the company a significant data advantage.
– 94% of sales have no credit exposure: Upstart is a platform for banks, the company is not a bank, nor does it compete with banks. It offers a marketplace for loans and charges a platform fee and generally does not own the loans. Even if it's 6% of credit exposure defaults, Upstart's high margin earnings can absorb it. The loans it carries are for R&D purposes (discussed below), meaning that its credit exposure should decline going forward.
– Upstart is highly profitable at scale: Loan volumes soared 338% YoY to 1.3 million and total sales increased 264% YoY to $849 million. Contribution margin increased 400 bps YoY to 50%, adjusted EBITDA increased YoY from 13% to 27% and GAAP EPS soared to $1.73. Cash flows from operations increased to $168 million and co-founder-CEO Dave Girouard explained on the Q4 that “We generated more cash in 2021 than we burned in our entire eight-plus years as a private company”. CFO Sanjay Datta added that “the natural profitability of [our] overall model will trend to its equilibrium direction, which we believe is higher than where it is today”
– Upstart’s customers, banks, are outperforming: Upstart's partner banks are doing really well. For example, Customers Bancorp was its first bank partner and Customers' funding form landing page includes a URL link to upstart.com (https://customersbank.upstart.com/funding_formupstart.com/funding_form). Customers Bank was the 2nd largest PPP lender, despite being a relatively small bank, and is a strong lender in personal loans. The company’s partnership with Upstart has likely allowed the company to outperform. Furthermore, high levels of deposits and liquidity levels following the COVID relief programs has created a unique environment for bank lending, and loan demand has been increasing.
– Market opportunity is wide open: Upstart is currently in personal and auto loans. It can expand into the following credit markets: credit cards, mortgages, student loans, small business loans, point-of-sale loans and HELOC. Lending is one of the largest markets ($16T loans since 2014) and is still primarily based on legacy models developed before the cloud era.
– Room for continued improvement: Conversion rates are still relatively low at 24%. As AI models improve from increased repayment data, the conversion rate will rise, leading to more volumes. Also room for continued improvement in fully automated approvals, which were at 69% of total loans.
– Outperformed during COVID: Upstart disclosed in its 10k that during the peak of the COVID pandemic, 5.6% of Upstart’s borrowers had enrolled in a hardship program, less than half of the rate of online industry benchmarks. Furthermore, 95% of these borrowers exited the hardship program and resumed repayments. The COVID-19 pandemic provided valuable data for Upstart, further improving its models and likely also improving the confidence lenders have with its AI powered models. Prior to COVID, Upstart’s models had not been tested during market turmoil, so it was unclear if its AI models were superior. The pandemic may have been an inflection point for the company that proved that its models worked.
Risks:
– Significant customer concentration: Two customers accounted for 83% of total revenues. High exposure to two customers naturally increases the risk of an investment. Furthermore, customer concentration from these two banks increased YoY from 81% of sales in 2020 to 83%. Upstart's largest customer is Cross River Bank, which originated 55% of 2021 loans for the company and also accounted for 56% of fee revenue. Cross River Bank is a partner to many fintech companies and is a conduit between Upstart and institutional investors that will ultimately buy its loans. As a result, the high customer concentration is not as concerning since its actual customer base is much broader. Furthermore, Upstart's reliance on Cross River Bank has been reduced and its second largest customer increased from 18% of 2020 sales to 27% of 2021 sales.
– Cyclical market: Lending is inherently a cyclical market that is impacted by economic strength. If lending stalls, Upstart’s growth will also stall. However, the company is a technology company and while it may be impacted by short term cyclical trends, it is a long-term secular change to the entire industry that should outperform over time.
– Credit exposure to sales has increased from 3% of Q2 sales to 6% of Q4 sales: Upstart is not in the business of collecting interest income, but a portion of its sales come from holding credit risk (loans). Loans carried on its balance sheet increased YoY from $78 million to $252 million in Q4 2021. Management explained on the Q4 call that the large increase in loans was for R&D purposes, as it expands into auto lending. CFO Datta explained that “Most notably, auto lending has been funded since inception entirely from our own balance sheet. This is, as always, a temporary incubation period until we reach the point where the loans can be directed to our bank partners and institutional investors at reasonable scale, which we anticipate will begin to happen next quarter”. However, in the company’s 10K, it disclosed that only $50 million of its $252 million in loans were auto loans; it is unclear why the company holds an additional $200 million in loans on its balance sheet. We will want to see Upstart’s loan balance decline going forward. Luckily, loans >90 days past due are low at just $287,000, so credit impairment risk is low.
Disclaimer: the I/O Fund owns a beneficial ownership in Upstart. The I/O Fund did not receive compensation for authoring this article from any of the discussed companies,
Bill.com is a fast-growing company that is benefitting from a strong cohort of customers: small-medium businesses (SMB). The company has also completed a couple of transformational M&A transactions in recent quarters which have led to successful cross-selling of solutions, inflecting growth at the core company and the acquired businesses. We believe that the company’s large asset of B2B payment data gives them an advantage in understanding their end market and allows them to efficiently grow. Furthermore, network effects should sustain topline growth going forward. I discuss the company’s fundamentals in more detail below, followed by a discussion of Bill.com’s recent financial results and risks to our thesis.
Bill.com’s Market Position and hidden assets
Bill.com is a back-end accounting software platform that was built to facilitate transactions for small-medium businesses (SMB). The company’s niche is facilitating accounts receivables (AR) and accounts payable transactions (AP), which is the most common business transaction. Every AR transaction involves an AP transaction, and Bill.com has positioned itself to be between this essential business function.
The company’s platform includes accounts payable automation which streamlines the entire process: from bill receipt, to approval, to payment and then entry into an accounting system such as QuickBooks. Bill.com provides a portal that allows customers and suppliers to link their bank accounts and to make electronic payments, improving payment times. If the invoice is mailed, customers can scan the invoice and Bill.com’s AI-enabled software can automatically input the key details. Furthermore, all invoices are stored and searchable which helps settle outstanding AP issues.
The AP automation also allows for bill approval, which Bill.com states is one of the top three uses of its software. Inherent in the approval process is the separation of duties, which assigns roles such as payor, approver, clerk or accountant. This ensures the checks and balances of a back office and helps reduce fraud and provides an audit trail for auditors.
The AR automation solution provides a template to create an invoice and sync with accounting systems. Furthermore, if both parties of the transaction are on Bill.com’s network, then customers can see if the invoice has been viewed and if it has been authorized. Simply put, the AP and AR solutions allow for easier payments and trackability.
Being positioned between AP and AR transactions gives Bill.com two significant assets: a data asset and a network. The data set includes payment data from over 130,000 customers, 3.2 million network members and millions of transaction details. Having access to B2B payment data is a significant advantage in today’s AI/ML-enabled world, and Bill.com is able to leverage this data to find insights that fuel topline growth. In fact, payment data was estimated at a total value of $58 billion in 2020. Bill.com disclosed that data is key to its success. It stated in its 10-K that:
“We recognize and understand patterns that our customers may not, because we see the aggregate – millions of accounts payable and accounts receivable transactions per month. We use what we learn to continuously improve the platform and the customer experience.”because we see the aggregate – millions of accounts payable and accounts receivable transactions per month. We use what we learn to continuously improve the platform and the customer experience.”
Furthermore, this data is not an asset shown on the balance sheet, nor does it directly impact the income statement. However, access to this data allows Bill.com to better understand its customer’s needs, leading to outsized growth over time.
Another asset that isn’t shown on the balance sheet is Bill.com’s network. When a customer signs onto the platform, they also add on their clients and suppliers as the other side of the AR/AP transaction. This increases the network beyond customers, and Bill.com has built a B2B payment directory of over 3.2 million network members. These network members are all potential customers, leading to a low-cost customer acquisition strategy. As more customers sign up, they add clients and suppliers as AP/AR transactions, further increasing the network and providing more payment data. This network effect can lead to robust, high margin growth in the future as the business scales.
Catalysts for future growth
Bill.com has reported a series of quarters with accelerating growth, highlighting both the success of its cloud-based solutions and the strength of its main customer cohort: SMB.
If economic activity picks up, especially among SMB, then AP and AR transactions will also grow, benefitting Bill.com’s usage-based business model (discussed in more detail below). SMBs appear well-positioned to succeed in the digital economy. This is because major corporations are providing tools that help SMB better compete with legacy enterprises.
For instance, SMBs can quickly build a working e-commerce website on Shopify without hiring and employing an army of web developers. An SMB can also rent server capacity from AWS without investing large amounts of upfront capital to run its operations at scale.
The SMB market opportunity in front of Bill.com is large. There are over 6 million SMB in the US and 20 million globally. As of the latest quarter (Q2 FY2022), Bill.com has captured just over 2% of this market. With an annualized core revenue run rate of $2,000 per customer, Bill.com’s total addressable market is around $70 billion.
Furthermore, the Small Business Administration (SBA) has prioritized increasing capital to small business owners in the U.S. The SBA disclosed that in 2021, they had provided $45 billion in loans through more than 61,000 individual loans, this was up from $28 billion in the prior year. This also excludes the over $500 billion in PPP loans provided to SMB during 2020. Clearly, SMBs are flush with capital, which should lead to increased business activity for this cohort in the near term.
Data from the Kansas City Fed showed that SMB loan demand remained robust in 2021 (excluding PPP loans). The chart below shows that net change in loan demand for small businesses, and “about 10 percent of respondents indicated stronger loan demand in the third quarter, which is the third consecutive quarter of net increases in loan demand”. More recent data from the New York Fed showed that credit card balances increased $52 billion in Q4, the largest increase in the 22-year history of the data. However, credit card debt remained $71 billion below 2019 levels, suggesting continued room for growth. The rise in credit card balances may be a sign that SMB activity was robust in Q4, as credit cards are often a short-term funding tool used by small businesses. Bill.com also has exposure to this with its corporate card product, discussed below.
Moreover, Bill.com has made a couple of transformational acquisitions in 2021 that allow it to cross-sell solutions. The company acquired corporate card issuer Divvy in June 2021 for $2 billion. When Divvy was acquired, sales were growing over 100% with annualized revenue of around $100 million. Bill.com’s CEO-Founder explained on during the Q4 2021 call that the Divvy acquisition allows for a “sizable cross-sell opportunity that we will aggressively pursue”. He added that the Divvy acquisition “more than doubled” the company’s domestic addressable market.
We can see signs that there has been significant cross-selling between platforms. For instance, Divvy customers have increased from 7,500 in March 2021 to 15,500 customers as of December 2021. At the same time, Bill.com reported that Q4 customer count had increased 8,100 QoQ in the December quarter to 135,000, which was well above trend of ~5,000-6,000 quarterly additions. The robust customer metrics between the two segments suggest that Bill.com has been successful in cross-selling both solutions. Further highlighting this trend, Divvy’s sales increased 188% and 187% in Q2 and Q1 FY2022, respectively, an acceleration from its growth rate of 100% before it was acquired. Likewise, Bill.com’s organic sales have accelerated for five consecutive quarters.
Another recent acquisition was Invoice2go, which was acquired in September 2021 for $674 million, which added 220,000 customers to the platform and $25 billion in annual invoice volumes. On the Q2 FY2022 call, CEO Lacerte explained that the acquisition was driven by management’s intention to cross-sell payable solutions to Invoice2go customers, and vice versa. Highlighting the momentum in Bill.com’s ability to cross-sell solutions, management recently raised their full-year sales guide for Invoice2go from $24 million to $34 million, an increase of 42%.
However, it should be noted that customer count declined QoQ at Invoice2go and deaccelerated for Divvy in the most recent quarter. Management stated this was due to higher credit standards and onboarding criteria after being acquired. I discuss this risk and others in more detail further below.
Financials
As mentioned above, Bill.com has reported five consecutive quarters of accelerating topline growth. Organic sales most recently grew 85% YoY to $97 million, an acceleration from the 78%, 73%, 45%, and 38% YoY growth rates in the prior four quarters. The continued acceleration in core sales has been driven by its ability to cross-sell solutions and strength with its SMB cohort.
Total sales increased 190% YoY to $156 million in the latest quarter. Sales were driven by subscription fees (31% of Q2 FY2022 sales) and transaction fees (68%). Subscriptions are fixed payments while transaction fees are based on usage and include interchange fees on a fixed or variable rate per transaction. Bill.com also earns interest on funds held for clients, which was 1% of total sales.
Subscription sales increased 85% YoY to $49 million, or 31% of Q2 FY2022 sales. The increase was driven by a 24% YoY rise in core customer count, which increased to 135,000 customers and a rise in ARPU. Bill.com also adopted a new accounting standard which added $4 million to subscription revenues and signed a new partnership agreement with Bank of America that added ~$6 million in subscription sales. Absent these one-time items, organic subscription sales increased 51% YoY, which still represented an acceleration from the 43% YoY growth rate in the prior quarter.
Accounting for the majority of Bill.com’s recent topline outperformance was growth in transaction fees, which increased 314% YoY to $106 million, or 68% of Q2 sales. Transactions fees followed a 62% YoY rise in total purchase volumes (TPV), which increased to $56.4 billion. TPV per customer also increased 31% YoY to $418,000, highlighting the company’s ability to successfully cross-sell solutions from recently acquired companies.
Further fueling Bill.com’s transaction fees was an increase in the take rate, which rose 3 bps YoY to 10 bps, following a shift to variable-priced products. Payment volumes on Bill.com’s core platform increased 36% YoY to 9.8 million and revenue per transaction also increased 62%, following the higher take rate. On the Q2 call, CFO John Rettig explained that transaction revenue was driven by “strong TPV growth, increased adoption of our ad valorem products and increased usage of our spend management card solution”. On an organic basis, transaction revenue increased 121% YoY.
The growth in transaction fees has been a key driver of Bill.com’s success, and there is room for continued improvement since new customers typically ramp spending over time. According to Bill.com’s pricing schedule, credit and debit card fees are variable, suggesting that there has been a material rise in credit card usage in recent quarters. This ties back to the fundamental data discussed above, as the New York Fed stated that credit card usage grew at the fastest pace in Q4, dating back 22 years. However, credit card balances still remain below 2019 levels, suggesting that there may be room for continued growth.
Adjusted operating profit was $3.4 million and non-GAAP EPS broke even at $0.00, which beat estimates by $0.17. The market tends to award companies that report consistent profitability and Bill.com is likely nearing that threshold. Bill.com had $2.8 billion of cash on balance as of Q2, allowing the company to continue to scale its business. Furthermore, Bill.com held $3.4 billion of customer funds, up 39% QoQ driven by the ramp in TPV discussed above. If interest rates rise, Bill.com’s float could be a material contributor to its topline. CFO Rettig explained that if the federal funds rate rose 100 bps, its annual float revenue would rise to ~$35 million, or 9% of TTM sales.
Looking forward, management expects sales to be $158 million, up 164% YoY and besting estimates that expected growth of 146%. Q3 sales are expected to be driven by 67% organic growth while Divvy is expected to increase 132% YoY. Non-GAAP EPS is expected to be a loss of -$0.16, which was better than the initial -$0.22 loss expected by the Street. Management also raised their full-year 2022 topline estimate to $600 million. Organic growth expectations were increased from 55% to 69% and Divvy sales growth was raised from 115% to 132% growth. Invoice2go sales are expected to be $34 million for the year, up from the initial guide of $24 million.
Valuation and risks
Bill.com is performing strongly, likely as a result of its large data asset of B2B payment data that gives it insights into what its customer’s needs are. Bill.com has leveraged this data and has made some transformational acquisitions that have increased cross-selling opportunities, leading to accelerating growth at the core platform and the newly acquired companies. Following this success, the company trades at a premium.
As shown below, Bill.com has outsized growth relative to peers, which has contributed to a premium multiple. The company trades at a 42x 1-year forward P/S multiple, which is well above peers. However, Bill.com has a largely untapped market in front of it, and has captured just 2% of its market opportunity, suggesting that there is a long runway of growth ahead of the company. The company’s data asset of B2B payment data and network effects from signing on new customers also support a premium multiple. Moreover, considering the nearly $70 billion software opportunity in front of it, coupled with the uncapped usage-based revenue, there is a significant opportunity for growth.
While Bill.com trades at a premium, this is due to its outsized growth rate. Viewed differently, if Bill.com's growth slows down to the per median rate of 33% and its multiple compresses to the peer median of 11x, then Bill.com will grow into its valuation in less than five years. However, we expect Bill.com to grow faster than peers given its unique data advantage, network effects, and untapped market opportunity.
Other near-term risks include a slight slow down in customer growth at Bill.com’s recently acquired companies. While there are clear signs of cross-selling, ultimately customer growth needs to be sustained to support Bill.com’s multiple. However, management explained that the slowdown was driven by higher credit standards onboarding new clients, which we view as a positive.
The company has also taken on relatively higher levels of risk by entering the credit card market. This has led to higher variable fees, which has led to outsized growth, but also introduces the possibility of fraud and liability. However, fraud losses have been low and the increase in credit standards discussed above should limit this risk. Furthermore, a decline in credit card usage would pressure Bill.com's grow rate.
Bill.com is also beholden to having a strong relationship with its partners, especially Intuit. Bill.com’s platform is integrated into Intuit’s QuickBooks product, and the company has an agreement with Inuit that extends until June 2023. The agreement enables continued support of Bill.com with QuickBooks. While this is a risk, the longer the two platforms are integrated, the greater the lock-in, which likely results in a symbiotic relationship between the two platforms.
In conclusion, Bill.com is positioned between AP and AR transactions which allow the company to capture valuable B2B payment data. The company’s main cohort of customers, SMB, appear well funded and have the tools to compete in the digital economy. Bill.com has also completed a transformational acquisition with Divvy, which has led to accelerating growth at both companies and increased cross-selling opportunities. While there are risks, such as its partnership with Inuit and expansion into credit cards, we believe that Bill.com will continue to perform well given its unique position that benefits from increased SMB business activity and network effects.
Fintech companies aim to disrupt traditional finance and with our worlds increasingly going digital, it makes sense that traditional finance is also moving online. There are multiple different innovations that have taken place, from digital payments to using A.I. to better price credit risk.
We are in the middle of the Q4 fintech earnings period, and there have been a handful of fintech companies that have reported already, most notably PayPal. PayPal disappointed when its guide came in below expectations. The company cited weakness in lower income cohorts, and explained on its Q4 conference call that while spending was strong during the Q4 holiday season, it has since stagnated in 2022. This led the company to reduce its guide that it had originally issued in November.
This negative commentary was offset by Bill.com, which reported strong Q4 results, driven by strength in small and medium businesses. Bill.com reported its fourth consecutive quarter of accelerating topline growth, which suggests that SMB are performing strongly.
In the discussion that follows, I give an overview of the fintech space and outline key metrics that investors should be aware of heading into Q4 earnings.
Fintech: Top 10 EV/FWD Revenue Multiples
Below we ranked fintech stocks based on their EV/NTM sales multiples. Bill.com (BILL) ranks the highest, as the company has reported a series of strong results in recent quarters. For instance, sales have accelerated for four consecutive quarters, even after adjusting for acquisitions. As mentioned above, the company has done well with its primary cohort of small-medium businesses, suggesting that business activity continues to be robust beyond enterprises.
Global payment processors Visa (V) and Mastercard (MA) also sport premium multiples, likely due to their payment duopoly. However, it is noteworthy that Visa and Mastercard underperformed in 2021, as investors may be wary that the pair will be able to keep their relatively high fees. For example, Amazon has stopped accepting Visa credit cards in the U.K. over a dispute over payment fees. Amazon controls over 40% of e-commerce, so the ecommerce giant may be able to pressure the duopoly to reduce fees.
Fintech: Top 10 Three-month Forward YoY Growth Rates
Below is a chart of fintech stocks that are expected to grow sales the fastest in the upcoming quarter. Looking forward, Upstart (UPST) is expected to grow sales 203% YoY in Q4, which is well above peers but slightly slower than its Q3 growth rate of 262%. Upstart’s growth has benefitted from bank partnerships, which utilize Upstart’s AI-driven lending platform to originate loans. The company primarily originates personal and auto loans, which have seen strong growth in recent months. The New York Federal Reserve recently released its quarterly report on household debt and credit, which highlighted that Auto loans and personal loans were both up $15 billion sequentially and that delinquencies had also declined across the different loan categories, highlighting the favorable macro environment for Upstart.
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Coinbase (COIN) is also expected to grow over 200% in the upcoming quarter, as trading volume on the cryptocurrency exchange has exploded this year, with trading volumes up over 600% YoY to $327 billion in Q3 2021. Management guided for higher trading volumes in Q4 relative to Q3, driven by higher levels of volatility. Also noteworthy is Voyager (VYGVF), a cryptocurrency trading platform that is expected to grow sales over 3,000% YoY in the upcoming quarter. Voyager was excluded in the below chart for presentation reasons, because sales are growing off of a low base. However, sales are expected to grow 50% sequentially, highlighting the overall strength in cryptocurrency demand.
Top 10 Weekly Share Price Movements
Below is a table of the weekly change in share price for our universe of fintech stocks (as of 2/08). As mentioned above, Bill.com recently reported results and organic sales accelerated for the fourth consecutive quarter, leading to a rebound in its share price. However, Bill.com’s share price is still down year to date. In fact, most fintech stocks are down YTD, with the exception of Visa and Mastercard. Investors likely sold fast growing fintech companies in favor of ‘safer’ blue chip fintech stocks such as Visa and Mastercard. Nonetheless, fintech has started to rebound over the last week and Q4 earnings may be a further catalyst for a rebound in valuations.
Top 10 Changes in sales growth estimates – last 90 days
The table below ranks fintech stocks by their topline revisions over the last 90 days. An increase in topline revisions signals that the Street believes that the company will grow faster than initially believed, which can result in outperformance. Block Inc. (SQ) has had large revisions, in part due to its recent acquisition of BNPL platform Afterpay. Bill.com’s (BILL) guidance came in above expectations, leading to a higher sales estimate. It is noteworthy that Bill.com’s peer, Intuit (INTU), has also had its topline estimate increased by 5% over the last three-months. The QuickBooks software provider is likely benefitting from similar tailwinds as Bill.com, as SMB have performed well over the last few quarters.
Update on EV/Fwd revenue multiples:
Overall stats:
Overall fintech forward median: 4x
Top 5 fintech forward median: 15x
Overall fintech forward average: 6x
EV/FWD SALES:
As shown below, the median and average fintech EV/NTM sales multiple had been relatively static throughout 2021 but has since compressed meaningful in 2022. Valuations are now below levels they were in 2020. The market may be fearing that consumer spending will decline due to a lack of stimulus and a slowing economy. With Q4 earnings on the horizon, new information could lead to a “risk-on” environment in fintech and a rebound in valuations.
Top 5 EV/FWD SALES:
In the chart below, we can more clearly see the large dispersion in fintech valuations, as the top 5 premium valued fintech stocks have had their EV/Fwd sales multiples trend up throughout 2021 with a peak in October, followed by a general sell-off heading into 2022. Both the top 5 valued fintech stocks and the median sold off, which suggests that the sell-off was broad based and related to changing sentiment.
EV TO FWD Sales Growth Buckets:
We can further dissect the change in fintech valuations by breaking up the group into high growth (>30%), mid growth (>15% and <30%) and low growth (<15%). The below chart shows the historical valuations for stocks in various growth buckets. Each growth bucket has had their valuations compress since November; however, the high-growth and low-growth buckets have underperformed the mid-growth bucket. The market is likely fleeing to ‘blue-chip’ fintech stocks until it receives more information on the general health of the consumer.
Top EV TO FWD SALES:
The below chart provides a more holistic view of fintech valuations heading into Q4 earnings, sorted by EV to NTM revenue multiples. There is a wide disparity in valuations, with companies grouped closer to the tails rather than the median. As mentioned above, Bill.com (BILL) has a premium valuation and has already reported Q4 results, which surprised to the upside. PayPal (PYPL) has fallen below the median fintech valuation based on NTM sales after its Q4 results disappointed, as management explained that spending on its platform had slowed after the holiday shopping season.
The last chart is based on EV to FWD sales but also takes into account forward growth expectations. By scaling valuation relative to forward growth, we can more clearly see which companies are cheapest relative to forward growth. Companies with negative growth expectations are excluded from the below chart. A low value in the below chart means that a company is cheap relative to growth. It is interesting to note that PayPal (PYPL) rises to a relative premium valuation after considering its forward growth. On the other hand, DLocal (DLO) falls closer to the median valuation once we consider its 112% expected growth rate heading into Q4 earnings.
Finally, the last table we will be discussing includes aggregate fintech operating metrics. The below table illustrates the median topline growth, margins and FCF generation for the fintech industry. The median growth rate was 60%, and the market expects the median fintech stock to grow sales by 42% YoY next quarter. Median gross margins were 54% and the median free cash flow margin was 9%.
As shown above, the overall fintech space appears to be healthy, with high growth rates and strong margins. This provides support for a rebound in valuations heading into Q4 earnings. The I/O fund will be watching this industry closely heading into Q4 earnings. Find out what the Street is saying about fintech stocks headed into Q4 earnings in our I/O Fund’s preview of 7 Fintech stocks for Q4 Earnings.
The I/O Fund is a team of analysts that share their research publicly as they build a portfolio of 30 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here.by clicking here or sign up for our free newsletter here.
Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.
Fintech companies are disrupting the global economy with their innovative products. The global growth is expected to continue despite medium-term challenges like higher interest rates and Covid-19. We believe that the recent sell-off once again provides opportunities to pick stocks for the long term.
PayPal released its results earlier this month. Q4 revenue grew by 13% to $6.9 billion and beat estimates marginally by $30 million. The soft revenue guidance of 6% growth in Q1 disappointed investors. On the other hand, Dutch payment processor Adyen reported strong results as its 2H revenue grew by 47% to €556.5 million and EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization) grew by 51% to €357.3 million.
In this earnings preview, we cover Upstart, Block, Coinbase, Sea Limited, MercadoLibre, Remitly, and DLocal. To understand valuations across the Fintech companies and how the sector is positioned moving into earnings, please refer to our analysis, “I/O Fund’s Fintech Q4 Earnings Overview.”
The company’s revenue grew by 250% in Q3 and the analysts estimate revenue to grow 203% YoY to $262.85 million. Upstart has gained popularity due to its Artificial Intelligence lending platform, which saves time in loan processing. The management believes that the auto lending market is at least six times the personal loan market size and that customers pay higher interest rates for car loans. Last year, it bought Prodigy Software, an automotive retail software provider, which further helped the company focus on the auto loan market.
Atlantic analyst Simon Clinch has a price target of $170. He has an overweight rating on the stock as he believes that there is upside potential to EBITDA from the auto segment.
Piper Sandler analyst Arvind Ramnani has lowered the price target for the company to $223 from $300. He reset the price target in the vertical software and fintech stocks following the correction in the tech sector.
The company’s revenue grew 27% YoY to $3.84 billion. Analysts expect revenue to grow 28% to $4.05 billion. The company missed analysts’ revenue estimates by 14% and adjusted EPS by 3% in the last quarter.
It has completed the acquisition of Afterpay recently and has integrated Afterpay’s Buy Now Pay Later (BNPL) functionality to Square Online sellers in the U.S. and Australia. According to Grand View Research, the BNPL market is expected to reach $20.4 billion by 2028, growing at a compound annual growth rate of 22% from 2021 to 2028.
J.P. Morgan analyst Tien-tsin-Huang is optimistic about the deal and expects it to boost its gross profits. He also believes, "positive catalysts de-risking the hard/soft landing concern for stand-alone Cash App growth deceleration near-term."
Barclays analyst Ramsey El-Assal has lowered the firm's price target to $205 from $300. He has kept an Overweight rating on the shares. In his view, “While app download and usage data point to continued strength at Cash App and Square, the company continues to lap very tough COVID-related comps.” He also expects investor focus to be on the reacceleration of Cash App, the Afterpay acquisition, and Block's crypto initiatives.
Please note that the I/O Fund may or may not agree with the above financial analysts, yet we objectively report what the Street is saying. You may view our previous analysis of the company below:
Our lead analyst Beth Kindig had discussed two years back about the company’s high charges that would come under pressure from the blockchain in the long-term. Recently, she also discussed that the company’s name change from Square to Block was a defensive move rather than coming out of its strength.
The company’s revenue grew by 316% to $1.31 billion in Q3. For Q4, analysts expect revenue to grow 235% to $1.96 billion. Due to better trading activity in October, the management believes that the retail Monthly Transacting Users (MTUs) will be higher in Q4 than Q3. For the month of October, it was 11.7 million.
Bank of America analyst Jason Kupferberg has upgraded the company from a neutral to buy rating. He is optimistic about the company launching the NFT trading platform, as it was diversifying its revenue sources to rely less on cryptocurrency trading.
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Mizuho analyst Dan Dolev believes that the zero-commission business model adopted by Robinhood is better than the fee-based model adopted by Coinbase. In his words, "If you think about three years from now, everything that's fee-based right now, like crypto trading, is going to be free."
You may view our previous analysis of the company below. We had also discussed Coinbase reporting lower revenue in Q3.
Sea Limited operates in three segments: digital entertainment, e-commerce, and digital payments & financial services. The company's revenue grew 122% in Q3 and the analysts expect revenue to grow 92% to $3.0 billion in Q4. The company derives its significant revenue from South East Asia, and more recently, it has been focussing on Latin America.
Barclays analyst Jiong Shao lowered the firm's price target to $218 from $427 and has kept an Overweight rating. He believes, “The post-COVID economic reopening is having a negative impact on both the company's gaming and e-commerce business as consumers spend less time online.”
Goldman Sachs analyst Miang Chuen Koh has removed the stock from the Goldman’s Conviction List. "While Sea (SE) remains on a growth path, with an expanding ecommerce footprint and its multiple studios finalizing games to be released in the next few quarters," the analyst cautions that the slower economic growth will limit the growth of its three business lines.
You may view our previous analysis of the company below.
The company’s revenues grew 67% in Q3 and the analysts expect Q4 revenue to grow 53% to $2.03 billion. MercadoLibre has been popularly known as the Amazon of Latin America. The company is benefitting from the region’s strong e-commerce and fintech growth. The stock rose about 450% in the past five years. MELI’s quarterly active users showed strong growth in Q3, growing 50% YoY to 78.7 million and unique Fintech users grew by 13% to 31.6 million.
Source: YCharts
Stifel analyst Scott Devitt lowered the price target on the company to $1,600 from $2,200 and has kept the Buy rating. He forecast GMV growth of 26% to $7.71 billion and revenue estimate of $2.09 billion for the next quarter, slightly ahead of consensus. However, as the comparable valuation multiples of the company's publicly traded peers have declined, he has lowered his price target.
Jefferies analyst John Colantuoni has downgraded the company to Hold from Buy with a price target of $1,250, down from $2,000. He makes a note that the heightened macro uncertainty in Brazil, which represents 60% of the company's revenue, could hold back MercadoLibre's near-term valuation. He believes that the company is in an ideal position to benefit over the long-term from attractive secular shifts in e-commerce and payments across Latin America and expects the stock to trade at the low end of its historical trading range until macro uncertainty subsides.
Remitly Global Inc – Earnings Date not released yet
Global remittance provider Remitly’s Q3 revenue grew by 69%. It was the first earnings report since it became a public company in September 2021. The full lock-up expiry is expected next month. Active customers were up 51% and the average revenue per active customer was up 12% YoY to $47.34. Adjusted EBITDA came at $0.3 million compared to $0.6 million in the same period last year. The analysts expect revenue to grow 57% to $125.36 million in Q4. The management expects full-year revenue to grow about 74% YoY in the range of $445 million to $450 million.
JMP Securities analyst David Scharf has lowered the company’s price target to $40 from $52 and has kept the Outperform rating. The analyst remains positive on Remitly’s leadership position as a mobile-first, all-digital network serving a large and expanding total addressable market and believes that its secular tailwinds will continue. However, he cautions that the shares might be volatile in the near term due to the negative market sentiment.
DLocal Ltd – Tentative Earnings Date is February 28th
The company’s revenue grew by 123% in Q3 and the analysts expect revenue to grow 115% to $74.52 million. The total payment value (TPV) increased by 217% in Q3 to $1.8 billion. The net revenue retention rate was 185%. The management expects NRR in the range of 150% to 160% in the medium term and to come down to about 120% to 130% in the long term.
Goldman Sachs analyst Tito Labarta has upgraded the company to Buy from Neutral and has a price target of $55. He believes that “The company should experience relatively minor impacts from higher interest rates considering that it has no debt on its balance sheet and does not focus on the pre-payment of receivables.”
The I/O Fund is a team of analysts who share their research publicly as they build a portfolio of 20 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here.by clicking here or sign up for our free newsletter here.
Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.
Affirm’s Q1 Results and Exclusive Agreement with Amazon
Affirm reported strong Q1 FY2022 results that beat on the topline as sales grew 55% YoY to $269 million. Management also raised its guide for FY2022 sales to grow 42% YoY to $1.2 billion, up from its prior guide of 35% YoY growth. On top of the strong growth, Affirm announced an exclusive agreement with Amazon to be the only BNPL payment option on the e-commerce platform for at least the next two years, just in time for the holidays. This exclusive agreement is not yet included in management’s FY2022 sales guide.
The Amazon partnership was initially announced in August but was made exclusive in November. The exclusive agreement with Amazon follows partnerships with Shopify, Walmart and Target, all since June 2021 and before the holiday shopping season ramps. As shown below, Affirm has exposure to >60% of total retail e-commerce market share following these partnerships.
However, these partnerships do have a cost. In exchange for the exclusive agreement, Amazon is receiving up to 15 million warrants of Affirm equity with a strike price of $100. While this is a hefty price to pay, it does create a mutual interest in Affirm’s success on Amazon’s platform. For example, Amazon will conduct its own marketing to encourage the conversion and adoption of the Affirm program.
The terms of the agreement highlighted a few different marketing strategies that Amazon may use to promote BNPL to its customers, such as promoting BNPL to Prime members when they use credit cards; include cashback for Prime members that use BNPL; email Prime members about Affirm’s BNPL offering; and even use packing tape to promote the program (AFRM 8k, 11/10/2021). The exclusive agreement has Amazon working to encourage adoption of Affirm’s payment methods, because if Affirm succeeds, Amazon will also benefit. Considering that Affirm wants to quickly scale, this was a huge win for the company.
In the chart below, we can clearly see the benefits that these partnerships have on Affirm’s growth. Active merchants surged nearly 1,500% YoY to 102,200. Active merchant growth is important, because it is the primary driver of consumer growth. Merchant growth is a forward looking metric that supports sales growth in the future. Importantly, the rapid rise in active merchants shown below was driven by the Shopify agreement signed in June 2021, implying that merchant growth will likely continue to ramp following the Amazon agreement discussed above.
Affirm’s Q1 FY2022 Financial Results
Following the rapid growth in active merchants, Affirm’s topline growth also came in strong. Q1 sales increased 55% YoY to $269 million, which beat estimates by $20 million. Network fees, which are fees paid by merchants, increased 13% YoY to $112 million and interest income and gains on sale of loans increased 116% and 89% YoY to $117 million and $31 million, respectively. To be complete, servicing revenue increased 132% YoY to $10 million.
Gross merchandise volume (GMV) increased 83% YoY to $2.7 billion, and this growth flowed into loans, as loans held for investment increased 62% YoY to $2.1 billion. However, expenses also rose, driven in part by stock based compensation (SBC) from the recent IPO and a change in estimates. Q1 net loss was -$307 million, and excluding $87 million in SBC following the IPO and $142 million due to changes acquisition related expenses, adjusted net loss was $78 million, or -$0.29/share, slightly ahead of estimates at -$0.30.
Management also raised their guide for the year. The midpoint of its GMV guide was raised 5% to $13.3 billion for the year, while the mid-point of its FY2022 sales guide was also raised 5% to $1.2 billion, implying a 42% YoY growth rate. Adjusted operated loss is guided to be -13% of revenues, slightly higher than the initial -12% guide.
Importantly, management’s guide is somewhat conservative as it does not include any contribution from the exclusive Amazon agreement discussed above (however the dilution from the warrants is included in the EPS guide). Once Affirm has gathered sufficient data from the program, they will incorporate that into their guide going forward. Based on management’s current guide and Affirm’s stock price, Affirm trades at ~35x P/S.
Finally, the company’s credit metrics appear healthy. Provisions for loan losses increased 133% YoY to $64 million, which was skewed by a low base period due to provision releases in the prior year quarter. The rise in provisions drove allowance for loan losses up 24% YoY to $152 million, or 7% of total loans. The rise in allowance for loan losses provides a ‘safety net’ in case defaults begin to rise in the future. As shown below, Affirm’s allowance for loan losses is near its historical average of ~9% of total loans.
Affirm’s reserves for loan losses has trended up with the company’s rapid growth, which provides downside protection from rising defaults. As Affirm’s credit risk model is proven overtime, the company’s reserve for loan losses may decline relative to loan growth, which would fuel earnings growth in the future.
The company’s recent partnerships with major online retailers such as Shopify and Amazon, positions the company well for strong growth going forward. The company’s credit metrics appear healthy and growth should continue to be robust as we enter the holiday shopping season.
Update on Palantir
Palantir reported Q3 results on 11/9/21 and sales grew 36% YoY to $392 million which beat topline estimates by $5 million. Commercial sales accelerated to 37% YoY growth in Q3, up from 28%, 19% and 4% YoY growth rates in Q2, Q1 and Q4 2020, respectively, while government sales increased 33% YoY to $218 million.
On the call, Palantir COO Shyam Sankar explained that the company’s commercial offerings have been robust and that the Foundry tool (primarily used in commercial offerings) has benefited from three key trends: 1) defense industrial 2) automotive and mobility and 3) healthcare. Specifically, defense and healthcare are benefitting from increased spending while automotive and mobility are benefitting from the ramp in EVs and the large amounts of data that this secular trend is creating.
Continuing down the income statement, adjusted gross margin was 82%, up from 81% in the prior year quarter. Q3 operating margin was a slight loss of 1% while adjusted operating profit margin was 30%, its 4th consecutive quarter at or above 30%. Adjusted EBITDA increased 59% YoY to $119 million and adjusted EBITDA margin increased YoY from 26% to 30%. Non-GAAP earnings were $0.04, which met the consensus estimate.
Adjusted earnings exclude large amounts of SBC, but SBC has materially declined and was down 78% YoY to $184 million during the most recent quarter. The normalization of Palantir’s high SBC is due to the outsized levels from last year following its IPO, and a continued normalization in this trend should benefit shareholders going forward as dilution slows.
Looking ahead, management guided for Q4 sales to increase 30% YoY to $418 million, which was 4% higher than initial estimates. For the full year 2021, sales are expected to grow 40% YoY to $1.5 billion, 2% higher than initially expected. Management also raised their adjusted FCF guide to be in excess of $400 million, up from the prior guide of $300 million. The company continues to expect long-term topline growth of 30% or more through 2025.
While Palantir largely came in as expected, there were some concerns with Palantir’s results. For instance, sales growth slowed relative to the prior two quarters. Furthermore, cashflows from customers was lumpy, as deferred revenue and customer deposits decreased relative to sales growth. However, this was offset with a sharp rise in backlog, as RPO to be completed in the next twelve months increased 111% YoY to $393 million, while bookings increased 56% YoY to $510 million. The outsized growth in NTM RPO and bookings relative to sales suggests that there is ample support for future sales growth.
Palantir has also made a series of investments that could further help fuel topline growth going forward. The company invests in commercial customers that gives Palantir exposure to their success if they benefit from Palantir’s tools. As shown below, the company has invested $153 million in commercial partnerships YTD, with a maximum potential revenue from these contracts of $640 million.
Investments in commercial customers is similar to what Amazon has done with Affirm (discussed above), as Palantir gets exposure to companies that can materially benefit from its tools. While Palantir has a robust toolset that can transform data into actionable insights, it takes time for commercial customers to find uses for the products. These investment agreements can help accelerate the time it takes for commercial customers to realize the strength in Palantir’s services. These investments are not without risks, however, because if the company fails then Palantir will be required to write off the investments, impacting earnings.
Looking forward, Palantir’s guide appears reasonable as it has amble support from backlog and bookings to continue to grow 30%+. The company’s commercial segment has been robust, which has been aided by the company’s investments in commercial customers. While growth slightly slowed relative to prior periods, if government spending begins to ramp, then Palantir’s sales growth will likely reaccelerate in the future.
The I/O Fund initiated a new position in Affirm last week, here is Beth’s post on the forum announcing the decision and a brief discussion of what she liked about the name. In the discussion that follows, I dive deeper into the Affirm story and explain the key micro trends, how Affirm makes money, its recent financial performance and conclude with a discussion about its valuation relative to peers.
Affirm’s Opportunity
Affirm was founded in 2012 by current CEO Maksymilian “Max” Levchin, a co-founder of PayPal, along with Nathan Gettings, who was also a co-founder of Palantir Technologies. As Beth mentioned in her forum post, Affirm’s management team has deep connections in tech circles, which likely helped the company secure big partnerships with Shopify and Amazon in recent quarters. The company has ambitious goals of reinventing the financial ecosystem around consumer credit. Affirm explained in its Q3 10Q that it is “building the next generation platform for digital and mobile-first commerce” as it displaces legacy consumer payment methods such as debit and credit cards with a more consumer-friendly buy now, pay later (BNPL) payment option. The opportunity in front of Affirm is massive. As shown in the below slide from Affirm’s Q4 presentation, its total addressable market is $600 billion for U.S e-commerce sales, and Affirm has captured less than 1% of the market thus far.
Affirm’s core BNPL product is more consumer friendly than legacy products as it does not charge compounding interest or hidden fees, which are common throughout the credit card industry. Likely due to its consumer-friendly payment terms, BNPL products are among the fastest growing online payment methods in developed nations, and this growth is expected to continue. According to a 2021 Global Payments Study by FIS, BNPL accounted for 7% of European e-commerce payment methods in 2020, and BNPL is expected to double to 14% market share by 2024.
The 2021 Global Payments report also expects BNPL to take significant share in North America in the near term. The report projects that BNPL will grow 181%, from 1.6% of all e-commerce transactions in 2020 to 4.5% in 2024, taking share from credit and debit cards in North America. Furthermore, TD Bank’s Annual Consumer Spending Index showed that ~25% of millennials do not carry a credit card, likely to avoid being trapped by mounting credit card debt. With millennials and Gen Z being the largest percentage of the U.S. population, their avoidance of legacy credit cards and preference for BNPL products could help drive demand for Affirm going forward.
Another interesting trend in the 2021 Global Payment report showed that cashless societies tend to favor BNPL products. For example, Sweden’s economy is ~91% cashless, and 82% of the population makes purchases online. Interestingly, the most popular payment method for Swedish e-commerce shoppers is BNPL, which accounted for 23% of total e-commerce payments in 2020, above 19% share for debit cards and 11% share for credit cards. This trend may be a harbinger for other developed countries that are increasingly becoming cashless and shopping online.
Actual and estimated market share of BNPL in Europe and North America in 2020 and 2024
The continued rise of e-commerce will also benefit BNPL providers such as Affirm going forward. According to the US Department of Commerce, only ~13% of retail sales are online despite the rapid growth in recent years. The relatively low penetration of online retail sales suggests that there is still plenty of runway ahead for Affirm to continue to take market share from other legacy payment options.
The combination of rising e-commerce and mobile sales coupled with younger generations favoring BNPL over credit cards should support Affirm’s strong growth rate going forward. Consumers prefer Affirm’s BNPL products over legacy payment options because Affirm is a customer centric business. The company does not charge hidden fees or compound interest like most legacy financial products. By treating the customer right with simple payment terms, no hidden fees and an intuitive app, Affirm believes that it can continue take market share from legacy financial institutions.
How does Affirm make money?
Affirm’s revenue model is centered around both the merchant and the consumer. Affirm does well if these two parties do well, a symbiotic relationship that is different from the legacy model which benefits from high interest rates and hidden fees that punish the consumer.
The company makes money from merchants by charging a fee for helping them convert a sale and facilitating the payment. The fees vary per merchant agreement, but the fee is generally higher when interest-free 0% APR financing is used. Affirm claims that due to its superior risk models, which goes beyond traditional credit scores and also considers product level detail, the company approves 20% more consumers than its competitors. The higher rates of approvals benefits merchants by accelerating sales generation. We can also see that Affirm’s risk models are working well, as the company’s credit metrics have improved in recent quarters (discussed in greater detail below).
Affirm is also the demand driver for merchants, as the company’s proprietary data can help generate leads for merchants on its platform. Furthermore, Affirm’s BNPL products lead to higher average order sizes (AOVs) by financing large ticket items, which benefits merchants. Higher AOV also leads to higher fees for Affirm, benefitting its topline.
Affirm also makes money from consumers by charging simple interest on the loans that it facilitates. The company purchases loans from its bank partner that originate the loans for the company. These bank partnerships allow Affirm to focus on the technology while the banks focus on the various federal, state and other laws that need to be complied with. After purchasing the loans from its bank partners that it helps originate, Affirm then collects and earns interest and servicing fees from these loans. Since consumers are never charged deferred or compounding interest, late or other fees, the company is not incentivized to profit from consumers’ hardships.
Breakout of Affirm’s Q4 FY2021 Revenue Sources
Affirm will also sell loans that it purchases to various loan buyers and securitization investors. As shown above, gains on sale of loans were 16% of total sales in the latest quarter, well above the company’s average of ~8% of sales. The rise in gains on loan sales was driven by an increase in securitization transactions. A key component of Affirm’s success is its efficient capital deployment, as the company is not dependent on one source of capital. By selling its loans via securitization, it is able to recycle the capital into more loans, generating more fees and revenues.
Attesting to Affirm’s capital efficiency, the company’s required capital has fallen as a percentage of total platform loans over time (shown below). The lower amount of capital Affirm has to hold, the more loans it can make, increasing its revenues and improving its efficiencies. Furthermore, the company focuses on short duration loans, which creates a multiplier effect on Affirm’s committed capital. The short duration loans and numerous sources of capital allows funding to be recycled quickly which lets Affirm to increase its transaction volumes.
Affirm’s Platform Portfolio and Funding Mix
Affirm’s recent results: accelerating growth and improving credit metrics
Affirm reported 9/09/21 and disclosed that Q4 FY2021 sales had grown 71% YOY to $262 million, an acceleration from the 67% and 57% YOY growth rates in Q3 and Q2, respectively. Sales also beat estimates by $37 million, attesting to the rapid growth of BNPL payment methods. Shortly before earnings were released, the company had announced a partnership with Amazon, which is not yet live and did not contribute to the acceleration in sales.
Rather, the acceleration in sales was driven by a rapid rise in gross merchandise volumes (GMV). As shown in the chart below, GMV grew 106% YOY to $2.5 billion, an acceleration from the 83% and 55% YOY growth rates in Q3 and Q2 respectively. CEO-founder Max Levchin explained during the Q4 Earnings call that 38% of GMV was from 0% APR products, down from 54% in the prior year, while 62% of GMV was interest bearing. He explained that the shift was due to the type of transactions, as travel categories rebounded and generally have lower rates of 0% APR products. Customer concentration has also improved, as Peloton declined from 32% of GMV to just 9% of GMV in the current quarter.
Merchant data trends have also improved. Active merchants, which are merchants that have transacted at least once on Affirm’s platform over the last twelve months, increased to 29,000, up from 5,700 in the prior year. The acceleration was largely driven by Affirm’s recent partnership with Shopify, which makes Affirm available to all Shopify merchants in the U.S. With the potential for Amazon to onboard Affirm in the near term, and the Shopify partnership still ramping, active merchants should continue to rapidly grow going forward. Similarly, active consumer count increased 97% YOY to 7 million while transactions per customer rose 8% YOY to 2.3 per customer.
The strong results flowed in guidance. Specifically, Q1 FY2022 GMV is expected to increase 67% YOY to $2.5 billion, while sales are expected to increase 41% YOY to $245 million at the mid-point. For the year, GMV is expected to rise 52% YOY to $12.6 billion while sales are guided to be $1.8 billion at the mid-point. Importantly, management’s guide is conservative, as it does not include benefits from the roll out of the debit+ card (which lets Affirm capture fees from merchants not on its platform) nor does the guide include any revenues from the recently announced Amazon partnership. These two events will likely be material to sales, which may lead to growth rates above management’s initial guide.
Continuing down the income statement, revenues after transaction expenses, increased 37% YOY to $148 million, which was well above management’s initial guidance of $80 million to $85 million. As a percentage of GMV, revenues less transaction expenses grew to 6% of GMV, or 200 bps above the two-year average. The growth in the capture rate of GMV highlights how Affirm’s operations are improving, as the company’s revenues are scaling faster than expenses.
To be complete, Affirm’s bottom-line missed the consensus estimate after the company reported an EPS loss of $0.47, wider than the Street’s expectation by $0.23. The large miss was mostly driven by non-cash expenses such as stock based compensation and warrants issued to Shopify in conjunction with their commercial agreement. Absent these non-cash expenses, adjusted operating income was $14 million, down from $47 million in the prior year.
The company’s credit metrics have also improved during the quarter, however we need the 10K to make a full assessment, which has yet to be released. Based on what’s been disclosed so far, Affirm’s credit quality has improved, which is impressive considering the rapid growth in GMV and sales. It is great to see that Affirm’s rapid growth is also high-quality, as Affirm is not taking on increased risk to grow its topline.
For instance, Affirm is well reserved for potential credit losses. Its allowance for loan losses increased 24% to $118 million, which was well above the trailing twelve month charge off rate of $55 million. Sated differently, Affirm has reserved for ~2.1 years’ worth of charge offs, up from ~1.3 years of reserves in the prior year. The higher rates of reserves lowers earnings by driving up provisions, but provides downside protection if defaults start to pick up. In other words, Affirm’s financials are more conservative than prior years, a positive trend.
Furthermore, provisions for loan losses have outpaced net charge offs. Provisions for loan losses are management’s estimates of future charge offs and provisioning at a faster rate than charge offs is conservative and provides downside protection. Affirm provisioned for $25 million of loan losses during Q4, or 103% of Q4 charge-offs, and on a TTM basis, provisions were 121% of net charge offs.
We can also see that charge-off rates have been improving, meaning that fewer consumers are defaulting on Affirm’s loans. As shown below, Affirm’s net charge off rate has materially declined since 2018 and was around 1.5% of total loans when Affirm went public. As of the latest quarter, Affirm charged off $25 million loans, or 1.3% of total loans outstanding, highlighting that credit quality has continued to improve since the IPO. The I/O Fund believes that Affirm’s acceleration in GMV and sales coupled with an improvement in credit quality warrants a premium valuation.
Valuation and conclusion
Affirm currently trades at a P/S multiple of 29x, below its most direct peer, Afterpay, which trades at a 40x P/S multiple. Afterpay grew its FY2021 sales by 98% YOY, faster than Affirm’s 71% YOY growth rate, which may explain the higher valuation. However, it is noteworthy that Afterpay’s credit quality deteriorated during the year as credit impairment expense rose 106% YOY while Affirm’s provisions declined 36% YOY during FY2021.
Relative to the legacy card issuers such as Visa and Mastercard, Affirm’s P/S ratio is just ~34% above their P/S multiple of 22x and 21x, respectively. Importantly, Affirm is growing much faster than Visa and Mastercard. For example, Affirm grew its topline by 71% YOY in the most recent quarter, which was above the 27% and 36% YOY growth rates for Visa and Mastercard in their most recent quarters, respectively.
As discussed above, Affirm has ambitious plans to disrupt the consumer credit industry, and its opportunity is massive. The company has a strong management team that has resulted in key partnerships with Shopify and Amazon. Growth has recently accelerated and credit metrics have also improved. The firm trades at a premium valuation, which is warranted considering its strong management team, growth and solid credit metrics. There are also favorable microtrends that should benefit Affirm going forward, such as the continued rise of e-commerce and younger generations’ aversion to legacy financial products such as credit cards. Looking forward, management provided strong guidance that did not include potential topline benefits from its recent Amazon partnership nor the roll out of the debit+ card, suggesting that growth will be higher than the initial guide. The company is well positioned to disrupt a very large market and Affirm is just getting started.
Disclosure: The I/O Fund own shares in Affirm and does not have plans to change its position within the next 72 hours. You can access the I/O Fund’s positions here. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies
We are considering a short-term trade on FUTU due to the technical setup.
Quick Overview:
Futu Limited (FUTU) is a holding company that operates in Hong Kong. They are an online broker and wealth management platform that provides a one-stop ecosystem for investors. They provides news, market data, trading services, wealth management for Mainland China, Singapore, Hong Kong and U.S. equity markets. They even own a popular social media platform for investors.
There is nothing disruptive or technologically unique about Futu. It operates as a relatively standard online broker, much like the online options we have in the U.S. What differentiates it from other the well-known brokerage firms is its location and timing.
Since the March 2020 crash, we have seen a relative explosion of retail interest in stocks. This retail interest in equities is a global phenomenon, including China. China’s stock markets have been open for just over 30 years, compared to the U.S. that has been in operation for 229 years. As a result, in the mature U.S. equity markets, about 52% of Americans participate in the stocks markets, compared to about 13% in China. This number is up nearly 7% from a year ago.
With the growth of China’s wealth coupled with the opening of the tech focused Star Market in China, the interest in equity markets is only expected to increase, which should bode well for FUTU.
This growth shows within Futu’s projected revenue growth. It’s expected to grow revenue by 164% this year from $337M to $891M, although the 1-year forward is around 50% projected growth from $891M to $1.32B for FY2022. We will see in time if the estimates will be revised or if Futu is having its breakout year and growth will level off quickly.
Futu has strong growth this year, however, it is not anchored by a long-lasting microtrend. Instead, it’s riding the popular trend of Chinese stock investing. As long as the Chinese stock markets perform well, we believe the interest and growth in Chinese equities will continue to grow. Gains attract more retail investors, and Futu has a strong competitive edge for retail Chinese investors.
The story is not one that we would consider for the I/O Fund’s LTBH or even a longer-term momentum position. What we mainly like about Futu is its current technical setup. We like it enough to write-up a quick chart and consider taking a swing trade. We will set an initial stop to protect our losses, just in case our timing is off, and we will look to exit into strength when we believe the trend is coming to an end.
We believe FUTU is about to breakout and into the 5th wave (red count) within a larger 3rd wave (green count). The 5th wave within 3rd waves tends to extend, especially in high growth names like FUTU.
Also, note the RSI pattern. It’s flashing a reversal warning (the RSI is making a higher high, while the price is making a lower high). This, I believe, will setup for a drawdown into the $135-$125 region. It will also setup a nice inverse head and shoulders pattern just below the primary breakout price at $169.
We will look to buy on the coming pullback, or a breakout above $169. We will use a stop to limit our loss, and seek the targets overhead.
Voyager Digital is a smaller cap that gives investors exposure to the Bitcoin and crypto trading trend at a reasonable valuation. The company offers zero commissions and more coins than its competitors, including the rumored $100 billion market cap Coinbase that is going public soon, Kraken and Gemini. The stock is listed on the OTC market, which is higher risk than the Nasdaq as these stocks tend to be thinly traded.
Voyager is a zero-commission competitor to Robinhood, and due to many PR mishaps, has opened a door for Voyager to become a replacement for customers who seek fewer politics around their crypto trading app.
Voyager also comes with the added benefit of offering 9% interest on stable coins as the company is a consortium for stable coins, including USD Coin (USDC) and Tether’s USDT, which have surpassed $7 billion in circulation. As such, it provides exposure to decentralized coins like Bitcoin and stable coins based on the fiat system.
Although I am personally in favor of decentralized crypto and not stable coins, Big Tech and the Fed are likely to put immense pressure on adopting stable coins. Voyager allows investors exposure to both at a market cap of $2.18 billion, at time of writing. You can read my Facebook Libra article here where I am especially against this company entering the stable coin market.
Below we explain what makes Voyager a compelling investment, including what it does, how it makes money, valuation, catalysts, management, and potential risks.
Voyager: Zero Commissions, More Coins
As longtime crypto investors, we know all too well the issues around Coinbase and the other sites. The primary issue is the commissions that Coinbase charges, which are exorbitant to say the least. To make a $5000 trade on Coinbase, you will be charged about $80 in commissions. This isn’t competitive in an environment where stocks are traded at $0.
Voyager does not charge commissions on crypto trades and offers 9% interest on stable coins. One thing to note is that Voyager does not offer insurance like Gemini, and that our fund does not hold large amounts of crypto on trading platforms. Instead, we store crypto in cold storage wallets and use trading platforms for trading only. We discuss how Voyager makes money below, the differences in crypto platforms and how investors typically store their crypto below.
The fallout with Robinhood over GameStop has created an influx of customers for Voyager. Total revenue growth between December and February was over 1000% from $1.7 million to $20 million in monthly revenue.
Please note, my readers often ask me about the volatility of crypto and my answer to this is that crypto promises to be some of my most volatile investments. Stocks and crypto prices can drop 60% or more – and this has happened since my official coverage on bitcoin when it was priced at $12,000 and saw $4,000 before finding a base. You can read my past coverage here on Bitcoin in the summer of 2019.
Financial Overview
Although Coinbase was first to market, there is plenty of room for competitors to disrupt the company’s non-existent customer service and excessive commissions. For those who don’t trade crypto, you might be surprised to know that after paying such high fees, you are given no customer service whatsoever. The I/O Fund prefers Gemini as a commission-based platform as there is insurance offered to offset the cost of commissions.
Voyager is FDIC-insured. However, the crypto held with Voyager is not insured. Gemini, which operates as a trust, has private insurance. Like us, crypto investors generally store their assets on a cold storage crypto wallet, which means it is not connected to the internet. In the event there is no insurance, the risk to cold storage wallets is minimal.
Significant Growth from Robinhood Tailwinds
Crypto investors are a tightknit community and we think word-of-mouth will grow nicely in this niche as it actively looks for new platforms. In December, the company reported $1.7 million in revenue and has grown to $8.5 million in January of 2021.
The company reported $2.5 million in revenue from Feb. 1 to Feb. 4—which we predicted could lead to $17 million in revenue in February. The company exceeded this and reported $20 million in revenue for February.
Assets under management (AUM) grew from $230 million in December to $800 million by early February. Total assets under management by the end of February was $1.7 billion.
Trades per day averaged more than 30,000 for the month ending Jan. 31, up from approximately 6,500 in Dec. of 2020, representing 450% growth in daily trade volume. By early February, daily trades averaged 60,000 trades per day or nearly 1000% growth. In the March earnings report, the company reported a total of 70,000 trades in February.
In January, the value of customer trades increased over 500% to $840 million, up from $150 million in December of 2020. Over twelve months, the overall number of trades increased from 8,500 trades in December of 2019 to 1 million trades in January of 2021, an increase of 117,000%. This number may be irrelevant as most of this is priced in right now, yet we think it's important to look at the ongoing strength before the Robinhood issues.
Basic users grew from 150,000 in December to 440,000 by early February. The company reported 605,000 verified users at the end of February.
Here is the full statement from Steve Ehrlich, cofounder and CEO of Voyager, regarding the Robinhood catalyst and what investors can expect moving forward:
"While we believe our recent business metrics reflect the growing interest in the cryptocurrency ecosystem and long-term benefits of our business model, the unprecedented external events over the past week, including decisions made by competitive products, have brought significant upside to our metrics.
While we don't expect a repeat of the unprecedented external events of the past few weeks that have catalyzed the recent growth, we anticipate continued meaningful growth in our business, including from the pipeline of approximately 80,000 customers who have signed up and that we are presently onboarding.
We remain focused on executing our long-term business plan and expect Voyager will continue to grow the business in a more traditional pattern throughout the balance of 2021. To support this growth, we anticipate increased expenditures to materially increase our employee headcount during this period, while also growing our technology architecture stack in the near-term to accommodate significantly more users."
The company closed a private placement of $46 million on January 21st, 2021.
Voyager has seen 75%+ sequential quarter growth with increasing operating margins in 2020. Per the Investors Presentation, Voyager had a previous goal of reaching $20 billion AUM based on $500 million AUM as of Q1 2021 (this was achieved at nearly 3X the company’s original goal with currently $1.7 billion AUM). The company believes it can achieve 90% CAGR on number of funded accounts and 35% CAGR on average account size.
The company also states it takes $35 to acquire an account, and the company makes $30 per account in monthly revenue—which is excellent unit economics. Customer acquisition costs have averaged from $20 to low $30s per new account, according to Stifel Research.
In contrast, monthly revenue per account has accelerated from $40 per month at the calendar end of 2020 to $80 per month in C2021. A catalog of research reports are available from various funds and analysts covering the company, which is fairly extensive coverage considering the company's small market cap.
Voyager is a strong choice for alternative coins, as the app allows you to trade many tokens that Coinbase or Kraken does not support. For example, Voyager offers Dogecoin, a meme coin pushed by Elon Musk. It also offers interest on Bitcoin, Ethereum, Polkadot, and Chainlink.
Voyager sees its diversification across revenue streams as a way to minimize volatility. The revenue streams include listing fees, interest revenue, alternative coins and major coins.
Quarterly Financials
Voyager reported Fiscal Q2 2021 results March 1 for the period ending Dec. 31. The company had $3.56 million in revenue with $2.06 million in fees and interest income of $1.51 million. There was a net and comprehensive loss of $9 million.
Voyager expects to continue bringing new products to The Voyager platform, according to the report. In 2021 and beyond, executives anticipate adding debit cards, credit cards, stock trading, and the ability to trade on margin. Voyager will also look to grow internationally by expanding into Canada and Europe.
Fiscal Q1 2021 results were reported on November 30th for the period ending September 30th. The company had $2 million with $1.6 million in fees and interest income of $400,000. There was a net and comprehensive loss of $3.97 million or ($0.04) EPS.
The company had cash and cash equivalents of $7.48 million and debt of $1.12 million at the last earnings report, which includes a PPP loan. There was an update for fiscal Q2 2021 on January 5th with quarterly revenue expected to reach $3.5 million.
Voyager also completed a private placement during the quarter, which increases gross proceeds raised during fiscal 2021 to C$13.8 million. It completed the acquisition of LGO, SAS, an AMF regulated entity that provides Voyager with a fully licensed European entity to accelerate its European strategy.
How does Voyager Make Money?
Voyager’s revenue is not dependent on commissions or fees. The company plans to introduce a debit card, credit card, margin, loans, and advisory products over the next year or so. Right now, the business model creates revenue in two specific ways:
1. Smart Order Routing: When you place an order to buy or sell a cryptocurrency, Voyager provides a listed price that you accept. It then connects your order to 12 exchanges. Unlike securities, which by law must have the same price across all domestic exchanges, cryptocurrencies are priced at variable levels. In other words, the same coin can be listed at two different prices at the exact same time.
Voyager uses your order to capitalize on this inefficiency by performing an arbitrage across various exchanges. The profits from such a move would typically surpass any commission or fee, allowing Voyager to provide exceptional pricing. Voyager will thus share the profits from this arbitrage with you in an attempt to execute your order at a lower price than you agreed to.
This business model will likely remain profitable until regulations change or there is too much competition in the arbitrage. Changes to the process would appear in the margins.
2. Voyager operates like a bank. In their terms and conditions, Voyager very clearly states “We will lend, sell, pledge, rehypothecate, assign, invest, use, commingle or otherwise dispose of funds and cryptocurrency assets to counterparties, and we will use our commercial best efforts to prevent losses.”
If you receive a loan from a bank, the loan is used by the bank as collateral for other investments. This creates multiple derivatives on a single asset. This is similar to Robinhood in that the users take on counterparty risk. Should Voyager become insolvent, you will need to stand in line behind other creditors to receive your money back.
For taking on this risk, Voyager offers significant yield in a yield-starved economy. Like a bank, a minimal deposit must be kept to receive this interest payment, which can be as high as 9%. As part of this program, it may take up to 7 days for you to withdraw any crypto from your account. Voyager Digital is engaging in fractional lending practices, which banks have been doing for centuries.
However, Voyager is not considered a bank or a broker-dealer. It does not provide FDIC or SPIC insurance for your cryptofor your crypto if there is a run on the bank, or if something occurs that would prevent them from meeting obligations. To conclude, FDIC insurance applies to the cash you hold at Voyager, but there is no insurance for the crypto held there. We discuss the differences in crypto trading platforms below.
Catalysts: Stablecoins and Global Expansion
Last March, Voyager acquired Circle Internet Financial’s trading app, which provided an additional 40,000 clients. The acquisition strengthens Voyager in offering the USDC stable coin that has $7 billion in circulation. Circle is backed by Goldman Sachs and is the founder of the consortium for USDC. The USDC coin allows global transfer of dollars at an instant and for a very low transaction cost.
The stable coin is part of a consortium that is also sponsored by Baidu, IDG Capital and Bitmain with participation on trading apps, such as Voyager and Coinbase. The supply of USDC has grown by 41% since the start of 2020. A recently announced acquisition of France-based digital asset exchange LGOUY expands Voyager Digital’s reach into Europe. Similarly, the firm is targeting to grow its footprint in Canada. We believe this global expansion should further boost Voyager's platform in terms of customers and revenue.
Valuation
When we first covered Voyager on our premium site in January, the company was trading at a forward P/S of 100. We knew the revenue was growing substantially and the company would catch up to its valuation quickly. This is one reason that we think following people who understand tech growth is essential as Voyager is now reporting $20 million in revenue for the month of February alone. This places Voyager’s valuation at a forward P/S of 10 if we assume $200 million in revenue this year based off February and January numbers.
Compare this to Coinbase, a company expected to open at a $100 billion valuation, per a private auction as reported by Bloomberg. The company’s revenue in 2020 was $1.14 billion, up from $482 million in 2019 for 136% growth. If we generously assume similar growth in 2021, the revenue will be between $2.5 billion and $3 billion. Therefore, even if Coinbase can continue this high level of growth, the company will trade at a 30 forward P/S or higher.
Given these numbers and the likelihood Voyager will surprise to the upside from February’s revenue, we think the valuation on Voyager is more attractive at this time. This comes with risk as Voyager is on the thinly traded OTC markets. However, Coinbase is pursuing a direct listing and these have not performed well historically with both Spotify and Slack trading well below their opening DPO price for nearly two years after listing.
Coinbase has 2.8 million monthly transacting users and 43 million verified users. Assets under management are at $90 billion, per the S-1 filing.
Management
We personally do not see any red flags among management, which can often be the case in smaller cap companies.
CEO Stephen Ehrlich has experience running brokerages and financial companies. He was the CEO of E-Trade Professional Trading arm before it was bought by Lightspeed, and was then the CEO of Lightspeed Financial, CEO of PennTrade, and CEO of Tradier. Oscar Salazar is a Co-founder and he was early in Uber as the CTO.
The one issue that I do see is that they are involved in another company called Pager, a digital health startup. I prefer a founding team with one focus.
Major Differences in Crypto Trading Platforms plus Risks …
Since then, most major exchanges like Coinbase and Gemini have become custodians, which addresses the security risks. Coinbase, for example, keeps 98% of cryptocurrencies held in cold storage, where it is stored securely offline. The remaining 2%, which are held in hot storage, comes with insurance.
Gemini takes these security features a step further. Being classified as a trust, Gemini adheres to strict fiduciary capital reserve and cybersecurity standards by one of the toughest financial regulators, the New York Department of Financial Services.
The company also secured the SOC for Service Organizations Type 1 examination, which is typically reserved for the most stringently run financial services or technology firms. A SOC 2 review from an independent, third-party like Deloitte validates that Gemini is holding itself to high security, availability and confidentiality standards. Because of these additional measures, Gemini has become a favorite exchange/custodian for intuitional investors.
Voyager Digital was hacked as recently as December of 2020, but no customer data or assets were lost as the company shut down its systems when the vulnerability was detected.
As mentioned above, cryptocurrencies do not come with FDIC or SPIC insurance. FDIC protects depositors from banks becoming insolvent, providing guaranteed insurance of up to $250,000. The SPIC protects investors from a broker-dealer going bankrupt, providing insurance up to $500,000 in the unlikely occurrence of a broker-dealer becoming insolvent.
Counterparty risk is a reality for any crypto investor holding their coins at an exchange/custodian. If a custodian does not segregate coins and provide unique private keys that the company cannot access, the risk remains that an investor could lose a portion of their coins in the event of insolvency.
This happened to BitGrail in 2019, an Italian exchange. The courts declared that because all crypto deposits were directed towards the primary address of the exchange, and were not segregated, it was impossible to determine the coins' ownership. Thus, the remaining coins were used to pay off creditors, wiping out most of the individual investors using that exchange.
To be clear, we don't think this will happen with Voyager but are providing a 360-degree view of the risks. We think the crypto landscape has become much more secure since Mt. Gox and BitGrail, and these old stigmas prevent many investors from participating in this sweeping trend.
Coinbase, for example, clearly states that they do not segregate coins and control all private keys. In their terms and conditions, the company states that "Coinbase may use shared blockchain addresses, controlled by Coinbase, to hold Digital Currencies held on behalf of customers and/or held on behalf of Coinbase."
On the other hand, Gemini does segregate coins and states that not even the founders, CEO or president can access coins held in cold storage. They are further in the process of securing privately backed FDIC-like insurance for further protection and safeguards in the unlikely case of insolvency.
Please note, Voyager Digital is a thinly traded over-the-counter (OTC) stock. The OTC markets come with higher risk as there are no central brokers compared to stocks traded on the Nasdaq. As a small cap OTC stock tied to crypto moves, Voyager promises to be a roller-coaster ride.
Conclusion
Coinbase also now has a competitor (Voyager) undercutting them on commissions and on the breadth of tokens. For most crypto investors, the process of holding tokens securely in cold storage is easy enough, and therefore, Voyager Digital is likely to be very popular despite the lack of insurance on crypto.
In our opinion, Voyager is a serious competitor to Coinbase – and most certainly to Robinhood. For our goals and desired gains in the I/O fund, we will take the 10 forward P/S on a company growing rapidly rather than an overpriced DPO at a much higher valuation.
Eventually, Voyager’s growth will settle but we think the value proposition of undercutting Coinbase on commissions will continue to help the app take market share in the word-of-mouth community of crypto traders.
Gemini does well for the high-dollar crypto investors, but this is not the same crowd as Voyager Digital. We see Voyager Digital as a competitor to Robinhood and Coinbase at an attractive market cap. We like the management and the diversification with stablecoins, as the Fed and Big Tech are likely to support stablecoins as time goes on. Therefore, Voyager offers exposure to both and has global expansion on the horizon.
Beth Kindig and the I/O Fund currently owns shares of Voyager. This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.
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