Description

I’ve been on VIC for just over 10 years now and have made a point to try not to post the same idea twice, but I believe the opportunity in Pagseguro (PAGS) today warrants breaking that rule.  PAGS has been written up three times in the past including my first write up in early 2019 so I’m not going to go into the nitty gritty of the business model (it is the largest micro merchant acquirer in Brazil), but I will start with a few base level thoughts to get the ball rolling before going into the thesis.

The stock is down 70% in 6 months, why?

• As inflation picked up in 2021 the Brazilian Selic rate went from 2% to 11.5%, the Brazilian merchant acquiring industry is exposed to funding costs in their pre-payments businesses so the profit spread narrowed dramatically, the market picked up on this as an issue on PAGS/STNE Q2 conference calls, and estimates came materially down as a result

• The Brazilian central bank has introduced a free real time money transfer service called PIX, bears think this will disintermediate the legacy payments ecosystem

• The general tech wreck that picked up steam last fall

• PAGS is an ADR, Chinese ADRs have been hammered on de-listing fears, this has been amplified by the possibility of China participating in the Russia/Ukraine conflict given that most foreign listed Russian securities have been deemed nearly worthless, so some investors are likely drawing a line to all ADRs regardless of domicile country

• Fear of a large holder unwinding, not going to speculate but their name is in the news a lot...

Before addressing the points above, lets look at the bull case from a high level

• Non-cash payments in Brazil is still a solid secular growth story, they are at a low-30’s% of transactions vs the West in the mid-60% range, the continuation of this trend should drive above-GDP growth for years to come

  

• Despite the initial bear case that pricing competition from the legacy acquirers would crush PAGS/STNE, the opposite has been true, they continue to gain share and due to PAGS digital-first distribution model (see SQ..) and PagBank offering this trend should continue

  

• Within PAGS is the second largest NeoBank in Brazil, PagBank, active users have gone from 3.7m in Q1 2020 to around 13m in Q2 2021, users on the PagBank platform are undermonetized at an ARPU of $80/client vs NuBank at around $225/client

• PAGS grew revenue about 50% in 2021 and will likely grow 25%+ in 2022, it has a clean balance sheet, and it trades at 11x 2023 EPS (fwiw, I think #s are too low, but more on this below)

Addressing the bear points

• The whole ball game here is pricing to recover the increase in funding costs.  Street forecasts do not assume they are able to take much pricing at all.  To be clear, I think PAGS is cheap enough to work even if very little pricing is actually taken, but I think it is more than likely that the industry will move to recover most of the lost economics over the next few years.  STNE’s take rate in Q4 was 2% up 50bps from the 1.5% in Q4 2020 as pricing started to kick in.  The situation is a no brainer because it is already happening and everyone is effectively ignoring it….

• 

• From STNE’s Q4 call

Q - Daer Labarta

Thanks, Thiago. That's helpful. Maybe one follow-up on that. On the take rate, which you mentioned in January, is already above 2%. And as you reprice, any color on how high do you think that can get? Yes, I mean, I guess that's the main question. How much more can that increase as you continue to reprice?

A - Thiago Dos Santos Piau

Tito, we are seeing two things here. One is that we see competitors talking more about repricing in their own strategy. So, I think that this is a trend in the market, and it's a positive trend. The second thing is that we are focused to use not only the repricing, but the offering itself. So, we

have created an offering. In TON, we adjust automatically with the SELIC improvements here in Brazil once we scale banking and we have more expanding balance for our clients. That money receives interest rates because we put that capital in investments in the Central Bank, and we receive interest rates on that outstanding balance.

And regarding competition, as you said, I think that everybody is being more rational in this challenging environment regarding interest rates. So I think that, that's what we are seeing.

• From Cielo’s Q4 Call

Q - Mario Pierry

Hi everybody, good morning. Let me ask few questions, please. One, Gustavo, is related to the competitive environment, right, because when I look at your revenue wheels and you show on your presentation, you barely passed on any price increases when I look on a year-over-year basis? However, you continue to lose market share, especially the SMB segment and I'm focusing on the SMB segment, right? When I look at Page 8 of your presentation, it seems like the active merchants in the SMB segment is declining.

So I wanted to understand is how are you seeing this competitive environment? And why wouldn't you try to maintain your prices stable and try to regain some market share, is that part of your thinking? Or are you going to try to pass on these higher financial expenses to your clients?

A - Gustavo Henrique Santos De Sousa

Mario, Gustavo here. Thank you for your question. You got cut off a little bit. So if I don't answer any aspect of what you have asked, please follow up. Okay?

So specifically on higher funding costs for Brazilian companies as a whole, this is a new reality, and we started the year already transferring this new funding cost to our entire product portfolio. Based on what we have been hearing in public comments from the competition, the industry is doing the same thing. Yes, you are correct. You haven't seen that on the fourth quarter, but this is something that we have initiated in the beginning of this year.

• Regarding PIX, a few thoughts:

• This is Brazil’s version of ACH, can anyone remember the last time they paid for a $15 grocery bill with ACH?

• The use case is mostly wire transfers, as you would expect

• But there is the argument to be made that larger retailers may try to negotiate directly with funding providers on the credit card side, for PAGS, it is highly unlikely that SMB’s are going to try to call up each individual provider and try to haggle directly…

• As it relates to the tech wreck and general carnage in Fintech names overall, the thing I hang my hat on here is profitability.  Even with the massive compression in prepayment economics PAGS is still very profitable.  There is a big difference between 11x EPS and 11x sales.  It feels like this is a throwing the baby out with the bath water situation

• On the ADR argument, this is above my pay grade.  I would just note that Brazil is not China or Russia or an autocratic country.  The other thing to note is that the Brazilian Real has appreciated 15% YTD while PAGS in USD has dropped 30%

To summarize

• I have PAGS earning $1.10/$1.70/$2.10 in 2022/2023/2024, I have them growing 25%+ this year and next, and these #s assume very little in the way of pricing recovery, this should trade at 20x earnings at a minimum so I have a $45 target on it, but I think in reality it will take out it’s old highs if the script plays out 

Catalyst

Q4 earnings....

Comfort around estimates bottoming