Description

Background

DLO is one of the most attractive ways to gain exposure to rising electronification of payments & eCommerce penetration in emerging markets, with the ability to compound top line at 40%+ per year for the foreseeable future. Through their one direct API, referred to as the One dLocal model, the company enables global enterprise merchants to get paid (pay-in) and to make payments (pay-out) within emerging market countries powering both cross-border & local-to-local payments. Their solution is payment agnostic, enabling global merchants to connect with over 600 local payment methods across 29 countries including Mexico, Argentina, Colombia, and Chile in Latin America; India and Indonesia in Asia; and Egypt, Nigeria, and South Africa in Africa, for client such as Amazon, Netflix, Google, Microsoft, Spotify, Facebook, Nike, Uber, and Visa. Notably DLO does not act as the acquirer of record in most cases, but instead is connected to hundreds of local acquirers, allowing dLocal to offer a smart routing solution that maximizes acceptance and conversion rates and reduces fraud risk.  

DLO’s clients span 8 key verticals including retail, streaming, ride hailing, financial institutions, advertising, SaaS, travel, e-learning and gaming. In 2020, on average DLO merchants used DLO’s platform in 6 different counties across 44 payment methods, up from 5 countries & 35 payment methods in 2019. While DLO sales cycles span 6 months to 1 year from commercial agreement to operational implementation & connection, this serves as a moat vs. local players who are benchmarking providers across (i) Pricing (ii) Conversion Rates (iii) Fraud Risk (iv) Client Services & (v) Platform reliability / UpTime. DLocal has had 0% merchant churn since inception, with 171% net revenue retention in 2020, 159% in 2019, and 185% in 3Q21 (196% in 2Q21 and 186% in 1Q21). 

Given the macro tailwinds, complex product & sales-cycle, network effects & regulatory licensing / moats, DLO is one of the more unique assets in all of paymnets, with the market overly focused on '22 & '23 numbers. 

Market Opportunity 

DLO pegs their current TAM at $1.2T of addressable TPV ($0.4T pay-ins; $0.8T of pay-puts) which consists of the total eCommerce volume in the countries they serve (ex-China), expected to grow at a 27% CAGR from ‘20A-’24E.  Of the estimated US$428 billion pay-in volume for 2020, 86% corresponded to local-to-local transactions, and only 14% corresponded to cross-border transactions. Overall, pay-in volume is expected to grow to U$1.1T by 2024. 

EM macro tailwinds are beyond the scope of this write up but in the DLO S1 they highlight that according to the IMF in ‘19 emerging markets represented 57% of aggregate global GDP up  from 43% in 2000 & EM’s are expected to continue growing faster than developed markets overall. Yet, global merchants face numerous challenges trying to enter these markets. Banking penetration remains low across these countries, falling below 20% of the adult population in some cases. 

As opposed to developed economies where card-based transactions relying on international card schemes are prevalent, local card, bank transfer-based payment methods, digital wallet, and cash-like payments, such as using Boleto in Brazil or UPI in India, and making payments at Oxxo in Mexico, are the predominant payment methods for end users in emerging markets. Furthermore, in order to gain access to emerging markets, merchants also need to:

• adhere to local compliance, regulatory, and tax frameworks,

• offer transparency and security for their end users,

• address inherent fraud risk while maximizing acceptance and conversion,

• gain insights from their transaction data, and

• identify and engage with partners that can scale as their emerging markets operations expand.

According to AMI, local payment methods dominate the EM ecosystem representing ~83% of total e-commerce expenditure in 2020 vs the US/Europe where credit/debit are widely held & used. They studied Brazil (one of DLO’s largest markets) which showed internationally-enabled credit cards only represented 10% of the aggregate e-commerce payment volumes, whereas domestic-only credit cards & cash-based methods represented 55% / 13% of the aggregate e-commerce payment volumes in ‘20, & the remaining 35% were alternative payment methods. In India, internationally-enabled credit cards  represented 30% of the aggregate e-commerce payment volumes, whereas debit cards and bank transfers represented 19% and 14%, respectively. In Nigeria, internationally-enabled credit cards only represented 13% of the aggregate e-commerce payment volumes in ‘20, whereas debit cards and bank transfers represented 28% and 27%, respectively. The prevalence of these local payment methods creates a fragmented payment system in emerging market countries, which hampers global merchants’ ability to expand in these new markets. 

DLO highlights several macro tailwinds including:

• Increasing globalization of commerce- According to Bloomberg, cross-border trade involving developing or emerging economies constituted 53% of global trade in ‘17, a ~10% increase over the past 20 years. As global merchants broaden their geographic footprint in search of greater scale and growth, they are faced with the challenge of operating in a multi-jurisdictional environment where they must ensure appropriate compliance with local regulatory, FX, and tax frameworks, and deal with the diverse set of available or preferred local payment methods of end users. Maintaining compliance with these regulatory and market standards can be costly, burdensome, and often hard to address without the help of a partner such as dLocal with the adequate know-how, technology, and level of connectivity to the broad local payment infrastructure.

• Continued rise of the digital economy- In 2020, smartphone penetration levels for Turkey, Brazil, and Mexico reached 61%, 80%, and 75% respectively. According to AMI, 80 million Nigerians are estimated to come online in the next five years. As a result of these growing trends, e-commerce penetration has experienced an accelerated expansion. eCommerce among the core emerging countries DLO operates in, grew 27% in 2020, while global GDP contracted 3.5% during the same year. 

• Middle Class in EM Expansion- On the back of continued economic growth, the middle class in emerging markets has been increasing its level of spending and online transaction frequency. Citing research by Next Big Future, DLO cites the global middle class was expected to surpass 4 billion people by the end of 2020, & is growing by 120 to 160 million people every year, mostly in emerging markets; expected to reach 5.3 billion people by 2030.

• Cross-Border ​​payments in emerging markets are fragmented and poised for growth- Although eCommerce e-commerce is mainstream, cross-border transactions present unique challenges due to low approval rates, poor predictability of timing, low transparency, volatile exchange rates, dynamic regulatory requirements, and significant complexity that comes from having to settle transactions across multiple parties and currencies without a consistent regulatory and tax framework or an integrated payments infrastructure, as EM countries lack  a coherent interoperability between regulatory and technical payments systems. This requires integrated payment solutions to replace legacy disparate players operating in silos, requiring incremental connection between participants which further increases friction in the payments value chain.

• Global enterprise merchants are establishing local presence in selected emerging markets- Once global merchants are established locally, they need to facilitate pay-outs to local vendors, employees, and contractors, and pay-ins from local customers via their preferred method of payment.  

• Highly complex and evolving local regulatory and tax environments- The increase in fraud and cyberattacks continues to push regulators to increase scrutiny across the payments value chain. Regulators have also been concerned with the higher cost of services charged by legacy payments providers driving the creation of new APMs such as the PIX in Brazil. Ensuring adherence to and compliance with these regulatory and tax requirements are costly and burdensome for global merchants, often deterring or limiting their entry to certain jurisdictions, particularly in emerging markets. This presents an attractive opportunity for service providers such as dLocal that have local expertise to offer robust, up-to-date, and integrated capabilities that comply with regulatory, FX, and tax frameworks across emerging markets.

DLO Product Overview / Growth Algorithm

DLO operates as a payment service provider that offers merchants and PSP partners payment processing, FX management, fund collection, fund settlement, fund disbursement, and additional value-enhancing features including fraud prevention, reports and analytics, regulatory, compliance and tax withholding management through a single API. 

DLO offers numerous features to minimize friction for merchants, increase conversion rates and reduce fraud including: 

• Fraud management tools built on machine learning algorithms and rules-based technology to help identify potentially problematic activity and execute transactions with increased levels of security

• Tax & compliance capabilities that streamline regulatory compliance by helping merchants stay up-to-date with complex and frequently changing local laws and regulations

• FX management and multi-currency collection and settlement capabilities to address their needs in cross-border transactions

• Comprehensive merchant dashboard that gives clients visibility into key information and provides valuable tools that can be accessed through a secure, individually-tailored interface

There are real network effects to the DLO business, with value increasing as they expand to new geographies, and add new products, the platform becomes more valuable for existing clients, increasing switching costs, ensuring strong retention, and pricing power. This also makes DLO as a more interesting partner to potential acquirers / other pieces of local market infrastructure; as DLO is responsible for routing payment volume to the least expensive / higher conversion route. Over time the data set they are building is incredibly unique in the regions that they operate given their perch as an aggregator often times sitting a level above the processors.

The company highlights four core growth vectors

• Commercial Efforts- A combination of organic growth, account management, and new clients. DLO is focused on growing their existing enterprise merchant base and deepening their relationships with them. They had 185% NRR in 3Q21 (up from 159% in ‘3Q20), with $12M of new client revenue in the quarter (up from $9M in 3Q20). They are also focused on increasing the number of global merchant clients. DLO’s process from the initial RFP to final integration can take several months and typically involves multiple functional areas of the merchant, including payments infrastructure, operations, legal, compliance, and tax departments. Per the DLO S1, the combined RFP and on-boarding processes can take in general between two months to just over two years. Between 2016-2020, they have successfully added on average nearly six new pay-in merchants per month and one new pay-out merchant per month.

• Products- Enhance the portfolio including pay-in & pay-out capabilities, while developing new solutions such as issuance.

• Geographies- Enhance their presence in each of the 29 countries they operate today, while entering new countries (e.g., in 3Q21 they entered Thailand & El Salvador). In 2021 thus far they’ve entered 6 new markets in total. They have developed a systematic approach to understand the local regulatory and tax frameworks, obtain all necessary licenses and required approvals, and establish relationships and connectivity with key partners (including APMs and local financial institutions). They have typically been able to set up operations in new local markets they enter in less than six months.  

• Their global expansion strategy follows the needs of their merchants by prioritizing markets with the most attractive opportunities and where their merchants face the most complex payments, compliance, and regulatory challenges. 

• Inorganic Initiatives- DLO has continually explored M&A to add new products & geo’s to their suite. With a strong public currency they should be a buyer of choice for countless EM payment infrastructure companies. 

TPV Growth: DLO has grown TPV at a 97.4% CAGR from ‘16 until today but still has <1% penetration in its core markets. 

Business Model

DLO generates revenue from two main sources:

• Net MDR- Typically charged as bps over the transaction volume. In the case of cards, likely the most common payment method for DLocal, fees involved in the operation are (i) gross MDRs charged by DLocal from merchants (revenue to DLocal) and (ii) interchange and network fee + net spread of the acquirer (cost to DLocal). If DLocal decides to anticipate the receivables, prepayment cost is also a cost bundled in the providers’ price. We exemplify a credit card transaction in Brazil below.

• FX Spreads- On payments that involve conversion and expatriation of funds to and from various currencies DLO earns fees on an FX spread. While disclosure is relatively limited, XB transactions likely represent a significant portion of DLO’s total volume. 

• Other Revenue- This is a small part of the overall business but they also earn fees on initial set up, installments, minimum monthly fees, chargebacks, and refunds. 

Competition

DLO competes with global players such as Adyen, and Nuvei, as well as local players such as Stone, Cielo, Network International, and Ebanx.  Out of its competitors the company is the only one to offer pay-out solutions across its different regions. The company processed $2.1bn in TPV in 2020, which represents less than 1% of total e-commerce sales in the countries in which it operates. 

Given the complexity associated with operating in these local jurisdictions, the licensing / regulatory requirements, tax regime, and client relationships DLO continually ranks favorably from its customers as best-in-class. 

Valuation 

While DLO "screens rich" on both '22E & '23E consensus metrics (31x / 19.5x '22E / '23E GP & 52.7x / 32.0x '23E EBITDA) they continue to exhibt NRR in excess of 150%, while growing new client logos on a quarterly basis. With total TPV growth in the regions in which they operate growing at a 15-20% CAGR from now until '25E, and their current <0.5% market share) DLO should be able to grow top line at a 40-50% CAGR over the next 5 years, generating $1.5B in revenue in '25E (I model a 45% CAGR between now and 2030E for TPV which is still ~2.0% market share). 

DLO has strong operating leverage, given the high percentage of fixed costs, as they have greater volume the cost per transaction falls. In 2021 EBITDA margins will be ~39% and by 2030E I expect that to grow to 55-60%, as the business starts to look more like V/MA from an operating leverage perspective.

Assuming a 15% discount rate and 7% terminal growth rate we get an EV of $15.5B today compared to the current EV of $8.2B or a share price of  $53.75.

M&A

There are numerous private competitors in LatAm / Africa / SE Asia that have received large amounts of venture funding that would be attractive tuck-in candidates for DLO to grow TPV / customer base and further penetrate those clients in new jurisdictions.

DLO itself is also an attractive takover candiadte for any of the global payment companies (MA, V, FISV, FIS, GPN) but given the dual class structure & current multiple would be difficult for any of them to execute on. 

Risks

A few notable risks:

• Like other LatAm payment companies DLO provides limited disclosure regarding revenue, volumes, & pricing on a product, client, and geography basis. 

• DLO’s top 10 clients accounted for ~64% of revenue in 2020; while they haven't seen churn to-date given what is a much higher take rate that in DM economies (unclear how much comes from XB) this likely won't be the case forever.

• General Atlantic owns 35.6% of the shares outstanding which likely remains an overhang for some time. They sold 5.0M shares in October when the stock was in the low $40s and would expect them to continue to be a seller on strength.  

• EM FX risk

• Dual Class structure 

Catalyst

While there's no hard catalyst for the DLO thesis it's continued execution with their existing client base, adding new logos, new geo's, and new products while the operating leverage fuels margin expansion in the out-years. Given the EM exposure the market will apply a higher discount rate compensating long-term holders.