Description

Nubank is the largest digital bank in the world (ex-Asia) with 59.6M accounts (+61% YoY) at the end of 1Q22 and 46.5M active customers (+82% YoY). Founded in Brazil by David Velez in 2013, NU sought to target the most highly profitable banking sector in the world (as measured by ROE) of the incumbent Brazilian banks. NU initially launched a retail credit card product with a mobile-first experience, and has since expanded into a full suite of banking products to serve customers across: spending, saving, investing, borrowing & insurance. 

NU is now the best positioned brand in LatAm broadly with a 90+ NPS (one of the highest of any consumer company in the world let alone in financial services), with the scale benefits of any incumbent with 59.6M accounts yet their cost to serve is 85% lower (20x more efficient), enabling them to compete on price, which increases at scale, and best in class unit economics which continue to compound at scale >30x LTV/CAC. In addition to Brazil, they've since expanded to Mexico & Colombia and now any individual or SME in Brazil, Mexico, or Colombia with a smartphone can become a customer. LatAm as an economic block has 600M people, with the market cap of financial service incumbents ~$1.0T+ yet banking & credit card penetration are amongst the lowest in the world. 

The growth algorithm is very simple consisting of: (i) Growing Customer base (ii) Increasing Average Revenue Per Active Customer ("ARPAC") & (iii) Lower Cost to Serve.

In terms of customer growth this can come from (i) deeper penetration of existing markets & (ii) expansion into new markets. In Brazil they currently have ~33% of the adult population (with active customers representing ~25.9%), while they have just 7% of credit card balances, 3.7% of personal loans, 2.1% of deposits, and 0.7% of investment accounts. They recently launched in Mexico & Colombia and two years in Mexico is beating Brazil at every metric, starting with an NPS of 95+. Mexico credit card penetration is just 12% vs Brazil at 35%, creating higher consumer pain, leading to better product market fit & a flywheel around CAC. They recently surpassed 2M customers in Mexico & are the #1 issuer of new cards in the country. Colombia is earlier in its journey and grew 85% QoQ, with 200K customers and a waitlist of 1.0M+ people. At present they have just 2.2% of the adult population in Mexico (with active customers representing 1.9%), while their credit card represents ~1.1%, and personal loans are a rounding error. In Colombia they are even more underpenetrated with 0.5% of the adult population, 0.4% of credit cards, and 0% of personal loan market. In addition to the retail market NU continues to emphasize SME's with a core account product, and products are payment acceptance and credit cards. Given the market penetration NU can generate attractive above market returns in Brazil alone, with success in Mexico and / or Colombia enabling a 100M+ financial service company with best in-class-unit economics. 

The easier part of the growth algorithm to underwrite is the ARPAC. In 1Q22 monthly ARPAC grew up $6.70 ($80.40/year) while cost to serve decreased to $0.70 ($8.40/year), however if we look at their "mature cohorts" defined as 3+ years they are already at a monthly ARPAC of $19/month ($228 per year) and finally customers that utilize 3+ products (credit card, NUAccount, and personal loans) of NU had a monthly ARPAC of $35-$40 ($420-$480 per year), leading to a >30x+ LTV/CAC. This monthly ARPAC was $3.60 in 2020, and roughly the same in 2021 ($42 annual) with the Street at $65 in 20223, $80-$90 in 2024 both of which feel conservative given where 1Q22 came in, mature cohorts already at $228+ and the user growth we saw in 2020 and 2021, and the success they've had in cross-selling products. The Street is leaning on growth in lending to drive 45% of ARPAC expansion over the next 5 years, even at a fully loaded $80-$90 of annual ARPAC NU would be generating just half of the net fee revenue of incumbent Brazilian Banks ($157) prior to accounting for the lending opportunity ($322 ARPAC). This also fails to give any credit to the nascent crypto offering which saw a notable uptick in gross profit per user at Cash App and ARPU per user at Robinhood. Given the carnage in public & private Fintech, NU is also in position for bolt-on M&A in new geo's (e.g., Africa or other parts of LatAm). 

The current bear thesis is predicated on deteriorating asset & credit quality in Brazil given the macro backdrop. David was quick to point out that in the ~10 years since they founded the company, NU has operated almost exclusively in periods of inflation, recession, or political turmoil, and as a credit first product, credit has always been a core competency. NU has the ability to cherry pick loans/users, since loans are only a cross-sell product, where they pick only the best risk credit card customers. The Brazilian credit card market saw greater deterioration than NU. Under IFRS NU needs to front-load credit loss provision whenever a loan is booked, so the faster they grow the credit book the more short term pressure on gross profit margin which should be 60%+ longer-term but finished 1Q at 33.5% which is another part of the bear thesis. A recent MS survey found that Nubank's borrowers have average debt service ratios in-line with incumbent peers (37%, vs 37% for Itau, 37% for Bradesco, 35% for Banco de Brasil, and 38% for Santander), while survey data showed that Nu CC delinquency was better than most bank and fintech peers, as ~11% of NU CC clients said they were past due on payments (vs. average of 13% for all lenders and 14% for fintech peers). 

We see a path to $150 ARPAC by 2025, 95M users, with 22.5% OI margins driving $3.2B of operating income, $2.5B of NI or $0.55 in EPS which implies NU currently trading at 7.2x '25E EPS at a time that they'll be growing EPS at 100%+ per annum. As NU continues to execute, inflects to profitability, given the lower cost to serve, higher ROE, and higher growth rates, with a larger TAM (SME's + other geo's) we think NU can command a ~20x P/E multiple or trade $11 or a ~40% IRR from current levels. 

Catalyst

The NU IPO lock-up expired on 5/17 which unlocked 3.1B shares vs the 306M shares that were freely tradeable prior to lock-up expiry, since that time NU has traded 1.26B shares (805M of excess shares vs pre lock-up). Since the beginning of April NU has underperformed peers by ~20% into this highly anticipated lock-up expiry with short interest reaching a high of 25%. There are still large venture funds / cross-over funds such as Tiger Global distributing shares in the market. As this technical overhang abates, and NU continues to see organic customer growth, new product launch, and ARPAC expansion, with an inflection to profitability by year-end '22 or 1Q23 shares should re-rate accordingly.