With Warren Buffett buying shares of StoneCo (STNE) and revenue growth and profitability at the net income level, the company seems a very interesting name. StoneCo does not seem very cheap compared to other peers operating in Brazil. But if revenue growth and net income keep increasing, the company is a clear buy.
Some of the best people on Wall Street are working on this deal. It will retain the interest of many investors:
Incorporated in The Cayman Islands and headquartered in São Paulo, Brazil, StoneCo provides financial technology solutions helping merchants and partners execute transactions online and through mobile channels.
With a business model that combines different solutions with a cloud-based technology platform, an integrated distribution approach and on-demand customer service, StoneCo has revealed itself as completely disruptive. Despite launching only four years ago, the Nilson Report notes that StoneCo is the largest independent merchant acquirer in Brazil.
With over 200,000 active clients of different sizes, the company’s ambitious and target market seems large. It is targeting a market of 8.8 million small-and-medium-sized businesses in Brazil. Additionally, as of June 2018 the company provides solutions to over 95 integrated partners including global payment service providers, digital marketplaces among others. They use StoneCo’s technology embedded into their own system. Thanks to these two channels, the company has seen how its key performance indicators performed astonishingly.
The total payment volume (“TPV”) in the three months ended September 30, 2018 was 83.7% more than that in the same period in 2017. Additionally, the TPV for the nine months ended September 30, 2018, equal to R$56.8 billion, represented 70.9% increase compared to that of September 30, 2017.
The number of active clients is also growing at a high pace. The number of active clients in Q2 2018 was equal to 0.2 million, 216% more than in Q2 2016.
The images below show the increase in active clients and TPV in the last nine quarters:
Market Size: A Lot Is To Be Done
Brazil represents a market that is growing at fast pace. Statista notes that retail e-commerce sales are expected to reach $31.664 billion in 2022, 89% more than in 2016. The image below provides further details on this matter:
With that, StoneCo believes that a lot is to be done since the penetration of electronic payments is significant compared to other developed markets. The World Bank and ABECS note that electronic payments volume was equal to only 28.4% of the total consumption in Brazil in 2016. There seems to be significant growth for improvement. Keep in mind that this figure in the United States is equal to 46.0%. That’s not all. The World Bank also reports that only 17.6% Brazilians make payment through the internet. This number is quite low compared to the same stat in the United States, which is 77.2%.
The company seems very well positioned to capitalize on these new technological changes. It has the technology in place, which clients seem to get to know right now. The business growth shows this fact. With this in mind, it seems to be an interesting time to jump into this market.
With an asset/liability ratio of 1.11x, the company’s financial shape seems stable. However, investors will need to check the company’s working capital very closely, which seems to be large. As of June 30, 2018, the account receivables is equal to $1.511 billion, which represents 82% of the total amount of assets. This means that the company is getting paid a bit late. Additionally, the amount of account payables, equal to $1.025 billion, represents 62% of the total amount of liabilities, which shows that StoneCo is paying a bit late too. With that, the company is paying suppliers at a faster rate than the rate at which it is paid. It is not an issue right now, but it is a feature to be supervised closely. In order to finance its working capital, StoneCo received money by signing obligations that are worth $0.533 billion as of June 30, 2018. The image below provides balance sheet as reported in the prospectus:
As of today, StoneCo should not have liquidity issues. According to the list of contractual obligations, the company will need to pay the senior debt in one to three years. If the company raises capital to repay debt, the stock dilution risk could push the share price down. Investors should remember this date. The contractual obligations are shown below. The numbers are given in the currency of Brazil:
74% y/y Revenue Growth
The revenue growth is astonishing. In 2017, the company reported $198.8 million, 74% more than that of 2016. The net income is not positive. In 2017, it was equal to -$27.2 million. The cost of services, equal to $58.1 million, and financial expenses of $61 million seem too large. With that, if the company keeps growing revenues at this level, growth investors will not really care about the net income losses in 2017. The market should study revenue growth very carefully in the next quarters. If it continues to grow at the same level, the share price should go higher.
Investors may also check the figures reported in the six months ended June 30, 2018. The net income reported was positive, $22.7 million, which is beneficial. If the net income is positive in 2018, growth investors should not be the only ones appreciating this name. Value investors will also commence assessing the figures reported by StoneCo.
Use Of Proceeds
The company will use the proceeds for general corporate purposes. The prospectus reads that the company may use the money for mergers. However, M&A activity does not seem likely in this case. Keep in mind that the company is growing organically. In this case, StoneCo seems more likely to finance its working capital with the money received from the IPO. Additionally, it is expected that the company will use some money to repurchase shares from a shareholder. Some investors will not appreciate this feature. The image below provides further details:
Share Classes And Valuation
The image below shows the capitalization expected after the IPO. It is beneficial that the company will not use the proceeds to pay debt. The total amount of debt will remain $534.3 million. Take a look at it:
The company expects to have two types of shares, class A and class B shares. StoneCo is selling class A shares, which hold one vote. Class B shareholders have the right to 10 votes. This is not unusual. Most investors will not appreciate it. The lines below provide further details:
“Class A common shares and our Class B common shares. The rights of the holders of Class A common shares and Class B common shares will be identical, except with respect to voting, conversion and transfer restrictions applicable to the Class B common shares. Each Class A common share will be entitled to one vote. Each Class B common share will be entitled to 10 votes and will be convertible into one Class A common share automatically upon transfer, subject to certain exceptions. Holders of Class A common shares and Class B common shares will vote together as a single class on all matters unless otherwise required by law.” Source: Prospectus
In total, after the IPO, there will be 268.062 million shares. At $22 per share, the total market capitalization will be 5.897 billion. Adding debt of $0.534 billion and deducting $852.8 million in cash from the IPO and $91 million in cash in June 2018, the enterprise value is expected to be $5.487 billion. With revenues of $164 million in the six months ended June 30, 2018, forward revenues of $328 million for the year 2018 seem reasonable. With this figure in mind, the company is selling shares at 16.72x forward sales.
The lines below provide information about the competitors of StoneCo:
Competitors like First Data Corporation (FDC) and Global Payments Inc. (GPN) seem too large and too diversified to be comparable to StoneCo. PagSeguro Digital seems to be the best peer to assess the valuation of StoneCo. PagSeguro Digital Ltd. (PAGS), which also operates in Brazil, with an enterprise value of $7.78 billion, trades at 6.85x sales. Its net income in 2014 seemed similar to that of StoneCo right now. If StoneCo is able to increase its net income to the level of PAGS as of today, its capitalization should increase.
Source: Seeking Alpha
PAGS seems to be growing revenues at a higher pace than StoneCo. Total revenues were equal to $326 million and $790 million in 2016 and 2017 respectively. Additionally, PAGS has no debt. It makes sense that the market capitalization of PAGS is larger than that of StoneCo. The image below provides further details:
Source: Seeking Alpha
StoneCo does not seem undervalued compared to PAGS. With that, both PAGS and StoneCo are growing at a high pace. Thus, it may be the same buying one or the other. Investors interested in getting exposure to this may acquire both to diversify. If revenues and net income keep growing at the same pace, the share price of both should increase.
Berkshire Hathaway Could Buy Shares
It is very interesting that Berkshire Hathaway A (BRK.A) could acquire approximately 13.712 million shares of StoneCo. Additionally, T. Rowe Price Group, Inc (TROW) and Madrone Opportunity Fund could acquire acquire large stakes in the company. The stock price could increase after the IPO as demand will increase after the market sees these shareholders.
The Jurisdiction Will Be That Of The Cayman Islands
Investors should be aware of the fact that the jurisdiction is that of the The Cayman Islands. The assets are located in Brazil, but the company was incorporated in The Cayman Islands. The image below provides the business structure:
As a result, the right of shareholders will not be that of the United States. The protection of shareholders is a bit less significant than that in the U.S. The lines below provide further details on this matter:
“We are a Cayman Islands exempted company with limited liability. The rights of our shareholders may be different from the rights of shareholders governed by the laws of U.S. jurisdictions” Source: Prospectus
StoneCo seems a very interesting opportunity for several reasons. First of all, the e-commerce brazilian market is large and is growing at a high pace. Additionally, StoneCo shows large revenue growth and profitability at the net income level in 2018. The company does not seem cheap compared to PAGS, but it seems a clear buy. Also, both are growing at a high pace. Finally, the fact that Warren Buffett is expected to buy shares is quite interesting. The demand for the stock could increase because of this reason.
Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.