Chit Chat Stocks - DLocal (DLO) with Robert Cantwell and Joe Kowaleski

Episode Date: April 14, 2022

DLocal is a Latin American financial technology company. The company operates a payment platform that is similar to companies like Adyen and Stripe. Listen as Brett and Ryan ask Robert and Joe Kowaleski questions about the company, its business model, and valuation. Enjoy the show! This episode is sponsored by Stream by AlphaSense, the highest quality expert network library. Sign-up here: https://streamrg.co/CCM Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested to learn more about Upholdings? Find them on Twitter here: https://twitter.com/UPHOLDINGS?s=20&t=4KbtWXrwzWi-2QiItDFNMg Contact us: [e-mail]  Timestamps Dlocal | (4:26) Competition | (16:02) How to Measure Success | (25:40) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we typically interview an expert on a single stock. But today we have two experts on. It's Robert Cantwell and Joe Kowalewski. They both work at Upholdings. Robert is the portfolio manager there. And then Joe is an investment analyst. And we talk about D-Local, which is a fast-growing payments company out of Latin America. Pretty fascinating business. They both know it really well. Did you have any highlights from the interview? Yeah. If you know Stripe, if you know Adyen, it's a similar business model, but they're focused on South America. I mean, we just went through why they've succeeded so well in South America and Central America. And that is because of their

focus. And that is because the regulatory barriers to entry. I liked using the example of Facebook a lot where not even Facebook thought it was economical to try to copy what the local was doing. And now they're reaching the scale and you can kind of get a good, pretty good investment pitch here of why that rapid growth they're achieving should continue. Yeah. And you can see, and they illustrate it well, why this is such an attractive model. And I'll save that for the interview. But before we get to that, I want to talk about our sponsor for the episode, Stream by AlphaSense. Stream is an expert interview transcript library. We've talked about them here before. They have interviews with experts covering a range of industries and

tons of companies. I believe it was probably 10,000 plus call transcripts now. And that covers tech, consumer goods, industrials, real estate, plenty more. You can always get good insights from expert interviews. And it feels like you're talking, it feels like a more candid conference call sometimes. That's kind of how I would describe it. But you definitely get a lot of value out of it. And so if you're interested in signing up for it, go to StreamRG.com and you can sign up for a free 14-day trial using the promo code CCM. Definitely go check them out. Without further ado, let's get to the interview. Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview

industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital. and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. Today, we are joined by Robert Cantwell and Joe Kowalewski, I believe. I think we talked about it before the show. I think I'm saying that right. And Robert is the portfolio manager at Upholdings. And Joe is an investment analyst there as well. Came across Robert on

Twitter. So this is his first time on the show. So first of all, welcome to the show. Can you kind of give us the thumbnails on what Upholdings is? What is the strategy there? What do you guys do? Thanks, Ryan and Brett. Great to be with you guys. So Upholdings, we're an investment advisor based in Nashville. We oversee the Compound King strategy, which is an investment strategy that we've been running here since 2019. And the short version of it is that we are very selective in the companies we invest into. We own about 25 businesses on the long side. And a Compound King has four dimensions to it. It's in an industry that is growing with a small number of competitors so that there's

lots of profit to be shared. The businesses that we target tend to be market leaders that either have high sustained market share or are expanding their market share within that industry. The third dimension is the reinvestment. It's really important that management is not pursuing growth at all costs, but instead sustaining the return on equity and margins within the business or expanding them. And then the last dimension of that is price. We need to make sure that the share price that we're entering a business ensures that

we've got a really good chance of earning double-digit returns over multi-year periods. So that's what we focus on inside this compound king strategy that we run. Okay. And today we are talking about D-Local, which is maybe, I guess, the name that people are probably less familiar with. How did you come across the company? It's great business. Briefly, my own personal background, the first eight years of my career, I spent as a

private equity analyst at an institutional investment firm. I spent the next eight years, I dropped into a company that we invested in called Everlane, which was one of the early online direct consumer brands that grew alongside of Instagram and other social media firms during the 2010s. And one of the key enablers of running an online commerce shop was the ability to accept payments from anyone, anywhere. We were extremely early customers of the Braintree product that was acquired by PayPal. We were also early customers of Stripe that very quickly came in as a far superior alternative to Braintree. What was so fascinating over that period was seeing how much faster a business like Stripe was growing than any of its individual customers because Stripe

was expanding at the compound effect of all of its customers growing as opposed to taking the risk of just any single industry or any single company. So Stripe's business model had certainly been one of the most impressive things to have witnessed during the 2010s. And when we started managing the strategy back in 2019, very difficult to access private shares of Stripe. However, However, they had a couple of competitors, Adyen that was originally founded in Europe back in 2006, DLocal that was originally formed as AstroPay back in 2009 in Southern America. And both of those businesses have iterated quite a bit during their existences. But for all intents and purposes, they look and feel very similar to Stripe, except they

have different geographies, which gives them a little bit of different access to customers. As we'll get into later in today's deep dive, being local has unique advantages to these businesses because a lot of what makes these companies so valuable is the amount of local regulation that they have to contend with. So Adyen being in Europe is much better equipped to deal with European regulation than say a Stripe that's based in America, similarly a D-Local based in Latin America. So the three of these businesses we look at and compare and they compete all against each other.

And we've had both Adyen and D-Local now since it's gone public in our portfolio now for some time and are excited to share more about the business and why we're so excited about it. Dan, you kind of just alluded to it a little bit, but can you go maybe into a little more depth on what D-Local really does? And then could you provide like an example customer use case? Because I saw some of their customers, and they were pretty big names. So maybe mention one of those as well.

So these businesses, officially what they do is they develop APIs, application programming interfaces. And the reason why APIs caught on so fast is because they were developer tools that essentially were a line of code that a developer could implement into any system that they're architecting. So instead of a traditional sales model of having to go to a company's, say, finance department and say, we have this phenomenal payment software that you should use, here's what we're going to charge for, you should sign up for it. And it's slow and cumbersome, and it's impossible, and it takes forever to onboard that customer. Instead, Stripe or DLocal,

in this case, writes this code. And then the engineers are like, hey, this code works really well. This is going to make it easier for us to accept payments in a foreign country where we don't have any nexus yet. So we're just going to use this line of code so that we can start accepting payments there. And so this API notion of being able to essentially turn on customers without having to enter into formal contracts and documentation and things like that was a particularly easy way to onboard new customers. And then, of course, it was really easy for the payments companies to say, hey, well, we've got various folks using these APIs.

We started out by offering them for free. It's really clear that there's some people moving real volume over this. So let's start with those heavy volume users and actually build a contract around that and make sure that we can get paid. And that's where the real magic really lies inside of payments companies, is that they charge such a small take rate, but they unlock enormous value for companies. So using Everlane as an example, we didn't transact outside of the United States, and we wanted to launch Latin America. And to do so, DLocal had gone out there and accumulated

a method for accepting all these various forms of payment that weren't available in the United States, whether it's Mercado Pago or some other bank you've never heard of. And through a single API, now all of a sudden we're plugged into all the common use cases of what customers in Brazil actually use to pay and check out for things. So that's what the technology does. That's how they've built a business model around it of taking a small percent of every transaction that happens with the company. And ultimately, this is why these businesses grow so fast with their existing customers is because they get plugged in once, but then they get to grow with those companies for their lifetimes. Okay. And that kind of does lead into the next question here. And I'll maybe

go into something else where they make money off of the total payment volume flowing through that business. If you look at any of their IR pages, it is growing extremely rapidly. What is, is there anything else driving that growth? Just signing on new customers, signing on, you know, having these companies grow within them. And are there any other parts of the business that we're missing besides the take rate on the payment volume? Yeah, so like Robert said, I would boil it down to there's two huge drivers that the company is benefiting from. So the first thing is the geographic fragmentation.

So in America, we have Visa and MasterCard and Discover and American Express, and they're the big payment methods. But across the world, there's hundreds. I think D-Local accepts something like 600 different payment methods. And in certain countries, less than 20% of adults have a bank account. So it's really tough for companies like an Audion or a Stripe to compete on those types of geographies. And then the second thing is the technology changes. changes so this isn't um this is applicable also to audion but uh the point of sale has has gotten

you know infinitely more complex so if you think about you know a hundred years ago when people were transacting uh it's just a cash registered cash and then we moved to you know point of sale systems and now we're on you know you can pay through mobile apps um there's stuff like venmo um, so that's sort of unlocked a whole nother, um, dimension dimension to that. Okay. And is part of the part in, uh, South America, Latin America, that a lot of people are, don't even have bank accounts. So it's way, way more complicated than even having multiple countries in Europe. Is that part of the UK is what makes it so much harder for someone? Um, sorry, I forget the company that Robert was talking about, uh, Everland, I think

from building something themselves and going into Latin America, it's just way, way too difficult for an individual company to do. Go ahead, Robert. Yeah. And I'm going to jump on this where, forget Everlane, Facebook. Facebook wanted to expand in Latin America. And you had local websites that wanted to acquire ads on Facebook. And Facebook themselves looked at the amount of engineering time and legal work that would be required for them to sign up 600 different payment methods that were commonly used in Latin America. And so for a business of that size to come into a foreign continent like that and say, rather than even say going to one of their existing, because Facebook is a Stripe customer,

they're a PayPal customer, Facebook with their cloud could have gone to Stripe and said, hey, Stripe developed this for us. But instead, the most economical thing for Facebook was to go to Latin America and say, hey, D-Local, you've already done all this work. It's actually much less expensive for us to do this with your take rates than it is for us to build it ourselves or to ask one of our existing surface providers to build it for us. And to get to the first part of your question about, well, what happens in a continent where you have a lot of unbanked? Well, this is one of the truly exceptional aspects of DLocal and why their take rates are as high as they are.

We look at gross profit as a percent of transaction volume instead of revenue. We think that's a fair comparison across competitors, so they keep about 2%. They keep about 2% in gross profit of all the transaction volume that they process. The reason why their take rate is so much higher than, say, Stripe's take rate in the U.S. is because the actual acceptance rate, anytime a card is swiped or someone is trying to do a payment, it is so much lower in developing countries than it is in developed countries. So let's take D-local. This is highly variable, but the numbers estimated that about 90% of the time, a transaction is successful. In the U.S., you're looking at a 99.9% success rate. If you

look at DLocal's next nearest competitor, they're at around a 70%, maybe 75% improving. And so if you're Facebook going to a foreign continent like this, you're going to put a phenomenal premium on the fact that DLocal has done the work to get that transaction approval rate to happen 90% of the time instead of 70 to 75% of the time. And that's why they're willing to give up sort of that extra take rate chunk than you'd see in a developed market version of the same company. Okay. Then even from Facebook's point of view is they're in a customer acquisition game. They want as many advertisers. They have 10 million advertisers. They want to get to 20 million. So for them, sacrificing another 2% or 3% of that revenue is way more important than as long as they can acquire those customers. Okay. No, that makes total sense.

And can you list maybe, you mentioned PayPal, Adyen, just for anyone that's interested in researching these competitors, can you maybe say who they are, like those 70% ones and what, like, is the MercadoLibre kind of in this or not? What's causing them, like, why is DLocal better than them, all these other ones right now? Is it just focus? What is it? So eBanks is probably the closest comparable. So they were supposed to go public and they pulled it a few months ago.

There's also legacy players like PayU. I believe they're owned by Naspers, which has become sort of the Tencent tracking stock. But yeah, those companies are more in sort of the old, you know, one-to-one point of sale system, where DLocal is more on the, you know, building the new technology. So they're the main guys that they're competing against. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham.

They have free high-speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free bright side breakfast. Or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day. Tonight, La Quinta. Tomorrow, you triumph. book your stay at lq.com is is anything prohibiting um someone that's not local so say like a stripe or an adian from going and uh trying to grow in those latin american markets is is there like any legal hurdles or is it just sort of like the they don't know the area as well yeah there's

a lot of you know like robert said there's a lot of compliance you know issues with that Audien is in Latin America. So basically, you know, two years ago, Audien's business in Latin America was the same size as D-Local. And now D-Local is three and a half times bigger than Audien's business. And I think Audien doesn't do pay-ins. So pay-ins are basically when, you know, Facebook is collecting for their business where payouts are like you're paying your Uber driver. So Audien, I've heard that they don't do pay-ins. So that's one of the advantages to D-Local. And, And I think over time, it's something, companies only have so many resources, right? So on a long enough time horizon, I'm sure they could build something comparable.

But there's a lot of nooks and crannies, and like Robert said, to compliance and that sort of thing. Okay, makes sense. And then the team is based in Uruguay, and this might be the first company I've ever come across from Uruguay that we've looked at or had on the podcast. So I'm just kind of curious, what's the management team like? What are you guys' thoughts on management overall? And then I believe Robert mentioned AstroPay earlier. What was kind of the relationship there? So this is a pretty unique case.

One of the few times in which, let's say, U.S. investors will go outside of the United States and feel like they're investing in companies of similar quality outside the U.S., there tend to be two components. One is the software is of a comparable or even superior technology and or the customer set is not as risky as the end market might lead you to otherwise believe. So working backwards, in the D-Local case, most of D-Local's customers are the largest companies in America, Facebook, Microsoft, Google. And so you're not actually talking about a business that has Latin American customers. Then from the technology standpoint, where from everything that we've been able to diligence, one of the things that, and this will get into the management team, So DLocal was originally founded by Sergio Fogel, who's actually a serial entrepreneur in the payment space. And when he originally founded the business, it was primarily founded within AstroPay.

And they found that this technology was so powerful that it worked across a vast number of industries. And this founding team had the insight to know that both investors as well as regulators don't treat all industries the same. And you have the call it the sin businesses of casinos and sex workers and other areas where you potentially get a lot of regulatory involvement that has very little to do with the payments technology itself. And they said, we need to separate this business such that this legacy AstroPay business can continue to serve businesses that might be under additional scrutiny for whatever reason. And then we have this other business, D-Local,

for which it's going to participate in a lot of less regulated businesses, whether it's e-commerce or rideshare or digital advertising or what have you. And by the way, the founding team to have that insight is what also helped D-Local avoid some of the issues that, say, a Wirecard ran into. Now, that business obviously went down a very fraudulent path and had a very ugly outcome, but it was a good example of why it was important to separate these two businesses when they did. The founder, Sergio, he's not terrifically involved in the business now on a day-to-day basis. He's now working on a new startup that's got another angle on the payment space. But from everything that we've seen from the management team thus far,

They've been extremely transparent that a company like Adyen has been their North Star. And from everything that we've seen, as Joe pointed out, relative to their ability to take share in Latin America, much fascinating, is that this is a team that absolutely can execute, has executed against those goals. And we expect them to remain the market leader within Latin America, at least for the next five to seven years. Okay. And speaking of Adyen, it kind of leads into the next question. DLocal's take rate is much higher than I believe Stripe and both Adyen, but Adyen's is much lower than theirs. And you mentioned it's because of the complications within the market. Do you think the take rate is sustainable or do you guys expect it to kind of steadily fall over time? I believe when I was going over the numbers, it has steadily fallen. Is that something that is a concern here or is

just kind of how it's going to play out, you know, as the competition or as they scale up the business? Yeah, it's tough to predict. So we like, you know, we like putting ourselves in the shoes of the operators. So if you listen to any DLocal earnings call, they're always saying, you know, we don't run the business on take rate. And I think investors, you know, they pay a lot more attention to the take rate than the operators do. And, you know, to begin, it's tough to even defined take rate, right? So if you look at Ogden's business, they report a gross revenue and a net revenue number. And the difference there is the fees that go to the issuers generally. So the financial institutions that are issuing the payment methods. Well, DLocal actually has some

of that in their cost of revenue. So like Robert, I think mentioned earlier, we think the take rate is actually closer to 2% because if you take the gross margin divided by the TPV overtaking the just the revenue. I think there's some expenses in there that if you were comping it directly to Adyen, it would be, you know, it'd be a little bit lower, but yeah, I don't, it's really, it's really tough to predict. If what you're, if the end goal here is how to build the model, the interesting thing is you could, you could build two models. You can either say, you know, this business is never going to grow faster than 20% a year. Again, It's going to grow at low double digits, and it's going to compound like that and continue

to print cash flow. And if you do that, the take rates aren't going anywhere. But if the business is going to continue to compound growth at 40%, 50% plus, then absolutely those take rates are going to continue to come down. Because as this business continues to access larger and larger pools of capital, it's inevitable that the take rate has to shrink in any of those larger pools of capital that they access. And this is where, you know, when Joe talks about the operator mindset, they're thinking about gross margin dollars to the company relative to the amount of resources the company has to sacrifice to pursue those margin dollars. So I would say if you want to, when you're building your model, you almost need to make your take rate assumption flexible to your top line growth assumption, because the two are going to be inversely correlated to each other.

And maybe I'm missing something, but why when revenue is going faster, is the take rate going to be lower? Is that just because the larger customers are going to have better negotiating leverage? Is that what it is? Yeah, primarily, yes. Is there a specific industry that you think will be driving growth for D-Local? Or does their solution apply to so many different ones that it could come from anywhere? it's mostly you know high growth technology companies i think you can go down the list of you know netflix and and spotify and uber and uh they're all customers so there's definitely a

secular tailwind that you know d local has from from riding really great customers so i was you know back to robert's original story of what stripe did i think stripe was actually in i think they were in the Y Combinator ecosystem, if I remember correctly. And, you know, one became Airbnb and one became this. And, you know, they were just sort of there and they were able to grow faster because it was Airbnb and this company. Sometimes we like to talk about these payment networks as it's almost like better than being an LP in a venture capital fund, because the success of these companies is a super high free cash flow margin business model that collects money from all of the fastest growing companies anywhere in the world.

If you're the venture capital company, you have to invest in a lot of losers to get a couple of winners that work right for you. But by opening these payment businesses, you only are exposing yourself ultimately to whoever the winners are. that's an incredible risk return opportunity that doesn't come along too often. And on top of it, it's inflation protected. This episode is brought to you by KPMG. As a business leader, how can you innovate, build trust and move forward in a digital era? KPMG can help by bringing together the right talent and technologies, generating insights that

spark opportunities. To explore their thinking, visit reed.kpmg.us slash opportunities. Yeah, it sounds like a pretty incredible model. What metrics do you guys use to, I guess, measure the success of DLO or just earlier stage companies in general? So this is a harder thing to do, especially when the companies are this small, because even a company like Delocal, they've got less than 500 customers. So you're looking at a pretty small customer base in order to build a business as large as theirs. So we focus on a number of things. One of the things we've particularly found for enterprise software companies at this size is there's an extremely high correlation between the number of employees working at the business

and the number of customers that they have. So if you're purely paying really close attention, and we track a lot of LinkedIn numbers that are out there to the rate of hiring that's happening within these companies, that'll tell you pretty darn early what their rate of customer acquisition looks like. Now, that makes it a little bit harder to track, well, how much are they continuing to grow their existing customers? And that's where, as Joe was mentioning previously, you can look at, you have other proxies for their growth. So Facebook's rest of world revenue segment, which is one of the fastest growing arms within Facebook. A lot of that is Facebook in Latin America, and a lot of that is correlated to DLO's expansion. So we also have, so you combine

some of the employee metrics with some of these other revenue line items that get reported by a diverse set of successful technology companies, and you can kind of put those two together. And while you're waiting to hear from the DLO management team yourself, you can get a pretty accurate picture of how things are going at the company okay and uh joe did you have anything to add there i know yeah yeah i'll try to talk there yeah that's i mean i think robert summed it up pretty well ultimately the tpv is what's going to drive the outcome like we talked about take rates and how they're going to kind of fluctuate but ultimately i think for investors it's it's how how much volume can they get from all these you know and all these really great enterprise

customers and i think that's ultimately what's going to drive the outcome here all right and right now we're as we're speaking the market cap is at approximately 10 billion dollars i think a little bit less as we're talking what are your thoughts on the valuation can you maybe give a few numbers as a reference point you know for that 10 billion dollar market cap this is the one thing that obviously audience the you know closest comparable so if you if you look at their numbers 7% of their business is in Latin America. So I think it's at a $62 billion market cap. So that implies about, you know, four and a half billion. These are really rough numbers. But like I said earlier, Adyen doesn't do pay-ins in Latin America. DLocal's pretty much crushing them there.

So, you know, we think there's somewhat of a floor there. I mean, the business also is very profitable. And that's one thing, you know, Robert mentioned earlier, the Compound King strategy is that we look for businesses that are showing clear signs of scaling. There's some guys out there that will buy software companies on revenue multiples because if private equity takes it out, they think they can slash all these expenses. But for us, if you look at the early days of a company like Facebook or Google, they were extremely profitable. And so we want to find companies like that that are showing scale.

And DLocal is already there. Joe, I appreciate Joe's conservatism, and we'll put our necks a little bit more on the line here. We think it's a $25 billion business. We don't think it's going to be that tomorrow, but they have all of the signs of a business that can continue to accumulate customers and TPV and sustain a good enough take rate to support their free cash flow margins. that this is a business that's going to generate a billion dollars in free cash flow within a three to 10-year investment horizon. And we can't guarantee if it happens a year five or year eight, but they're absolutely on a trajectory to do that. And so depending on how you want to discount the business back till today, as Joe mentioned, if the business hits a couple of rough

quarters and they lose 40% or 50%, we think there's potentially some take-up value given the size of Latin America, as you mentioned, for Adyen's business, because Stripe's going to want to compete against Adyen in Latin America, and this might be a good bolt-on acquisition for them. So you've got, call it a downside, a floor at $5 billion. And then anywhere between $5 billion and $15 billion, there's the potential to own this stock and still earn double-digit returns. And certainly the way that we've been trying to build our position is, given how volatile and earlier stage company like this can be steadily acquiring shares anywhere between that six to 10 range that we've seen over the past few months. Yeah. I was about to ask about that

because I'm looking at the one-year chart here and it's been a pretty wild ride. So is that kind of just the strategy? You kind of have like a range of prices that you like to add between? So it's always, my career has almost entirely been at this part of the market and this late stage private companies, early stage public. And it really does feel like it just happens again and again and again, where companies that are private, they do really well in the private markets, their private investors love them, they eventually come public. But then it takes years for the public to develop the same level of appreciation and understanding that many of those private investors have had for that business for a lot of its history. And it is not uncommon

for a small business like this, particularly one based in Latin America, to have a really volatile start in the public markets. And we don't think that volatile start is over. We absolutely think that there's a very high chance that this stock can be down 30 and up 30 in any given quarter over the next three to five quarters. But the longer track record that businesses like this tend to accumulate, you start to see less and less volatility in investor reactions over time. And something really interesting starts to happen when that starts to settle in because you'll actually start to see the multiple appreciate even more because investors are starting to price in the fact that they believe that the business now potentially

has less volatility in its fundamentals relative to the day that it started. So we always believe this is one of the best places in the market to look is, you know, IPOs of companies that are a year in, the stock prices have gotten beaten up. There's been almost no change in the company's fundamentals from the day that they launched to the day that, you know, we stand today. And we think this is one of the cool areas to spend most of our time. One question that kind of comes to mind for DLocal is they have so many, I guess, big name customers already. So many big tech companies that I would think it would like in my mind that screams maturity, but their customer base seems quite small. So is, do you guys have,

are they even close to a customer base ceiling or is it, is it much bigger than where it's at now? So even within their current customers, a lot of, a lot of businesses use multiple payment processors in different countries so usually uh and in this too this is you know extremely variable but for the most part you know the largest processor will take 60 or 70 percent of the volume uh the second one will do 20 to 30 percent and then usually they test other ones because you don't want to be you want to be you know dependent on on one one processor but from what we've heard you know a company like facebook there there's a lot of internal um expansion and you see that in in the numbers. So DLocal, they even report what volume is coming from new customers versus

existing customers. And last year, 90% of their growth came from existing customers. So when you think about Facebook's business in Latin America, DLocal isn't processing 100% of that. So there's a lot of room to go for existing customers. And to add more, there's a lot of nuance here of what it actually means to grow with existing customers. Because this is where this business looks a lot more like an enterprise software company than a traditional payments business. So we mentioned the example of Facebook collecting dollars from small business advertisers in Latin America. Well, that's a use case that DLocal is servicing Facebook with today. um facebook is building other new modern things say the facebook marketplace where they've

murdered craigslist and you know now they're enabling uh exchanges between individuals this is a perfectly uh fun this is a perfectly good example of where facebook would talk to a d local and say hey d local uh we want to try something new that maybe you know it allows a marketplace payment to happen in in advance of the exchange and you know there's a lot of different rules that we have to work around because this isn't necessarily offered today. And this is a very, I don't know if they're launching marketplace in Latin America or not, but these are the types of examples of where the payments companies build themselves deeper and deeper into the customers that they work with. Because a lot of the, it's not just about sitting

around waiting for Facebook to grow. It's about how do we take more of Facebook's business into what we do and so when they're thinking about their incremental technology and tool development they're thinking about their existing customer set and where inside their existing customer businesses today they can potentially grab more of the transaction volume that's happening really great customer or really great companies can grow the the tam you know within themselves so like the example earlier of the cash register and now you can you know order things off of your phone, you know, that's new economic activity that wouldn't have happened before. And that's example of, you know, how a company like BeLocal can grow that. Right. And we take it, we kind of

take it for granted here in the United States, but a lot of other countries might be 10, 15 years behind in that regard. So it sounds like we kind of know where the growth is going to be. And it's most likely going to be from the existing customers, at least over the next few years. But I think two questions I have are, can you give a reference on what their profit margins actually are? And are they trying to expand outside of South America and Central America? Yeah, so first on the margins, they've got it to 35% EBITDA margins. And, you know, we don't like using EBITDA, but for these particular businesses, they have a really high flow through to free cash flow. And if you look at, like I said earlier, if you look at the gross margin, it's actually

closer to 65%. So in the way that Audion would report. So those two businesses are pretty similar on margins. And, you know, they're really high. And I think there's there's a couple ways for them to increase that one of them is just, you know, employee count, because that's one of their big expenses, right? I mean, we talked about the financial, the fees of financial institutions, and their next really big expenses employees. So another thing that we track is gross profit per employee. So over the past two years, that's gone from 250 grand to 300 grand for DLocal. So that's probably, that shows right there that the SG&A is scaling. So I definitely think there's some upside there from margins. And what was your second question?

International. Are they going outside of South America and Central America? Yeah. So from what we've read, they obviously are trying. They're in places like India and China, But like we said earlier, there's a really big advantage to being in certain geographies. So there's a company called Razorpay that's in India, and they're running a little bit of the DLocal strategy too. So I would say, much like their existing growth is probably coming from existing customers, Latin America is probably going to be the significant driver. It's nice to have options though. Okay. And last question we have here. It seems like they have a pretty defensible position in the market. You know, we've talked about it a few times here about how there's the regulatory barriers to entry. Even the giant companies like Facebook can't come in. And there should be a large tailwind from growth from the existing customers. What do you guys see as the biggest threat to DLocal's business that maybe we haven't talked about yet? Yeah, so I think, you know, regulatory is definitely a big one. So you got to think to a lot of companies. I'm not sure companies as big as Facebook, but maybe some of the companies that are a little on the lower end of, you know, the local services, but a lot of them don't have, you know, entities set up in some of these countries.

So, you know, Facebook, like I said, Facebook's really big, but some companies might not have a presence in Ecuador or a presence in Chile. And so that, you know, there's all sorts of laws and, you know, how the company can, you know, D-Local can accept, you know, money on their behalf and then, you know, obviously ship it cross-border. So there's a lot of regulatory issues. On the other hand, though, like Robert said earlier, a lot of their customers are these large, profitable U.S. enterprises. So that's sort of the counter. If I were to emphasize the regulatory geopolitical risk here a little bit more bluntly, if D-local is perceived locally as a tool to extract value from developing countries and send that value to developed countries, you better believe that politicians in these South American countries are going to work very aggressively to regulate that, to put chains on this potentially perceived

removal of value from one country and into another. So there's definitely, I would say without question, the number one thing I'd ever lose sleep over on this investment is a potential sea change in regulation because we're talking about moving money across borders, moving from one currency into another, and those tend to be areas that attract a lot of regulation. So both the problem that they are solving is also the thing that has the potential for most change depending on the regulatory environment. Okay. I think that answers most of our questions. Is there anything we didn't touch on that you think is important for the D-Local investment thesis? Yeah. Another interesting stat that we had is D-Local spent... So we love

businesses too that aren't out there. So there's easy ways to grow your revenue, right? You can lower your prices or you can increase your sales and marketing expense. So D-Local spent just $6 million last year to acquire over 100 customers. And these are customers, like we said, like facebook like netflix like spotify so um when you think of really bad businesses generally they pull on the sales and marketing strings a lot and be local is quite clearly the opposite and you know yeah unless you have to pay yeah to get people to use your stuff that's a it's not a good sign yeah all right well i think that's going to do it for our questions uh for listeners that want to follow you guys or keep track of upholdings what's the best place to do that robert i know

you're on twitter uh do you have your twitter handle handy it's upholdings upholding how easy yeah okay and then uphold it is it upholdings.com too is the uh web page you got it perfect all right well robert joe thank you guys uh we want to remind our listeners that brett and i are not financial advisors. So anything we say or discuss here on Chit Chat Money is not formal advice or recommendation. We are, however, general partners at Arch Capital. So clients may have positions in the securities discussed in this podcast. Thank you all for listening. We'll see you next time.