FinTech is a term applied to new entrants into the traditional financial services industry that possess disruptive, new digital solutions. Mobile payments is an area of FinTech that refers to the ability for consumers to purchase products either online or offline using a digital wallet app that sits on a smartphone. In the United States, mobile payments have been slow to be adopted. Apps such as Apple Pay, Google Pay and PayPal are available but have had difficulty overcoming the ease and familiarity of other digital payment, such as credit or debit cards.
In many emerging markets, solutions such as Brazil, China and Indonesia, the vast majority of transactions are still conducted with cash as many consumers are unbanked and have no access to credit cards. However, smartphone penetration is substantial allowing digital wallets, peer-to-peer payment apps and other mobile payments solutions to be readily adopted. But, this is a two-sided story, as using one’s phone to make a payment in the offline world to requires a Point-of-Sale (“POS”) device (e.g., a credit card terminal) in the merchant’s store to consummate the digital transaction. Therefore, merchant adoption is a prerequisite and is being strongly encouraged by governments as a way to increase sales tax receipts.
Brazil is a particularly attractive economy for capturing the mobile payments trend. According to the IMF, Brazil is the 8th largest economy in the world and has the 5th largest population. Approximately 86% of the population lives in an urban environment. Despite these attractive characteristics, approximately 32% of Brazilians do not have a bank account and 68% do not possess a credit card, which in turn has led to just 28% of transactions made via debit or credit card, according to the World Bank.
While Brazil is significantly behind the US and other developed nations on the financial services front, it has been an early adopter of disruptive innovation. Brazil is 5th largest smartphone market globally with 96% penetration and 98% of the population having access to 3G wireless networks. Brazilians account for the third largest Uber market, second largest market for Waze, fourth largest Netflix market and third largest Facebook market.
In the face of slow adoption and use of traditional digital payment forms (i.e., debit and credit cards), Brazil’s forwardthinking regulatory body put forth a number of favorable regulatory actions over the last decade that opened up Brazil to adopt innovative alternative solutions giving rise to payments players, such as Pag Seguro (“PAGS”).
PAGS was established in 2006 and until its recent spin-off IPO was a subsidiary of e-commerce giant UOL. UOL is the “Yahoo” of Brazil - the most visited content and e-commerce site. The core of their product offering is a free digital account that both consumers and merchants use to store money and transact with other consumers and merchants. Much like a PayPal account, there are a myriad of ways to fund the account as well as pull the money out.
PAGS also actively markets POS solutions to merchants enabling them to accept digital or mobile payments. In this manner, they are very similar to Square as they lease their affordable terminals to micro-merchants and small businesses. This is a huge market with micro-merchants and small businesses accounting for 99.8% of Brazil’s 12 million businesses. 81% of their merchants use PAGS as their sole mobile payments service and 75% of merchants using their small, most popular terminal device did not accept any form of digital payment previously. PAGS’ solution is highly valuable to merchants as it streamlines and reduces the time merchants must wait for cash to a few days down from 30 days. The working capital efficiencies are well worth the small transaction fee PAGS receives for each transaction.
When combining the attractive macro backdrop with their best-in-class product ecosystem, PAGS has become the leading payments system for micro-merchants and small businesses in Brazil and is experiencing tremendous growth. Active merchants have grown to 4.4 million (43% y/y) and Total Payment Volume is growing at approximately 70% y/y. The Company is now rolling out several new products, including a prepaid card, a credit card, instant payments and payroll portability (which enables the user to receive payroll direct deposits to their wallet much like a checking account). PAGS continual product innovation creates a path to sustainable profitable growth long after they fully penetrate their initial addressable merchant acquiring market by entering the vast credit and banking markets.
From an investment standpoint, the above attributes are very attractive, however, we like this stock for three additional key reasons. First, we believe that their earnings power is grossly underappreciated. Second, the stock trades at a substantial valuation discount relative to its global peers despite much higher earnings growth. Third, PAGS plays an important role in diversifying portfolio risk.
To that end, the research team at Lear values the diversification this stock adds to the portfolio as it bears minimal association to the health of the US economy, the US-China trade dispute, Brexit or any other external factor that you hear about these days in the news.
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