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Why Warren Buffett and a Wal-Mart Heir Want a Slice of This Brazilian Payments IPO

Payment Processor StoneCo IPO Values Company at up to $6.2 Billion

By John Jannarone

Warren Buffett and Wal-Mart heir Rob Walton are buying tickets to Brazil. Should investors join them for the ride?

Brazilian digital-payments company StoneCo (ticker: STNE) plans to sell up to $1.1 billion in an offering of new and existing shares, valuing the company at $6.2 billion if they price at the top of the indicative range. The company, which bears some similarity to Jack Dorsey’s Square Inc., offers transaction processing, financing, and payment-hardware rentals to merchants across Brazil.

STNE turned heads this week when it announced Warren Buffett’s Berkshire Hathaway and the family office of Wal-Mart heir Rob Walton had made formal indications of interest in taking a large chunk of the shares offered. Backing from Mr. Buffett and Mr. Walton is both a sign of confidence in the business and a welcome pair of long-term holders who are unlikely to sell anytime soon.

Mr. Buffett’s firm has never expressed a formal indication of interest in an IPO, according to a search of SEC filings using Sentieo. He apparently learned about the deal from the founding partners of 3G Capital, who were early investors in STNE. 3G and Mr. Buffett’s Berkshire Hathaway are the largest shareholders in Kraft Heinz. Marc Hamburg, a press contact for Berkshire Hathaway, did not respond to multiple phone calls requesting comment. Goldman Sachs, the lead underwriter on the STNE IPO, declined to comment.

The heavyweight buyers have had another critical impact on the IPO: There are very few shares left to go around. Combined with other buyers who committed to purchase the IPO and will be allocated stock, a full 54% of the offering is already spoken for. That leaves a potential float of roughly $500 million – a relatively small amount for a high-profile company.

That makes the odds of getting shares at the IPO price slim to none, according to investors who attended a marketing event in New York Wednesday, which had hundreds of attendees. Those investors said they expect the IPO to open sharply higher than the offer price as buyers who couldn’t get an allocation chase the stock.

STNE is already causing a ripple effect across the market. On Wednesday, investors who realized the available STNE shares would be limited appeared to pile into shares of Brazilian peer company PagSeguro, which also went public earlier this year. PagSeguro jumped 10% Wednesday, reaching its highest level in several months. STNE’s clients tend to be small and medium businesses while PagSeguro focuses on much smaller “micro-merchants” so they don’t usually compete directly.

Source: Susquehanna Financial Group; IPO Edge Internal Calculations

What does all this mean for investors who can’t get IPO shares? Even if STNE opens, say, 50% above the IPO price, it would be trading at a multiple of 15.5 times 2020 earnings estimates from Susquehanna Financial Group, a broker that can write research on the deal because it’s not an advisor. That’s a reasonable price given STNE’s opportunity in Brazil, the fourth-largest payments market in the world.

Indeed, STNE has been expanding quickly, boosting both the top and bottom line. Net income should grow by 95% between 2019 and 2020, according to Susquehanna estimates. Some of that expansion is driven by general industry growth: For instance, a relatively small percentage of Brazilians currently make digital payments but smartphones are becoming ubiquitous.

What’s more, STNE was an early mover, launching shortly after regulators opened up the payments market to nonbank players in 2010. It was the first nonbank “merchant acquirer” meaning it is able to equip businesses with the ability to take cashless payments such as credit and debit cards.

It also has focused on regional cities where it has people on the ground across 180 “Stone Hubs” to offer badly-needed customer service. Those cities traditionally have had fewer options for merchants and incumbent players have therefore have been able to overcharge and under-deliver.  

STNE’s largest source of revenue, at just over 50%, is merchant financing. In many cases, customers in Brazil expect to pay in interest-free installments and merchants feel compelled to offer the service. To shoulder the financing, STNE can pay merchants an upfront sum minus a lucrative fee. The service is highly attractive to merchants that are often cash-strapped and don’t have a good bank relationship.

STNE can also step in with much-needed cash for merchants who don’t want to wait for card issuers to pay them. Unlike other markets where card issuers pay in a couple of days, such transactions take a full 30 days to settle in Brazil. Just as STNE provides financing for installments, it can pay merchants immediately for a fee and let them skip the 30-day wait.

Of course, regulation that shortened the settlement period could eliminate that revenue stream. But STNE has a captive audience of 200,000 clients and could probably raise transaction fees to ameliorate any negative financial impact.

Investors should also be mindful of the country’s volatile currency and often-turbulent political environment. Those factors will likely lead to a few bumps along way in years to come. But with a rock-solid business model and the backing of Mr. Buffett and Mr. Walton, investors shouldn’t get left behind.  

 

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