Nu Holdings Is A Reflexivity Play

Summary

• Nubank is already the largest bank in Brazil, with licenses incoming for other countries with large unbanked populations and still long growth horizons.
• The credit card business is a great way to start in markets unregulated and start developing presence among the unbanked with great APRs.
• The ecosystem model makes sense and the open field will mean massive ROI on low industry customer acquisition costs.
• Being Buffett backed, share price is likely to at least hold, and the business benefits from reflexivity with cash burn and equity raises likely to return money faster than dilution.
• Main risk is market sentiment towards unprofitable and growth style businesses, where sentiment needs to drive the reflexivity effects and keep reinvestment rates so high.
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Nu Holdings ($Nu Holdings Ltd.(NU)$), the company that runs Nubank, is an interesting prospect on the markets that play in emerging markets. The play here isn't so different from a company like Qudian (NYSE:QD), minus the risks that exist in Chinese markets around ownership of stock and regulation of high rates. However, in addition to the opportunity in online banking powered by AI, and the open field of unbanked populations, Nubank has tapped into a very compelling ecosystem concept that interacts well with the other factors that make Nubank attractive. With results continuing to be proved in today's Q4 call, we believe in the ROI of customer acquisition in this cash burning business, and note that reflexivity could play highly in the business' success, helped in part by being Buffett and Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) backed.

Q4 Proves the Ecosystem

The Q4 is looking attractive.The maturities are short on the credit card and bank loans, and the high APRs mean that together there is rapid and substantial payback of the loans given out to these otherwise unbanked customers. This open field means that Nubank is the first mover in digital retail banking and has become the largest bank in Brazil with users engaging with the several products that Nubank offers, including mobile payments, personal loans, credit cards and even investment accounts. Opportunities are also abound in short-term consumer finance, with partnering with merchants going well and having a part of the business imitate the well-received Klarna concept.

Indeed, Nubank is in time for some major trends that we are seeing among the younger middle class in the emerging markets. Greater involvement of young retail investors in the market is certainly something that Nu hascaptured with its acquisition of Easynvest. With several asset classes now available to Nu customers, including crypto which is an areathat N26 and otherssurely regretted not investing in, Nu starts to position itself as the Robinhood(NASDAQ:HOOD)of LatAm.

The ecosystem not only makes the model more defensive, and the ROIs on customer acquisition higher from cross-selling opportunities, which are reaped rather rapidly from first engagement, it also serves as an attraction in an area where bureaucracy in traditional banking gatekeeps much of the services required to financially empower oneself, thereby creating the large unbanked population. Frankly, there isn't really any competition in cost and value with traditional banks in the regions in which Nubank operates.

Deposits are also growing rapidly in Nubank's traditional business thanks to banking licenses in Brazil, and incoming licenses in other LatAm markets. Together with fundamental growth as a more nascent company achieves scale, and where that scale multiplies and makes the flywheel spin faster due to cross-selling opportunities and the rapid expansion in customer data upon which to train scalable credit models.

Reflexivity and Valuation

While Nu's markets are pretty large, so are its already existing active users. 41 million people is a lot, with current markets containing realistically around 500 million people depending on how Nu expands into other markets. 10% is already a decent penetration, so the sustained and long-term growth here on will have to come from the ecosystem and from greater cross-selling. Since growth is as recent as this quarter, maturity of the customers in recent cohorts into becoming more involved with the ecosystem has yet to be observed, and indeed 10% penetration is still quite low, so revenue growth should continue, but we expect that in the next 2 years we will see some diminishing marginal returns. Mexico and Colombia are still only 1% penetrated, with almost all the users being Brazilian, so we don't want to understate the meaningful growth that is coming ahead.

While the company is already achieving meaningful results, the company still stands to benefit from reflexivity. With a flywheel model due to network effects in the AI-based backend on a lot of the products, but also because Nubank is positioning to work with merchants and to expand the products on offer in their marketplace, there is a lot of value to be wringed out of onboarded customers.Marketing expenses are risingand cash is still being burned, with equity raising likely to continue for a while to also build up the lending businesses, so the financing terms hopefully will stay good at the 30x multiple on revenue to mean minimum dilution sacrifice in exchange for high LTV customer onboarding.

With Mexico and Colombia advances having barely started, marketing expenses are just going to rise, and financed by the stock backed by strong institutional presence with Buffett has traditional playersscared and even abandoning ship. With the mature customer providing an average revenue per quarter of $15, a 3x ROI at least if not 12x assuming that customers stay on for a year, a conservative assumption, the reinvestment rates are superb right now. Flywheel models mean a winner-take-all dynamic, and Nubank being an early mover can justify a high multiple, with growth rates above 200% likely to compress that 30x P/S multiple pretty quickly to more reasonable levels.

Although with consumer finance businesses likeKlarna -which face customers with similar credit profiles and services of which Nubank is beginning to offer itself in partnership with merchants -valued at around 45x, the multiple is already looking interesting. With operating leverage incoming and profitability only a couple of years away, and growth rates likely to hold a while longer with the big Colombian and Mexican populations still barely reached, you can start being optimistic about a SPY listing, and that'll only increase liquidity. We are bullish on Nubank, to be sure. The main risks are that it is a growth style company, and jitters in the market could turn favour away from them to more value names; and with reflexivity cutting both ways, the business' reinvestment rates would suffer due to worsening financing terms. But with growth already having taken a recent hit, we think Nubank has the wind at its back.