Rejecting dLocal and Bill Holdings

Today, I want to write to you about two Green Screen stocks that, at first glance, look like pretty attractive opportunities. However, when digging a little deeper, the bloom comes off the rose and too many risks expose themselves. As a result, both get a "pass". Here's a look at dLocal and Bill Holdings.

dLocal (DLO)

dLocal (DLO) is a payments processing company focused on enabling global companies to sell products and services in emerging markets, particularly Latin America, where over 90% of revenues originate.

dLocal offers a software API and technology platform that handle such intricacies as accepting numerous local payment methods, supplying fraud detection, complying with complex local regulations, settling foreign currency conversions, and more. The company makes money by charging fees on a per-transaction basis, as well as earning foreign exchange fees for cross-border transactions. dLocal counts some very large international companies as customers, including Microsoft, Nike, and Didi.

Payment processing is a good business. It is a classic "toll booth" model, taking a small cut of each transaction, making it fully recurring revenue. The market opportunity is vast, expected to reach $150 billion worldwide by 2030, an impressive compound annual growth (CAGR) rate of 14%. Also, there are high switching costs for companies - particularly the global enterprises that dLocal targets. Once embedded and working, it is expensive and disruptive for a firm to switch payment processors.

Put that profile against the backdrop of dLocal's 80% 3-year CAGR in sales, and already strong free cash flows, and you get what should be a prime candidate for the Watch List.

But there are problems under the surface with this company that make me want to avoid it.

Doing some diligence on the management team, a few concerns propped up. First, dLocal was split out of Astropay, a company that dealt in gambling and "adult entertainment" (i.e., porn). That naturally raises some concerns, warranted or not, about the legal stance and ethics of management. Adding to those concerns are a number of insider transactions and significant payment volume that is routed through third party, management-owned entities. Legal or not, allowing these kind of "insider side hustles" are just not the kind of governance we want to see from our investments.

Then there is the real hammer - a short report coming out of respected research firm Muddy Waters. In it, Muddy Waters exposes contradictory statements the company has made about its total payment volumes (TPVs), accounting discrepancies, altered accounts, and inflated take rates. In short, Muddy Waters is basically accusing dLocal of being an accounting fraud.

Now, I'm always skeptical on short seller reports, but this one hits hard. First, because it hardens concerns around management's ethical bend. But also because Muddy Waters has been right an awful lot. They called out Sino-Forest for being a fraud in 2012 (it was). They accused devices from St. Jude Medical for being hackable in 2016 (a follow-up FDA investigation confirmed this). They were one of the first and loudest to point out, in 2020, that Chinese Starbucks imitator Luckin Coffee was a complete sham, which was later admitted by the company itself.

That's a pretty solid track record. The last thing we want to invest into is an accounting sham. Whether dLocal is or isn't, I'm not taking the risk when there is plenty of smoke around this company. Hard pass.

Bill Holdings (BILL)

Bill Holdings (BILL) is a SaaS company that offers a payments management system (accounts receivable, accounts payable, spend management, and payments) for small-to-medium sized businesses (SMBs). Essentially, it simplifies the manual processes of producing invoices, writing checks, keeping accounting books, and filing cabinets full of paperwork for billing history. 68% of revenue comes from transaction fees, 25% from monthly subscription fees, and the rest from interest on the float held from clients to pay bills, making all revenue sources fully recurring.

Better yet, Bill is showing some impressive revenue growth. Since going public in 2019, the firm has generated a 3 year compound annual growth rate exceeding 80%. With about 450,000 customers, it has penetrated only a small fraction of the 70 million addressable SMBs worldwide for this product. The company has 5 million businesses that have either used or paid through its network, representing a nice organic marketing base.

Any moat potential here would be on switching costs, and certainly that could be a factor. Bill is already generating over 130% in net revenue retention, a sign that it both holds on to acquired customers and expands business with them rapidly. With the bulk of revenue in transaction fees, Bill grows as their clients grow, a very nice setup for organic growth.

Did I mention that Bill is still run by its original founder, Rene Lacerte?

So why pass on this one, particularly with the stock down nearly 70% from its all time highs? There are a number of things that concern me here. Most notably, I'm not a huge fan of the company's growth-by-acquisition strategy. Despite just going public a few years ago, Lacerte has spent like a drunken sailor to build out Bill's product suite, including Divvy (a business credit card solution) for a staggering $2.5 billion in 2021, Invoice2go for $625 million, and Finmark for an undisclosed amount. Altogether, the firm has spent well over $3 billion in acquisitions over the past 3 years, pretty heady for a company with under $1 billion in revenue.

Those acquisitions remind me a lot of Twilio's (TWLO) spending spree, and I fear a similar outcome down the line - large layoffs, restructurings, and write-downs to get the financials back in order. As it is, Bill now carries $2.5 billion in goodwill along with a sizable $1.8 billion in debt. Cash ROI is barely 2%, as the firm has just recently tipped into positive free cash flow territory. It's going to take a LOT of revenue growth and/or a LOT of cost cutting to bring this firm into attractive cash profitability.

Yeah, the stock is down 70%, but frankly it was obscenely overvalued before that. One has to build in a healthy discount to offset the financial risks here, even when modeling a lot of growth. I only see the stock worth about $75-80, and given all the uncertainties and a history of unattractive management strategies, I'm taking a pass here.