2 Fintech Stocks from Warren B
The existing banking system is categorized as expensive, clumsy and has a relatively poor user experience. The financial sector has traditionally been many years behind the rest of the market when it comes to technology.
Still, there are many financial technology (aka Fintech) startups that see these problems with the traditional financial system as an opportunity to disrupt the industry. Many Fintech companies offer lower costs, faster transactions and a much more user-centric experience. Therefore, it is no surprise that the global Fintech market is expected to grow at a rapid 20.5% compound annual growth rate to $699.50 billion by 2030, according to estimates by Adroid Market Research.
Therefore, in this article, let’s take a look at two of my favorite Fintech stocks, one of which was bought by
Warren Buffett (Trades, Portfolio) and the other that was bought by
Ray Dalio (Trades, Portfolio) in 2022; let’s dive in.
Please note that the guru that has the information in this article is based on 13Fs and other filings with the SEC. Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S. listed stocks and U.S. Depositary Receipts at quarter-end. They do not include short positions, non-ADR international holdings or other types of securities. But even this limited archiving can provide valuable information.
1. Now Holdings
Nu Holdings (NOW, Financial), also known as “NuBank” to its customers, is the largest Fintech bank in Latin America. The company has a bold mission to “bank the unbanked” as a large portion of transactions are still done with cash in Latin America. Thus, this represents an enormous growth opportunity.
Warren Buffett (Trades, Portfolio)’s investment conglomerate Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) bought shares worth a staggering $1 billion in the company in 2022. During the times of its purchases according to the 13F reports and other SEC filings, the stock traded at an average price of about $9.38. At the time of writing, the stock trades at about $5 per share and is thus significantly cheaper than the price at which Buffett’s firm invested (but if the firm invested before the IPO, it’s possible that it actually got a lower price – we don’t Unfortunately, I don’t know enough information about this, since the public only has access to the SEC filings).
Business model
The company was founded in 2013 as a simple Fintech platform that enabled a card from Mastercard (MA, Financial) to be managed via a mobile application. Since that time, however, the company has massively expanded its services to become a financial “super app.” The platform now enables customers to “spend, save, invest, protect and borrow”, thereby capturing value across all parts of the financial chain from payments to loans and even cryptocurrencies. As of 2022, the company has over 45 million active accounts, with 29 million credit card customers and 4 million customers with personal loans. The company also aims to help small and medium-sized businesses with cash flow, as this market has historically been underserved from a credit perspective.
Growing economy
Nubank generated record revenues of $1.2 billion in the second quarter of 2022, which increased by a rapid 244% year-over-year. This growth was driven by strong user growth of 51% year over year to 62.3 million across Brazil. The platform has also been adopted by over 36% of Brazil’s population and is the main bank for 55% of monthly active users. The transition from secondary to primary banking is an important tipping point and indicates mass adoption combined with abundant trust.
The business also recorded a record activity rate of 80% for users, up 8% year-on-year. As Nubank generates a significant part of its funds from transaction volume, more activity generally equates to higher payment volume over time.
Nu Holdings reported a slight decline in gross margin from 50% in 2021 to just 31% in Q2 2022. This was due to higher interest costs (thanks to rising interest rates). In addition, the company’s loan portfolio is still in an early phase, and thus it is expected to mature over time and gross margins will recover.
Nu Holdings reported an eye-popping 124% increase in operating expenses to $388.1 million. This was driven by an increased number of employees, share-based compensation for top managers and increased customer support expenses. Overall, I don’t think this is a huge problem as I believe investing in people and paying them well is key to long term retention and business success. An important metric to look at is expenses as a percentage of total revenue. In this case, we have seen a decline from 51% in Q2 2021 to just 34% by Q2 2022, which is a positive sign.
The high operating costs mean that the company operates with a loss of 24.6 million dollars. The good news is that the business has a solid balance sheet with $3.7 billion in cash and cash equivalents vs. total debt of just $617 million, which is manageable.
Valuation
To value Nu Holdings, I plugged the financial data into my valuation model, which uses a discounted cash flow valuation method. Given that the business grew its revenue by over 200% in the previous year, I have predicted 70% revenue growth for the next year and 50% per year over the next two to five years.
Over time, I estimate that operating leverage will take hold as the company benefits from fixed costs and platform growth. I therefore estimate that the operating margin will increase to 20% over the next 10 years.
Given these factors, I get a fair value estimate of $7.48 per share. The stock trades at ~$5 per share at the time of writing and is approximately 33% undervalued.
2. Fidelity National Information Services
Fidelity National Information Services (FIS, Financial), or FIS as it likes to call itself (although the name has yet to catch on), is a Fintech company that provides financial solutions for merchants, banks and financial institutions.
The world’s largest hedge fund, Bridgewater Associates, which was founded by
Ray Dalio (Trades, Portfolio), bought shares of Fidelity in Q2 2022. Dalio’s firm paid an average price of $19 per share, which is ~16% more expensive than where the stock trades at the time of writing.
Business model
The company’s Merchant Solutions segment helps small and medium-sized businesses as well as large retail chains process payments in 100 countries. In 2019, the company acquired payment giant Worldpay to help expand its offering and payment gateway solution.
The banking segment provides core processing software for banks and lenders, while the capital markets segment helps trading firms and asset managers with a range of buy-side and sell-side services.
Notable clients for the company include technology giant Microsoft (MSFT, Financial), which in 2022 expanded its partnership with Fidelity and Worldpay for its Xbox and Azure online cloud payments. Four of the top five crypto exchanges also use the platform to enable bank customers to buy and sell bitcoin directly from their bank accounts.
Growing economy
Fidelity generated solid financial results for the second quarter of 2022. The company reported $3.72 billion in revenue for the quarter, which beat analyst estimates by $53.07 million. This was driven by solid growth of 14% in the Merchant Solutions segment, despite a slight headwind from the Russia-Ukraine crisis. Organic revenue growth in the banking segment also increased by 6% year-on-year, while the capital markets segment grew by 7% year-on-year. The company also gained important investment management companies T. Rowe Price and Franklin Templeton as clients.
Earnings per share were $1.73 in the quarter, beating analyst estimates by $0.07. This was despite a 130 basis point decline in the bank-adjusted Ebitda margin, which was driven by inflation and additional charges.
Overall, the company generated a solid $800 million in free cash flow, which was in line with management’s expectations. Fidelity has a high free cash flow of ~95% of adjusted net income, which is solid.
Management showed confidence by saying the company will buy back $3 billion worth of stock during 2022. The company also reduced debt by ~$675 million, so it likely won’t need to take on additional debt to fund buybacks.
Valuation
The stock trades at a price-to-earnings ratio of 11.84, which is 40% cheaper than its five-year average.
The GF Value calculator indicates a fair value of $139 per share for the stock, which would make it appear undervalued. However, the GF Value calculator warns of a possible “value trap” that could be driven by the sharp drop in share prices and margin squeeze.
Final thoughts
The fintech industry is increasingly expanding as emerging markets and new business models are developed. Nu Holdings is the largest fintech bank in Brazil and is in a prime position to take advantage of the secular trends. Fidelity is also a great company, but it’s more niche and technical, and thus harder to value.
