STONECO: Digital Ecosystem of Payments in Emerging Market

Peter Lynch said to look for opportunities all around ourselves, Keep eyes and ears open. Find small companies growing earnings faster relative to their P/E and pay a fair price for good business.

One of my close friends has a knack for FinTechs and understands the Payments industry better than most of us can comprehend. He has a good amount of experience in the merchant side payments industry. Not long back, He pitched an idea to start a business and came up with a solution to provide a service that hooks effortlessly into the Payment workflow. According to him, If customers adopt that hook, we can charge a minimal fee for every transaction and make ourselves rich in the process. Think about how VISA/MASTERCARD do business today. They make money every time we swipe our cards. His idea might need some more time to groom, but it got me started with how FinTech companies today are helping redefine the concept of money transfer. The FinTech world is hot today (Peter Lynch suggested not to buy hot stocks in the hot industry). But here I am doing a bit of deep dive on one of the promising FinTechs from Brazil. It’s a company trading at ~85% down from its all-time high, and Berkshire has a ~4% stake in it.

I will again use a straightforward template until I know how to do the analysis better 🙂

  1. What is the industry?
  2. What is the business?
  3. How do they make money?
  4. Learn a bit about their finances.
  5. My Story and Conclusion.


The company operates in the Payment Industry, which brought 2 trillion dollars in revenue globally. According to McKinsey Global Payments Report, the market is enormous and is expected to grow to 2.6 trillion dollars by 2025 from 2 trillion today. The industry is growing with heaps and bounds and will continue growing for the foreseeable future. Part of the reason is the industry is deregulated, and the legacy banking system has left a lot to be desired. The disruptive payment companies are making the most of underpenetrated markets and underserved sections of society, coming up with innovative products to serve customers with their needs. Tailwinds provided by Covid’s fast-tracked adoption of e-commerce, there is a secular shift in how payments are processed. 

It’s also important to highlight that Payment segments are performing well for banking – well, not that good for banks. The payment companies continue to outperform traditional banks.

The company itself operates in Brazil and provides a suite of solutions to merchants. Cash usage is declining globally but will likely remain resilient in Latin America, characterized by a significant unbanked population. But disruptor opportunities reside in countries with low electronic penetration (Brazil, India, Indonesia, Thailand), as the next normal provides the impetus for electronification.

In absolute terms, Stone Co is in the merchant Acquiring business. Before we can understand the industry, It’s better to watch youtube and discover what Merchant Acquiring is. In layman’s terms, The acquiring bank (Bank used by the merchant) provides payment processing services to the merchant, enabling him to accept payments from cardholders.

The layman’s definition of merchant acquiring is old. As with everything else, it has evolved from a legacy payment processing and hardware (POS device) business to a full-stack software and merchant services solution. Even when the payment industry is crowded, the global underserved sections of society give means and focus for FinTechs to coexist. They have to compete, putting pressure on their profit margins while bringing down the cost of serving customers. The only way to stay relevant is by adding value to their services. The merchants seek to lower their cost of acceptance (Learn a bit more about this cost here.), which harms acquirer profit margins. Merchants are willing to pay more fees only if they can get more out of the value additions. i.e., digital service for seamless payment experience, improved cart conversions with finance options/BNPL options, inventory management, Merchandise return management, disputes settlement, etc. The merchant acquiring business is transforming into a digital marketplace of solutions that merchants can frictionlessly tap into when required. According to a McKinsey report, Digital marketplaces are expected to account for about 60 percent of digital-commerce volume in the next few years.

According to this article, merchant acquisition is a lucrative 100 billion dollars opportunity.


The business, in their own words, “We are a leading provider of financial technology solutions that empower merchants and integrated partners to conduct electronic commerce seamlessly across in-store, online, and mobile channels in Brazil.” They cited in their annual report that they are the largest independent merchant acquirer in Brazil and the fourth largest based on total volume in Brazil, and the first non-bank entity to operate as a Merchant Acquirer Payments Institution in Brazil.

Let’s cut to the chase and understand business in no-frills vanilla terms. They serve Merchants; They want more and more merchants to use their services. They lure and win merchants with competitive prices and a buffet of value-added services apart from traditional payment processing. These merchants, after onboarding, process payments using StoneCo services for which clients are charged and revenue is generated.

It’s a well-known fact that around ~2% of total payment is taken out of the transaction to pay the companies making transfer seamlessly possible. i.e., acquirer bank, VISA/MASTERCARD, etc. StoneCo acting as an acquirer (first non-bank acquirer in Brazil), make their cut from those transactions. More transactions, the merrier.

In mature markets, acquirers increasingly focus on distribution through ISOs (independent sales organizations), ISVs (integrated software vendors), and other indirect channels, relinquishing revenue margins as residuals to their channel partners. StoneCo does operate and partner with third parties for processing. Why do they need to share the revenue, you ask? Well, consider this example, In the restaurant space, food delivery apps like Doordash, Grubhub, Uber eats, etc., have gained scale, and transaction volume has shifted from merchant website/instore to food-delivery applications, meaning merchant acquirer or processor no longer processes those transactions. It may very well be a sound strategy for the long term.

The company serves clients of various sizes, including digital and brick-and-mortar merchants. Still, the company’s focus is on Small and Medium-sized businesses (SMBs), targetting 8.8 million clients in Brazil. They started targetting Micro merchants as well with their new acquisitions. Following are the solutions from hardware & software to credit provided by them:

  1. Connect clients: POS Solutions, e-commerce gateway solutions that seamlessly connect e-commerce merchants to their choice’s acquirers, enabling them to accept various electronic payment options. PSP Platform.
  2. Payment Solution: Accept electronic payment with features like Split-payment processing, Multi payment processing, recurring fees for subscriptions, and one-click buy functionality.
  3. Digital Account Solutions: Create a digital account that can be integrated into the POS and allows clients to receive and make payments.
  4. Software Solutions: POS and ERP software, reconciliation, customer relationship, etc
  5. Working Capital Solutions: Help clients manage their working capital needs and effectively plan for the future by offering them prepayment financing options.
  6. Credit Solutions: Provide clients with credit if they need further funding to grow their businesses beyond the working capital solutions that we provide

Solutions are distributed primarily through proprietary Stone Hubs (Small Offices across the country). That can help clients learn about the services and provide the necessary support to run their business.


They generate revenue based on the fees charged for the services used by clients.

  1. Payment processing fees for each transaction.
  2. Financing Fees and Interest fees related to Credit/Working Capital Solutions. Working Capital: They offer merchants prepayment options for their future expected receivables from credit card installments. They charge a discount rate equivalent to a percentage of the total volume requested to be prepaid. Credit Solution: This is a loan for the merchant to grow their business.
  3. Subscription and equipment rental fees (i.e., rented POS device).

These accounted for 34.5%, 49.6%, and 11.7% of their revenues in 2020. I have 2021 data as well, but there was a slight decrease in the portion of Financing fees because of issues with Credit Solutions which we will learn in a bit, so it’s better to keep in mind that credit might play a bigger role in future.

The payment processing fees and rental/subscription fees are self-explanatory and don’t require much imagination. The Working Captial and Credit solutions that make around 50% of revenue need to unfold. Understanding the process is vital because the new Brazilian regulation introduced in mid-2021 may impact long-term business.

As a business owner, you want to sell inventory and get paid to buy more merchandise to profit, thus repeating the cycle. In a world without financing, the business owner must wait until all transactions are settled. Unlike in other parts of the world, merchants don’t get paid what is owed to them all at once in Brazil. 50% of transactions are completed in monthly installments, leaving business owners cash deprived. The solution for the business owner to get the money quickly is by selling receivables at a discount. StoneCo helps merchants with the cash and makes money in the process.

Until last year, the acquirer set the discount rate (StoneCo in our case); as there was no real competition, the business was stuck with just one acquirer and had to agree to the terms, and it was considered the cost of doing business. But it changed last year when the Brazilian central bank created so-called “Registration Entities.” Which is like a marketplace for business owners to sell the receivables, and acquirers would need to make an offer for those receivables forcing acquirers/buys to become more competitive in their discount offers. This change makes it difficult for Stone Co to make big money on prepayments. However, it does open the market for new ideas and solutions. Only time will tell if StoneCo can make it into another opportunity or not.

Credit and Working Capital solutions make up to 50% of total revenue. It’s imperative to secure funding at a minimum cost. The optimization of the funding cost is the key driver of the net margins, and the following are some ways StoneCo funds prepayment. These funding options lead to different effects on the balance sheet and statement of cash flow.

  1. Fund prepayments by selling receivable rights owed to them by card issuers to banks – Because of the sale, both accounts receivable (cash coming in) from merchants and accounts payable (cash going out) are derecognized from the balance sheet in the same amount. The combined effect is positive cash flows equivalent to the net fees charged by them.
  2. Fund using special-purpose investment funds called FIDCs. To learn more about FIDC, click here. The issuance of senior or mezzanine quotas by FIDCs to institutional investors – The amount raised from such issuance is recorded on the balance sheet as cash and liability to senior quota holders. The receivables from card issuers (cash coming in) are transferred to FIDC, producing positive cash flows from financing. Since accounts receivables (cash coming in but not yet received) remain on the balance sheet but accounts payable(cash going out) are derecognized, it negatively impacts cash flows from operations. The net effect of impacts on cash flow from operations and cash flow from financing activities is positive.
  3. Fund by borrowing from a third party – private loans – The impact on cash flows is the same as FIDC funding.
  4. Fund by using their capital – Accounts receivables (cash coming in but hasn’t been received) remain on the balance sheet. Still, the account payable to clients are derecognized (cash going out), thus negatively impacting cash flow from operations.

Macroeconomics factors play an essential role in all kinds of investments. Peter Lynch suggested that spending 5 min on macroeconomics is 4 minutes too much. I like to spend that minute understanding the company’s correlation with those factors.

Interest rates: An increase in interest rates leads to decreased consumption, negatively impacting payment volume revenue. But it positively impacts the prepayment spreads, leading to the rise in prices because of increased funding costs.

Inflation: Revenue is hedged against inflation since total payment volume is higher because of inflation.

Currency: The results are denominated in Brazilian currency reais. They are subjected to fluctuations. As a matter of fact, The Brazilian reais are losing value against dollars. 

As I know already, the more merchants they acquire, the more transaction volume they process, and the more is their revenue. Active client growth must be essential for their long-term sustainability, and it is good to keep track of it for the near future.

Total volume processed is vital and can depend on two things

  1. More merchants acquired
  2. More processing volume from the same merchants – Cross-sell opportunities.

Take rate is the fee a marketplace charges on a transaction performed by a third-party seller or service provider. Maintaining a reasonable take rate for the longer term improves our assumptions about future margins. Below is a screenshot of the Take rate from 2020 to 2016 (n/a was for the quarter).


Over the past few months, I have been learning to look deeper into financial statements rather than just for the obvious things like growing assets, debt coverage, earnings, operating margins, etc. Following are some of the concepts learned for Balance Sheets and Income Statement – See if that makes sense for you with the StoneCo example. I am still learning, and I might make a mistake in understanding, but it’s a start, and this should get better with time.

The balance sheet has 3 purposes:

PURPOSE 1# How many assets are needed to produce earnings – Businesses that require fewer assets to generate the same earnings (other things being equal) are considered a better business. Its Return on Assets.
Net income for StoneCo for the year 2021 was negative. We can either use EBIT or operating income to calculate ROA, but it won’t be the same as net income and should consider valuing a company. It’s approx ~3.2% and a bit less than I want to see.

PURPOSE 2# Find out where these assets are coming from by inspecting the liability side. There are 3 significant sources.

  1. The owner is putting their own capital.
  2. Financing and Debt.Free Float – Free float is capital provided by Suppliers, Employees, Customers, or even the Government in the form of deferred taxes. For example, a supplier may sell raw materials to the business on credit. A customer may prepay for an order. Etc.

If more assets are created from the free float than equity or debt, owners earn more without risking their own capital.

Below is my attempt to classify free float from Debt and Equity. Approximately 70% of liabilities are Free float, making ~48% of total assets. Debt makes up 14% of assets. In contrast to the Home Depot example, which I took from 10K Driver Twitter tread, HD Debt makes 50% of assets, and free float makes 35% of the assets. It is not apples to apple comparison and should not be taken literally. Instead, consider this as a stepping stone to new learnings.

PURPOSE 3# How much surplus capital does the business have? A company that may require 1 million dollars of assets to generate earnings but has 2 million dollars of money on the balance sheet has 1 billion dollars of surplus capital that the business can distribute to owners as dividends, acquire more companies, or share buybacks.

I am still learning about this concept, and as of now, no surplus capital is reported on the balance sheet of StoneCo. And I am not sure if we can or cannot calculate with some assumptions.

Key Metrics of Income Statement:

METRIC #1 – Sales/Revenue Growth – Not all growth is good. If the company takes more capital to generate growth, it destroys the value. We may need to put an extra effort into understanding it. Revenue was ~99 million USD $ in 2017 and is not standing at 484 million, which gives us a growth rate of 69.22%. This probably is the textbook definition of growth on steroids. As pointed out already, growth is good when accompanied by good returns on capital. Here is 10-K Diver explaining it in more detail. 

METRIC #2 – Steady or Growing Gross Margins – Growing gross margins indicates bargaining power of the company.

METRIC #3 – Operating Levareage – Profits can grow faster than revenues, which means cost remains steady while revenues increase. As the net income is zero, I will compare it with Operating Income.

In the last 5 years, revenue grew at 69% CAGR vs. operating income, which increased 62.49%. This might be an excellent metric to check for a company that has been profitable for a couple of years.

METRIC #4 – Debt Coverage – Technically, net income should cover the near-term interest and principal payments. But new growing companies use a lot of capital in growth and building assets. Around 4 Billion Brazillian Dollars debt is due next year from loans (FDIC is not taken into account for debt), and the company makes only 1.3 Billion in operating income. Still, Total liabilities are covered by total assets.

METRIC #5 – Dilutions – The outstanding shares are not increasing rapidly. The company is getting diluted at 6.13%/year. Which isn’t a favorable matrix.

Share outstanding 2019 – 277,366,836

Share outstanding 2020 – 309,261,84

Share outstanding 2021 – 312,531,248

In cash flow statement, I like to see increasing cash flows from operations and increasing free cash flow. StoneCo is not cash flow positive and some of the reason were discussed in the sections above. Free cash flow below is with basic calculations cash from operations minus total capital expenditure.

I have learned that for financial institutions (may not precisely for fintech), PE isn’t a sound economic matrix to look upon. Book values play a significant role in valuing financial institutions – Book value is Total Assets – Total Liabilities. Following are a couple of more matrices used to value a financial institution:

  1. P/BV- Less is better – StoneCo increased its book value by around 8.8$/share. Which gives a value P/B of 1.12. Which is decent.
  2. Return on equity – Greater than 12 is good – ROE as par morningstar is negative but was positive for the last 3 years and avg around 11.6. 
  3. Return on Assets – 1.1 -1.4 is a good range – We calculated 3.2% but on operating income.
  4. Delinquency rates or non-performing loans (NPL) – I learned that company is expecting delinquencies rates to go higher because of their credit solutions and the new regulation “Registry system” created by Brazil’s central bank. They have kept reserves to cover expected delinquencies. And as of now, they are on target and with no surprises.
  5. Net interest margins – The spread b/w the interest they charge customers and what they pay their lender. I didn’t get a hold of data regarding net margins.
  6. Take Rate – We discussed the take rate above.


  1. Due to microchip shortages, Stone pre-ordered POS devices which impacted some cash flows. Also launched TapTon, a new solution that enables merchants to accept credit and debit card transactions directly through their cell phones, with no need for a POS device.
  2. Integration with Linx- increased their active client base and boosted their revenue and several other metrics.
  3. The net income was negative last year, and the company listed several reasons.
    1. Credit solutions were temporarily paused due to the “Registry system” changes discussed above.
    2. Higher base rates increased financial expenses. The base rate is the market rate that significantly increased from 2.0% in 2020 to 9.25% in 2021.
    3. Investment in business
      1. Hiring talent
      2. Research on a solution beyond payment, i.e., credit, banking, etc.
  4. The central bank launched the new instant payment system PIX last year, which may impact prepayment revenue in the long run. As of now, StoneCo added PIX as a payment option and does not see an impact on revenue. The increase in active client base and revenue does verify that claim. But I have read many investors are concerned because of these interruptions. It is better to keep an eye on the impact.
  5. The change in the Registry system impacted credit solutions. It was so dreadful that they paused giving out loans after the 2nd quarter. Also, the leaders acknowledged the gap b/w their understanding of credit solutions vs. the reality and how it assembles more delinquencies. Here is the quote from their earnings – “We ramped our credit offering quickly, but we did not manage this expansion well. Our execution challenges were magnified by the problems of the National Registry System, which we were also not well prepared to deal with. So in mid-2021, we decided to pull our credit operation, regroup, learn from our mistakes and go back to the drawing board”.
  6. Another quote from Earnings is – “In prepayment, we delayed repricing our solutions when interest rates in Brazil began to rise. We didn’t want to hurt our customers with higher costs, which we felt we could absorb for a while. But in the end, the impact was too much on our bottom line, and so we began repricing in November”.

This article was all about the business, In next article I will come up with my story and conclusion. Until then take care.

Disclaimer: Stocks discussed here are not recommendations. Please do your research before investing.