A recent dip in this fintech could be a huge opportunity in the long run

Brazilian FinTech PagSeguro (NYSE: PAGS) has plunged recently, dropping almost half to its recent low. It is now down about 37% from recent highs and 31% for 2021.

The drop can be attributed to a rule change proposal from Brazil’s central bank to cap interchange fees on prepaid cards at 0.5%.

While this change may affect Pagbank’s revenue from PagSeguro, prepaid interchange fees are only a small part of PagSeguro’s overall business, which is primarily driven by merchant processing fees and fund lending from rolling. With that in mind, such a large sale seems extremely over the top and could open up an opportunity for dumb long-term investors.

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PagSeguro is a leading brand with a long track of growth

PagSeguro was founded in 2006 under the umbrella of the Brazilian Internet company UOL, and became an independent company through its IPO in 2018. The company touts its comprehensive digital finance business through merchant acquisition, digital banking, point-of-sale devices, free digital bank accounts and other banking services. Its mission is “to disrupt and democratize financial services in Brazil, a concentrated, under-penetrated, and high-interest rate market, by providing an end-to-end digital banking ecosystem that is secure, affordable, simple and mobile.” first for both traders and consumers. ”

You can think of PagSeguro a bit like the Square (NYSE: SQ) from Brazil. The company offered online payment processing services and point-of-sale systems to small and micro merchants that had long operated in cash only. PagSeguro then started offering a free digital bank account to its merchants, through which it provides other services, such as prepayment on merchant receivables (installment payment plans are common among consumers in Brazil).

PagSeguro extended its digital banking to consumers with the launch of PagBank in 2019, where it earns money on wire transfers, interchange fees, credit cards, P2P transactions, loans and other services – a bit like Square moving from merchant point of sale systems to its consumers – in front of Cash App. It is PagBank’s prepaid cards that are likely to be affected by the new interchange fee limit.

What is the impact of the trade rule? Maybe not at all

While some financial analysts have estimated that PagSeguro’s 2022 revenue could be affected by low to mid-range figures and adjusted EBITDA in the coming years by the new rule, a recent press release from management had its own more positive opinion. Based on several scenarios, management now expects a negligible effect on net sales and net income 2022, and in fact expects a slight benefit to rule in 2023 and beyond.

How could that be? This is because while PagSeguro earns income from prepaid interchange fees related to its consumer bank accounts, the acquiring merchant pay interchange fees as cost of goods sold. Therefore, the larger acquiring company will become more profitable if the interchange fees decrease. “The fact that PAGS has complementary payment activities (acquisition and issuance of cards) creates a natural cover for the company,” the statement said.

Meanwhile, the company has a long track

Assuming this rule change does not affect PagSeguro’s growth prospects, its updated stock price could be a great opportunity. This is because Brazil’s banking system is still heavily concentrated among traditional institutions, there are a significant number of unbanked people in the country, and many still use cash for transactions – even e-commerce transactions.

In 2017, Brazil’s top five banking institutions held 83.4% of financial assets. As of 2017, 65% of bill payments were still made in cash in Brazil. And as of 2019, 57% of Brazilians hadn’t even heard of digital banking.

As more Brazilians embrace digital banking, move away from cash, and while PagSeguro can offer a more user-friendly solution than traditional banks, the opportunity remains quite significant. Management has just released preliminary results for the third quarter, showing a consolidated total payment volume up 85% year-on-year, with acquisition activities unaffected by these regulations up 49 %. Importantly, PagBank users grew by one million to 12.2 million active users, almost 9% quarter-over-quarter growth.

With the stock’s recent sell-off, it is now trading at just 27 times the average estimate for next year’s earnings. For a business that is growing so quickly, that’s a pretty undemanding assessment.

While regulatory overshoot and inflation fears in Brazil may weigh on sentiment in the near term, remember that PagSeguro earns most of its money as a percentage of transaction costs, so a large chunk of its revenue is expected. grow alongside any problematic inflation. Given that recent fears over interchange fees are not as severe as previously thought, the recent massive sell-off of PagSeguro appears to be a solid opportunity for this emerging market growth stock.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

About Jeff M. Thompson

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