Investors buy into XP Investimentos’ growth story

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By:
Rob Dwyer
Published on:

Itaú retains 49% stake, now equivalent to 10% of the group’s market cap, as rapid growth leads to runaway valuation.

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The outlook for new equity issuance from Brazilian financial institutions in 2020 has been brightened by the strong performance of XP Investimentos’ IPO in December 2019.

The Brazilian financial services group sold nearly $2 billion in shares on Nasdaq to become the fourth-largest US IPO offering in 2019. The transaction priced at $27, above the initial price range of $22 to $25, and then kept going: the stock popped by 28% in the first day of trading, which took the valuation of the company to more than $19 billion – more than Banco BTG Pactual (at $15.7 billion)

The listings valuation – of $14.9 billion – was already equivalent to 60 times 2019 earnings. The huge multiples (Charles Schwab, the investment company that XP’s CEO Guilherme Benchimol was consciously copying, has an average price/earnings ratio of around 18x) reflects a bet that XP can continue its recent growth. 

The company reported a compound annual growth rate of assets under custody of 92% between 2014 and 2018. Total assets under custody are R$350 billion and the company now has more than 1.5 million customers. The company had generated R$3.7 billion ($0.91 billion) in revenue in the first nine months of 2019 and net income of R$699 million.

This is the second time that XP has proposed an IPO. The first transaction, in 2017, was aborted during the process when one of the leading underwriters – Itaú – offered to buy a majority share in the company. The staggered deal initially valued the company on the basis of R$80 billion in assets under custody and 400,000 clients.

The central bank ultimately stepped in to prevent Itaú taking its then 49% stake into a majority ownership in XP Investimentos, fearing increasing consolidation in the banking sector. However, it is worth noting that Itaú didn’t sell any of its 49% participation in the IPO and, as such, its stake in XP becomes a material factor in its own valuation.

In a report, BTG Pactual pointed out that if half of XP Investimentos is now worth R$30 billion, it would be equal to about 10% of Itau's market capitalization (as well as being a strong return on its R$6.3 million outlay).

The IPO’s underwriters were: Goldman Sachs, JPMorgan, Morgan Stanley, XP Investimentos, Itaú, Bank of America, Credit Suisse and UBS. The deal was the biggest US listing of a Brazilian financial institution since PagSeguro’s IPO on the NYSE in January 2018.

'Bitter taste'

XP said it chose to list on the Nasdaq as local rules place restrictions on the dual-class structure of its Nasdaq offering (holders of class-B stock will get 10 votes to a single vote for class-A shares – a structure designed to keep the original shareholders with 56.2% of the voting power).

However, investment bankers also say that fintech IPOs in the US are able to generate stronger valuations than they believe would be paid by a deal listed on Brazil’s B3. Regardless, the deal has set in motion proposals to change the Brazilian stock exchange’s rules to allow greater structural flexibility on listings, with Gilson Finkelsztain, president of B3, reported by Brazilian newspaper Valor as saying the XP deal left a “bitter taste” in his mouth and he intended to work to “counter the export of Brazilian companies to US stock exchanges”.

Finkelsztain will have to work fast, however, according to ECM bankers, as the success of the XP IPO will encourage further financial companies to market in 2020.

XP’s strong valuation also reflects optimism about Brazil’s economy and, in particular, reflects the rapidly changing investment environment in the country as for the first time the country faces low interest rates. Combined with pension reform, which is leading to a growth in private pension savings, this has increased the appetite for investments in non-traditional (sovereign fixed income) asset classes – a trend upon which XP has been capitalizing.

Benchimol has said in the past that he is aiming for R$1 trillion in assets under custody by the end of 2020 and thinks that the “brutal” consolidation of the market presents a huge opportunity for XP’s continued growth (according to a report by Oliver Wyman, the largest five banks account for nearly 93% of the R$8.6 trillion under management).

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Guilherme Benchimol, XP Investimentos

Risks

However, as XP’s IPO prospectus points out, there are also risks. XP was the first mover in the sector – it has overtaken UBS’s Brazilian brokerage operation to become the country’s largest brokerage by equity-trading volume – but other fintechs are emerging and the banks are also responding by offering digital investment and brokerage services to their retail clients. The competition is likely to be fierce and lower industry fees.

The prospectus also highlights that: “Our business largely depends on certain of our institutional brokerage clients using our solutions and trading on our platforms. A limited number of such clients can account for a significant portion of our trading volumes, which, in turn, results in a significant portion of our transaction fees. Most of our institutional brokerage clients do not have long-term contractual arrangements with us and utilize our platform and solutions on a transaction-by-transaction basis and may choose not to use our platform at any time.”

Prospectuses have to outline all types of theoretical risks, of course, and it’s not surprising that the evident growth drowned out investors’ fears about the lack of long-term contracts. But with so many new entrants and pressures, this is a potential risk for XP.

To counter such vulnerability, XP intends to move quickly to becoming a full-service digital banking platform – including offering credit to its customers. The launch of the banking platform is expected in the first quarter of 2020 – the company already has a full banking licence.

Euromoney will publish a feature interview with CEO Guilherme Benchimol in February 2020, in which he will give details about his plans for the future of XP Investimentos.