IPO Update: XP Proposes Terms For U.S. IPO

Summary

• XP has filed to raise $1.7 billion in a U.S. IPO.
• The firm provides a range of financial services to consumers and businesses in Brazil.
• XP has grown impressively but the Brazilian economy has been unpredictable and the IPO price appears high.
• Looking for more stock ideas like this one? Get them exclusively at IPO Edge. Get started today »

Quick Take

XP Inc. (NASDAQ:XP) has filed to raise $1.7 billion in an IPO of its Class A shares, according to an amended registration statement.

The company provides a range of lending, brokerage, and advisory services for individuals and businesses in Brazil.

XP is producing impressive financial results but Brazil has been a volatile economy and the IPO may be overpriced.

Company And Technology

São Paulo, Brazil-based XP was founded in 2015 and provides debt financial services through its operating channels, branded as XP, Rico and Clear, which operate as a debt marketplace - offering services of both XP’s partners and its competitors.

Management is headed by CEO and Chairman Guilherme Dias Fernandes Benchimol, who holds a bachelor’s degree in business economics.

XP offers a suite of solutions, including advisory solutions, such as XP Investimentos for retail clients, XP Private for high-net-worth individual clients, XP Investments that is focused for international clients; as well as XP Issuer Services, for our corporate and institutional buyers.

Management says that the Brazilian investment industry is ‘generally inefficient’, expensive by global standards and often results in poor client experiences, primarily due to the landscape being dominated by five traditional financial institutions with assets worth about $1.5 trillion.

XP has a network of retail investors, institutions, and corporate issuers, accounting for about 1.5 million active clients and 125 billion Brazilian real (R$) in net in-flows of “new money year-to-date as of September 2019, up 101% year-over-year and 148% year-over-year, respectively.”

Investors in XP have included Actis and General Atlantic. Source: Crunchbase

Customer Acquisition

The firm markets its offerings through a variety of marketing campaigns, including advertising through traditional media, such as magazines, television, and newspapers, as well as online and offline advertising, primarily digital media, such as social media accounts, social media influencers, online videos and sponsored blogs.

The firm also has digital content and marketing operations, that consist of Infomoney, an investment portal in Latin America; XP Educação, an online financial education portal in Brazil; XP Research, a digital platform with over 500,000 monthly unique visitors; EXPERT, a large investment event in Latin America; as well as the company’s digital Influencers program, with over 3 million followers on social media.

Management also notes the firm operates Leadr - an investment-focused social media network, downloaded over 465,000 times and operated by 150,000 monthly active users.

Selling expenses as a percentage of revenue have been uneven, per the table below:

Selling	Expenses vs. Revenue
Period	Percentage
Nine Mos. Ended Sept. 30, 2019	2.4%
2018	3.2%
2017	1.7%

Source: Company registration statement

The selling efficiency rate, defined as how many dollars of additional new revenue generated by each dollar of sales & marketing spend, was a high 16.4x in the most recent nine-month period, as shown in the table below:

Selling	Efficiency Rate
Period	Multiple
Nine Mos. Ended Sept. 30, 2019	16.4
2018	11.0

Source: Company registration statement

Market And Competition

According to a market research report by Trading Economics, consumer credit in Brazil increased to BRL1.93 trillion in September 2019, an increase over the previous month's BRL1.91 trillion.

Below is an overview graphic of the market growth between October in 2018 and 2019:

In September 2018, year-over-year consumer loan growth in Brazil reached 22.6%, representing more than triple the industry average of 7%.

Competitive firms include:

• Itau (ITUB)

• Bradesco (BBD)

• Caixa (OTCPK:CAIXY)

• Banco do Brasil (OTCPK:BDORY)

• Santander (SAN)

• Guide

• Modal

• Genial

• Easyinvest

Financial Performance

XP’s recent financial results can be summarized as follows:

• Sharp growth in top line revenue

• Increasing operating profit but slightly decreasing operating margin

• Uneven but now positive cash flow from operations

Below are relevant financial metrics derived from the firm’s registration statement:

Total Revenue
Period	Total Revenue	% Variance vs. Prior
Nine Mos. Ended Sept. 30, 2019	$825,000,000	65.8%
2018	$711,000,000	55.3%
2017	$457,680,000
Operating Profit (Loss)
Period	Operating Profit (Loss)	Operating Margin
Nine Mos. Ended Sept. 30, 2019	$556,000,000	67.4%
2018	$485,000,000	68.2%
2017	$318,480,000	69.6%
Net Income (Loss)
Period	Net Income (Loss)
Nine Mos. Ended Sept. 30, 2019	$168,000,000
2018	$112,000,000
2017	$101,760,000
Cash Flow From Operations
Period	Cash Flow From Operations
Nine Mos. Ended Sept. 30, 2019	$18,421,000
2018	$(109,619,280)
2017	$62,968,080

Source: Company registration statement

As of September 30, 2019, the company had $16.9 million in cash and $155.1 million in borrowings (unaudited, interim).

Free cash flow during the twelve months ended September 30, 2019, was a negative ($154.5 million).

IPO Details

XP and selling shareholders intend to sell a total of 72.5 million shares of Class A shares at a midpoint price of $23.50 per share for gross proceeds of approximately $1.7 billion, not including the sale of customary underwriter options.

Class A shareholders will be entitled to one vote per share and Class B shareholders, who include existing shareholders, will have ten votes per share.

The S&P 500 Index no longer admits firms with multiple classes of stock into its index.

Certain entities have indicated an interest in purchasing up to 7.25 million Class A shares at the IPO price. This is a positive signal to prospective IPO investors.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $13.1 billion.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 13.14%.

Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds as follows:

to meet our anticipated increased working capital requirements resulting from the expected growth in our business

to accelerate customer acquisition through increased investments in marketing and advertising;

to invest in personnel that complement our existing business units;

to invest in new financial services verticals that we plan to enter or have recently entered into, such as digital banking, payments and insurance;

to fund potential future acquisition opportunities; and

to fund other general corporate purposes.

Management’s presentation of the company roadshow is available here.

Listed underwriters of the IPO are Goldman Sachs, J.P. Morgan, Morgan Stanley, XP Investments, Itau BBA, BofA Securities, Citigroup, Credit Suisse, and UBS Investment Bank.

Commentary

XP is a fast-growing Brazilian financial services firm seeking U.S. public investment for its growth plans.

The Brazilian economy has generally been performing better in recent quarters, however, it is subject to economic shocks.

Witness today’s announcement by the Trump Administration to reinstate steel tariffs on Brazil and Argentina.

The firm’s financials show impressive growth across major metrics, including its selling cost efficiency rate, which is high and improving.

The market opportunity for consumer financial services in Brazil is large and expected to grow at significant rates in the near term, however, the firm faces broad competition from other financial services companies in the country.

As to valuation, it is difficult to determine a young company’s future growth and earnings prospects with any certainty, so the DCF calculation is really only one reference point.

Another reference is the January 2019 basket of public valuations published by the NYU Stern School. It showed the Brokerage & Investment Banking industry as having an Enterprise Value/Revenue multiple of 5.56x.

XP is asking IPO investors to pay an EV/Revenue multiple of 12.6x, or more than twice the NYU Stern reference multiple.

While XP’s growth trajectory is much higher than the NYU Stern basket of companies, the question for IPO investors is whether you believe the premium management is asking IPO investors to pay is worth it.

I tend to be more cautious and want to avoid overpaying for stocks, if I can help it, so I'll be watching this IPO's performance in the post-IPO open market.

Expected IPO Pricing Date: December 10, 2019.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.