StoneCo: Challenges Surface In Q1

Summary

• StoneCo reduced its team by 20%.
• So why have you decided to lay off 20% of the company in mid-May when you have the numbers already recovering?
• In today’s world, I strongly believe that looking into the future, people make a difference.
• When I assess the recent decision made by StoneCo management I’m quite concerned about the long-term case for the company.

I’m a big fan and follower of Warren Buffett and Jorge Paulo Lehmann, therefore I closely watch how they allocate capital. When Berkshire Hathaway (BRK.A) (BRK.B) bought shares in StoneCo. (NASDAQ:STNE), I said it's outside of my circle of competence and I will not analyze the company. But as time has passed, I started to monitor the company. I was further attracted by the company seeing several other value investors talked or invested in the company.

About The Company

StoneCo. is 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. A customer-centric culture, no bureaucracy, and a deep entrepreneurial spirit are the company’s values. The primary mission is to remain focused on empowering clients to grow their businesses and help them conduct commerce and run their operations more effectively.

If you are value investors it's music for your ears. You want to find a company with a strong culture with a long run away. When you dive into StoneCo's case it has many elements of that narrative. For most investors, it's difficult to assess what company will “walk the talk” and who would rather “talk the talk.” The only way to make a reasonable assessment is to rigorously follow management actions.

Staff Reduction

I was quite surprised when I read a letter from CEO Thiago Piau and the announcement that StoneCo reduced its team by 20%, and 1,300 people left the company. Here's what he said: “This was an extremely hard decision, and we did not make it lightly. At the beginning of the crisis, we did not contemplate having to take this route. Having exhaustively considered all alternatives, we have concluded that it is a necessary step to maintain our purpose towards our clients and support them in such difficult times.”

At that point, my question was how can you serve better clients with 20% fewer people? It must be you are losing your clients, or you have discovered the new business model how to serve clients.

I listened to the conference call for Q1 2020 and found an interesting question regarding the staff reduction. Here's an abstract:

The tone of you guys have been generally constructive during this call, so you were talking about resilient take rates, growing loan portfolio, recovering volumes, as you showed in your presentation, right, with volumes for May already recovering and growing on a year-over-year basis. So why have you guys decided to lay off 20% of the company in mid-May when you have the numbers already recovering and obvious, let’s say, the more constructive tone being conveyed now? So what is the reason behind the layoff?

That was my opinion as well. I asked myself the same question several times. And here's the short version of answer by Piau:

We are living in very uncertain scenarios. And our assessment was that we had a mismatch between revenues and level of investments. As you know, we have to put investments upfront, and we have a kind of vertical business strategy in which all of our sales team, our customer service, our logistics, they’re all in-house, and we already invest more than we need for the moment because of future growth that we expect in order for everybody to be trained and to be ready….

I think that in two or maybe three months, we can establish the size of our sales team in the same level that we had before, and we have the optionality to hire back our team…

But at this moment, I think that it was the right decision to balance investments, the results that we are seeing.

My View

I don’t want to be misunderstood. I’m usually a long-term investor and I think about the company over many years. In today’s world, I strongly believe that looking at the future people makes a difference. If I go back, let’s say, 15-20 years ago, the capital could make a difference. The fact you had money. It’s still important, but let’s be honest, there's so much money around and a good story can find the money. Then, let’s say 10 years ago the perception was the equipment and assets were important. The way that has developed shows us that a lot of assets have commoditized. The only way to make a difference in the future is through people. That means that people are more important in the future then they are today, and then they were yesterday.

I’m even more confused when I read the Q4 2019 transcript. Here's a short abstract of what Piau said:

We also continue to attract talented people to our business with one of the biggest recruiting process in Latin America. And we are ranked by LinkedIn among the top companies where Brazilians dreams to work at.

It's a great statement of StoneCo's culture and position on the market, but then in three months, they changed completely narrative. When I assessed the recent decision made by StoneCo management I’m quite concerned about my long-term case for the company. Mark Cuban has recently said: “How companies treat their employees during the pandemic is going to define their brand for decades.”

In StoneCo's case the market was quite happy with quarterly development and the share price jumped on the results announcement by cca. 25%. I must admit I’m less enthusiastic and more concerned about long-term execution.

Conclusion

Putting it all together it's quite a strange situation. On one side, you have a high growth rate of the business, a great potential for future development, management with a distinctive culture. At the same time, the management makes some short-term decisions that could jeopardize the potential. I will continue to follow the company to see how it will execute against the competition, market opportunities, and develop the business. But I’m quite sure it's not Buffett's style to cut investments and lay off employees in times of crisis. In short, I think Buffet would do the other way around.

Analyst’s 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.