Brazilian digital bank operator, Nu Holdings Ltd. (NYSE:NU), which we will refer to from hereon as Nubank, cut its initial public offering (IPO) price by around 18%, after witnessing a tech selloff that has softened the market for IPOs. The Berkshire Hathaway (BRK.A)-backed company had aimed at raising $3.86 billion and earning a $50 billion valuation, in its last F-1 registration statement, but in its F-1/A filing, it indicated an intention to raise just $2.86 billion and earn a $41.5 billion valuation. The company has also reduced the number of shares it is offering the public, from 332,523,138 to 289,150,555 at an initial price range of between $8 and $9 per share, with 4,608,684,459 shares outstanding at the end of the IPO. If the IPO is a success, Nubank will be bigger than Brazil's largest traditional lender, Itaú Unibanco (ITUB).
People in the West are often blind to the opportunities available in the developing world. Nubank got to do what is at this point almost impossible to do in the West: attack a large, mostly unbacked segment of society and grow into the biggest bank in Brazil.
The company estimates that its serviceable addressable market (SAM) amounted to $99 billion in 2020 and will grow at a compound annual growth rate (CAGR) of 5% till 2025, reaching a size of $126 billion by that time. A sign of the size of this market opportunity is in the company's own revenue numbers, which were $737 million in 2020 and $1.265 billion for the first twelve months of the year ended September 30, 2021, which were just 1.3% of this market opportunity.
The company's total addressable market (TAM) was worth $186 billion in 2020 and is estimated to grow at a CAGR of 8% to $269 billion by 2025.
Nubank was founded in 2013 in order to seize a unique market opportunity: traditional lenders had neglected vast swathes of Brazilian society, failing to meet their most urgent banking needs. Nubank's first product was a zero-fee credit card which could be managed through an app. At the time, traditional financial services firms charged fees for all services, regardless of how basic, a practice that continues to this day. In a country and continent where many people are in the grip of poverty, fees act as barriers to opening or maintaining a bank account or accessing financial services. Today, the company has over 48 million users in Brazil, Columbia and Mexico. Nubank is not the only fintech startup that has risen to meet the challenge of the market, but it is the most successful.
These disruptors have succeeded because the Latin American banking system has two major flaws:
- The sector is highly concentrated and lacks competition. Typically, a lack of competition is great for businesses because they have pricing power, as seen in the ability of traditional lenders to charge fees for every aspect of their services, and allowing them to earn returns on capital greater than their cost of capital. However, this situation can only stand if that sector does not become vulnerable to a disruptor. If it does, then that period in a friendly competitive landscape will leave the market incumbents too soft, too traditional to meet the threat posed by market entrants. The five largest banks in each of Brazil, Colombia and Mexico control between 70% and 85% of the loan market, deposits and overall banking revenue, figures which beggar belief when seen in the light of the developed world. The lack of competition has led to a very conservative banking system that has shunned innovation, failed to increase the number of products it offers its clients, and is able to charge higher fees than are possible in developed markets. Nubank has been able to exploit the situation by using advanced technology, data and customer service to attract ever rising numbers of customers.
High Costs to Serve. These incumbent banks still rely on expensive and expansive branch networks to serve their customers. For instance, all Brazil's five incumbent banks have between 2,000 and 5,000 branches, and each bank employs around 80,000 employees. According to Nubank, this translates into a high cost to serve. The consequence is that incumbents are motivated to offer high-margin products that do not appeal to most of the country's population. Nubank's cost to serve in Brazil is estimated to be 85% lower than that of the incumbent banks.
The dissatisfaction of customers with the establishment can be seen in the graphic below:
Customers Have Rewarded Nubank With High Growth
It has to be said upfront that Nubank's growth is still profitless. The company made a net loss of $99.1 million in the first nine months of the year, compared to a $171.5 million, $92.5 million and $28.6 million loss in 2020, 2019, and 2018 respectively.
The company has grown its revenues because its products have displayed such immense product-market fit. Customers want what the company is offering, and they simply cannot get enough. It's not just revenues that are growing, the company has scaled the number of customers it has, from 5.2 million customers in 2018, to 48.1 million customers (a CAGR of 110% for that period). As of September 30, 2021, 73% of the company's customers were classified as monthly active users. In the third quarter, the company had a net gain of 2 million customers across Brazil, Colombia and Mexico.
Although Nubank's growth has been profitless, the company has the ingredients that indicate that it will be able to not only achieve profitability but also build substantial competitive advantages. Achieving profitability having grown as aggressively as Nubank is a function of a firm's ability to develop competitive advantages, and its investment in data, advanced technology, and a viral product and customer-centric business model are things that new market entrants will find difficult to replicate and which the incumbents have already struggled to tackle. The company is likely to earn whatever valuation it seeks because, despite market uncertainty due to Covid-19 related fears, a company of this calibre is very rare indeed.