DLocal’s Rebuttal To Muddy Waters’ Short-Report Falls Short (NASDAQ:DLO)

Introduction

On November 16, short-selling firm Muddy Waters Capital (I will refer to as MW) released a short report on Uruguayan payment services company DLocal (NASDAQ:DLO). That same day, DLocal responded claiming the report contained “numerous inaccurate statements” and said they would “rebut the allegations in the appropriate forum in due course”. Over a month later on December 20, the company released its rebuttal and announced a $100M share buyback program to boost investor confidence. I have been a DLO shareholder since April of 2022. I was impressed with their level of growth and profitability as well as their long-runway in several emerging markets. In this article, I cover the main arguments of the short-report, DLocal’s response, and what it all means for investors.

Short-reports are a nuanced part of investing. As investors, it’s important to examine the many biases and motives within markets, including our own. Short-sellers’ making a living off of stocks losing value. They have an interest in digging up as much dirt as possible to paint the company in the worst possible light. It can be easy to dismiss a report against a company we own as an attempt to make a quick buck, but in doing so, we reveal our own biases. Short-reports can be beneficial for investors and the health of the market as a whole. They are an opportunity for shareholders to objectively examine the companies they invest in, make more informed decisions, and push for improvements where things are lacking in said companies. With that in mind, here are Muddy Waters’ main arguments against DLocal.

Muddy Waters’ Accusations

In the 47 page report, MW dives into a host of problems at DLocal and even makes allegations that DLO is an outright fraud. I won’t go into all of the specifics, but a few of the main points include

• Contradictory total payment volume (‘TPV’) reporting

• Concealing/lying about the timing of company loans to executives

• Large portion of take rates (and hence revenue) buoyed by FX transactions

• Use of client funds to pay insiders

• Unnecessary complexity and dodging regulation

• Manual backend processes (mainly spreadsheets) at a multibillion dollar fintech firm

• Insiders selling $1B of shares and several executive resignations

The sum of these allegations leads MW to conclude that DLocal is either led by largely incompetent management with poor governance or that the firm is an outright fraud.

This report was clearly well researched and backed with evidence, pointing out several glaring issues with DLocal’s internal controls. Many of which cannot be directly refuted. Nonetheless, a good portion of the report takes evidence of mistakes and/or control problems to draw speculative conclusions of malicious intent culminating into a fraudulent house of cards. This is where I tend to disagree.

First, DLocal services several of the world’s biggest companies such as Google (GOOG) (GOOGL), Amazon (AMZN) and Microsoft (MSFT). In addition, one of the world’s largest Private Equity funds, General Atlantic (‘GA’), holds 19.4% of outstanding DLO shares. It is hard for me to believe that these large companies and institutions would not have thoroughly vetted out DLocal as a complete fraud. MW claims General Atlantic has already made their money back on DLO and is playing with “House Money”, but having such a significant amount still invested tells me GA still sees potential in DLO. Insiders also hold an astonishing 45% of outstanding shares. That is a ton of skin in the game and thus confidence in DLocal’s prospects. If the DLO ship sinks, its executives go down with it. In regards to the last point MW makes, $1B on insider sales and high rates of executive turnover are somewhat concerning: though it is common for insiders to take some IPO profits off the table. Now let’s move to DLO’s rebuttal.

DLocal’s Response

DLO opened their response highlighting their commitment to governance and transparency and have thus initiated a thorough internal review of the short seller’s allegations using in-house and third-party advisors. The company’s Audit Committee also conducted an internal audit with help from independent counsel, an independent global expert services and forensic accounting advisory firm. From the results of this audit, DLocal directly rebuts several, but not all, of MW’s accusations. Here are a few:

• Use of client funds: DLO maintains separate bank accounts for merchant and company cash and has not mingled these funds.

• Take Rates/FX fees: DLO believes the report’s comparison to other companies are inaccurate and unsubstantiated.

• Pre-IPO loans to executives: these loans were repaid prior to the IPO to comply with US legal requirements.

• TPV reporting: DLO has disclosed TPV cohort methodology, including a change in its methodology between its F-1 filing and 20-F filing. They claim the report makes misleading comparisons between DLO’s DRS and a subsequent period’s earnings presentation.

The company then announces a share buyback plan totaling $100M, expiring in July of 2023, to “reflect the Board’s confidence in our current performance and prospects and long-term growth.” In addition, DLO’s major shareholder, General Atlantic, and other insiders plan to acquire additional shares as well.

My initial reaction to DLO’s response is somewhat mixed. I was happy to see the company refute the major accusations of potentially illegal activity as well explain the contradicting TPV reporting. But for the amount of time it took to audit the allegations and send out a press release, the response left something to be desired. I understand the aversion to break down each MW allegation, but I would’ve liked to see more honesty around where the company is lacking in its internal controls and how it plans to shore this up going forward. This could come in the future though. The buyback plan is generally positive, but it does not obligate DLO or other insiders/institutions to repurchase shares. Unless they put their money where their mouth is, it doesn’t improve my confidence.

Final Conclusions

MW’s short report highlighted a few risks investors should take note of. Some of which were not sufficiently addressed by DLO in my view. First, a large portion of DLOs take rate, and thus revenues, are driven by FX transactions. Though this represents a valid part of a cross-border payments company’s revenue, it represents a less sustainable and lower quality source of revenue in my view. I would like to see DLO shift its revenue mix to rely less on FX. Second, DLocal seems to be unnecessarily complex and relying on manual backend processes, which I believe are the factors driving many of the mistakes pointed out by MW. On the surface these don’t seem to be major, but if DLO has any hopes of scaling into its massive market, these areas need to be improved. As a shareholder, I want to see more transparency from management on how they are seeking to resolve and prevent the many issues highlighted by the report going forward. If these issues persist and no changes are made, I will consider exiting my position. In addition, I will be monitoring DLO’s largest shareholders and customers. If major customers and institutional investors start abandoning ship, that would spell disaster for DLO in my view.

Being a long-term investor, I try to be slow to sell. As of now, DLO is in the ‘hotseat’ within my portfolio. This means I have paused adding shares until I see some positive developments around what was discussed in the previous paragraph. DLO’s business and potential growth are still compelling in my view, but until improvements are made, they are a cautionary hold.