VEF — NAV momentum

Since our initiation in November 2020, VEF’s net asset value (NAV) per share has risen by 16.8%, split into 5.5% in Q420 and 10.7% in Q121. Total NAV rose from US$268m to US$403m; this includes a successful US$61m rights issue concluded in December 2020.

Brazilian online secured lending platform Creditas (VEF stake: 9.8%) accounted for about half of this NAV increase. Creditas raised US$255m in a funding round in December 2020 in which VEF took up its rights. This increased VEF’s stake value by 66% to US$169m. Creditas accounts for 42% of VEF’s NAV and 47% of the investment portfolio ex-cash. Creditas management is steering the company towards an IPO, which, if successful, would increase the transparency of the value of the company in VEF’s portfolio. Creditas has been growing strongly in its three core lending lines (auto, home and payroll) and is expanding into Mexico. Revenues were up 50% y-o-y in Q120.

Konfio, a Mexican unsecured SME business lender, is VEF’s second largest investment (15% of VEF’s NAV) and has been the other big driver in VEF’s NAV uplift in the last two quarters. The value of the Konfio stake increased by about 50% from US$40.3m in Q320 to US$60.1m in Q121. Konfio has resumed its strong growth in Q420 with better than expected asset quality according to VEF. It is also broadening its product range to include credit as a service and has acquired an enterprise resource planning (ERP) company.

The other NAV highlights in Q120 were the c 30% increase in NAV of FinanZero (a Brazilian digital loan brokering platform) and Jumo (an African lending platform). Both companies have been doing well, and FinanZero had another successful round of financing (VEF invested US$1.5m in the rights issue, for an 18% stake), which set the higher valuation mark. FinanZero and Jumo combined make up 8% of VEF’s investment portfolio.

On the negative side, Guiabolso continues to be revalued downwards. It is now focusing on third-party products, which is less ambitious than the initial hopes and plans of a higher profit margin business model offering its own products. It now represents 3% of NAV and its performance is unlikely to be needle-moving for VEF in either direction.

VEF has disclosed that Revo in Russia is currently profitable and that Jumo is close to achieving profitability. All the remaining companies, including Creditas, are still losing money as they are scaling up. VEF has not disclosed any portfolio EBITDA or revenue numbers.

As we detail later in the portfolio section on page 6, nine of the 14 invested companies are valued on a mark to model basis, and the rest are valued on a recent transaction basis, either from purchases or recent funding rounds.

In terms of revenue, figures for Q121 are not available, but we understand that the portfolio revenue grew 62% in US dollar terms in FY20 and tripled over two years to c US$151m.

VEF made two investments in Q121 in new companies: Rupeek in India and Minu in Mexico. In a departure from its usual approach, these were small stakes (1.4% and 1.2%) and did not involve any representation on the board.

Rupeek is a fast-growing asset-backed lending platform focused on gold-secured loans. VEF expects it to broaden its asset-backed offering and potentially to become a second Creditas.

Minu is a an ‘employee financial wellness’ company and the leading pay on demand lender in Mexico. For a set fee, it allows employees instant access to their earned wages. The payroll deductions are automated and so require little administrative cost to the companies. Minu currently has almost 100 clients including Telefonica, Scotiabank and Rappi. VEF had already invested in this earned wage advance model through Xerpa in Brazil. It sees this as a hook product that can lead to cross selling other financial products.

Technology is increasingly having an impact on financial services at many levels, ranging from electronic payments, online commerce platforms, digital customer service to niche areas such as wealth management. Customers are increasing their digital adoption of financial services, incumbents are increasingly getting involved, while many governments and regulators are taking note and supporting this trend.

The technology advantage can arise from various angles including better collection and usage of customer data, superior service delivery and higher automatization. It can result in lower costs to customers and also greater customer reach, an important topic in emerging markets. The recent lockdown seems to have only increased the move to greater digitalisation. Accenture estimates that in Europe, 33% of all new financial services revenue since 2005 has been captured by fintech companies.

KPMG estimates that investment activity (venture capital, private equity and M&A) in global fintech rose from $18.8bn in 2013 to $168bn in 2019, and despite the pandemic there was still $105.3bn invested in 2020 with 2,861 deals, with a strong rebound in the second half of the year.

According to the FinTech Almanac, fintech activity in South America (VEF’s current largest geographic weighting) increased from $434m in 2015 to $1.8bn in 2019.

Emerging markets provide another lever for future growth. This stems not just from the economic and demographic growth outlook being better, but also a more significant amount of both retail and business clients that are underserved or poorly served. Clients are moving directly to digital platforms and bypassing bricks and mortar banking. This is particularly true in the relatively poorer emerging markets such as India, Pakistan and Africa, where the level of financial integration is still comparatively low. According to the World Bank, in 2017 the percentage of the population with a bank account was 21% in Pakistan and 31% in Africa compared to 96% in the EU.

Fintech investment activity has been growing strongly in emerging markets as a result, especially in Latin America. The value of fintech deals and financing in Latin America increased from just $44m in 2013 to about $2bn by 2019. According to Statistica, of this $2bn, 70% was in Brazil and 21% in Mexico.

VEF (formerly Vostok Emerging Finance) was launched in November 2015 and its headquarters are now in Sweden. Its Swedish depository receipts (SDRs) are listed on the Nasdaq First North exchange in Stockholm. Each SDR is equivalent to one ordinary share and has the same voting rights with no restrictions. As part of its focus on environmental, social, and corporate governance (ESG), VEF decided to change its domicile from offshore in Bermuda to Sweden in Q121. VEF sees many of its portfolio companies as driving financial inclusion and fairness and being ‘at the front line of sustainable finance’.

VEF’s investment targets are early to mid-stage modern financial services companies in emerging and frontier markets. The company looks for innovative early stage companies capable of challenging incumbent companies with new thinking and modern technology solutions. It also looks for entrepreneurs and teams with good track records, viable concepts and strategies and clear, scalable business models that can deliver high rates of growth.

VEF invests in the whole spectrum of financial services. The portfolio includes firms in consumer credit, payment solutions, money transfer, personal finance, asset management and various types of financial marketplace.

There is a strong preference for larger emerging markets where single-country scalability can provide greater returns. The investments have therefore been in large markets such as Brazil, Mexico, India, Russia, Turkey, Pakistan and Africa, which provide the opportunity to scale up. Brazil is a particular focus for VEF due to a strong online connected customer base, expensive incumbent financial services and the ability for VEF to make value creating deals.

Although VEF’s mandate gives it more flexibility, it typically aims for a 10–25% minority equity stake. Where appropriate, the team seeks board appointments where it can add value by knowledge, corporate governance investment profile and networks for capital raising and partnerships. However, as mentioned, VEF’s last two investments, Rupeek and Minu, have been smaller stakes of 1.4% and 1.2%, respectively. The average investment duration is expected to be five to seven years, but ultimately this is determined by exit opportunities including unsolicited bids. The permanent capital structure of a closed-end fund gives VEF flexibility in managing its holdings (eg not forcing it to sell due to investor redemptions) and therefore boosting its internal rate of return (IRR). There is no regular dividend target, with the focus being on capital appreciation.

Although VEF can use leverage, it currently operates without any debt and with no management fees. The operating expenses in 2020 were 0.9% of the investment portfolio’s NAV (including cash) if we exclude incentive programme expenses. This is down from 1.6% in 2019. If we include the incentive programme, the total operating expenses rise to 1.5% of the portfolio NAV in FY20 (2.25% in FY19).

VEF’s long-term incentive plans (LTIPs) initially had a three-year vesting period, but VEF decided to change the LTIP starting in 2020 (the LTIP 2020) to a five-year plan. The final reward depends on the portfolio’s NAV growth. Achieving NAV three-year CAGR targets of 10%, 15% and 20%+ results in participants correspondingly receiving 2x, 5x or 10x the number of purchased shares for the base payment. With the five-year plan, the programme is proportionally higher in the first year (2020) and then decreases on a linear basis until maturity. So the pay-out on the LTIP 2020 is 10x, 15x and 35x the number of purchased shares. For under 10% NAV CAGR there is no pay-out.

Exhibit 1 shows the dilution impact of the various levels of incentive scheme pay out in the two LTIPs. If VEF were to hit the 20%+ NAV CAGR, there would be an estimated dilution of 7%.

Management believes VEF’s companies are set up to function in the high political and economic volatility of emerging and frontier markets, which could also make them more resilient to the impact of COVID-19. The resilience comes from management teams being more accustomed to macro volatility and the secular growth opportunity that helps VEF ride out the negative shocks. VEF’s management also sees the pandemic as having accelerated the trends to greater digitalisation of banking services.

VEF believes that Konfio was perhaps its ‘most impressive holding in 2020, especially given the space/country it operates in and the natural macro/credit headwinds that came with COVID-19.’ It saw Konfio pass the asset quality stress test in good shape during 2020 and Konfio was able to be ‘first out of the blocks in terms of credit growth in 4Q20, which is delivering better quality clients’ at lower cost of risk and with a ‘broader range of financial services’ than before. VEF believes that Konfio may be its next Creditas in terms of breakout value creation and plans ‘to back Konfio harder on its path to being the number one digital financial services provider for SMEs in Mexico’.

In addition to Konfio, management also highlights its two Indian investments, Juspay and Rupeek, as having ‘a lot of value creation potential’ in 2021.

Management is seeing IPO and M&A activity in emerging fintech at elevated levels again following the peak of the pandemic concerns. Investors are excited by the upside from the growth prospects and the disruptive potential of emerging fintech companies. This is good news for business activity and for outsider interest in VEF’s investments. However, this also means discipline must be exercised in doing new deals. While it sees ‘deal flow as healthy as ever’, it is not in a position of great need to invest and can wait for the right deals. In Q121, VEF’s number of leads and qualified leads regarding possible deals more than double than in the similar period in Q120.

At the end of Q121, VEF’s portfolio consisted of 14 equity investments with a fair value of US$359m and US$45m in cash and liquidity investments ($41m). There is no debt and less than US$1m in liabilities for a company NAV of US$403m. The total amount invested on the current assets is US$212m, excluding the liquidity management cash.

Nine of the companies are valued according to model, ratified by KMPG, and five are currently valued on recent cash raising transactions or purchase price. The latter are Creditas, FinanZero, Finja, Rupeek and mino.

Companies can be split geographically or by sub sector. Of the 14 companies, 13 can be grouped into three areas of primary activity (Nibo is the outlier, being an accounting software services company):

Although the core of each company is its technology, they have different value drivers and competitive challenges. So, even though there is some country concentration in Brazil, the catalysts for performance are not always the same. Some companies may be more exposed to the credit cycles, others to the financial markets, and others such as Nibo are more resistant to the economic cycle.

Creditas is a Brazilian online platform offering secured loans, with about 35% backed by homes (home equity loans) and about 50% by vehicles and 15% in payroll deducted loans (payments are deducted from wages at source), a common loan product in Brazil. In May 2021, Creditas invested BRL95m (US$18m) in local electric motorcycle start-up Voltz. Creditas’s CEO expects that in five to 10 years only 20% of motorcycles will use traditional combustion engines and they want to be part of this growing trend towards greener energy sources. Creditas has become a relevant minority investor in Voltz, but the size of the stake has not been yet disclosed.

The home loans business opportunity arises from the fact that unsecured consumer loans are quite expensive in Brazil (average personal unsecured credit was 87% in March 2021, up from a trough of 70% in September 2020 according to central bank figures).

There is considerable unlocked equity value in Brazilian housing. In 2019, the Brazilian central bank was estimating that the market for home equity loans could be as much as BRL500bn. At the end of 2020, the amount of loans in this segment was still under BRL15bn, which suggests that there is more room to grow. Traditionally, property in Brazil could only have one loan attached to it, but this has now changed, allowing for this segment to grow.

Creditas has been capitalising on (1) the fact that the larger banks, although present in this niche, have not been overly focused on it, partly because it cannibalises the much higher-margin unsecured personal credit and (2) technology that can be used to deliver the loans quickly and conveniently.

Caixa Econômica Federal (a specialised government-owned mortgage lender) is the largest lender in the home equity niche, and this is followed by Santander and Itaú, two large private banks. We estimate that Creditas has been able to build up a c 3% market share and it hopes to increase it further. Bari Bank and Banco Inter are among the smaller players that also focus on this area.

While we see this asset class growing strongly in the future, it is of course very likely that there will be some margin erosion from increased competition.

Currently Creditas’s starting lending rates advertised on the website are 10.7% (quoted as 0.085% per month; in Brazil rates are usually quoted on a monthly basis, a hangover from the old high inflation years) plus IPCA consumer inflation index (currently 6.8%) for a total rate of 17.5%. With upfront fees, the rate goes above 20%. Mortgages and home equity loans are not the same product but as a reality check we note that the average mortgage rate in Brazil is 7.9% as of March 2021 (central bank data) in the regular non-special regime market.

Creditas runs an asset-light model and it securitises its portfolio and sells it to institutional investors. The funding rate is 6.75% on top of the IPCA. We would estimate that Creditas makes about a 5–6% interest rate spread on home equity loans, which is attractive enough in our view.

However, we note that the more established banks have a funding advantage due to their retail deposits as well as superior economies of scale. Not only can these banks under-price Creditas, but they have the greater flexibility in the structuring interest rate on loans (ie not necessarily tied to the IPCA index, which some clients might not like).

In the auto loan asset backed segment, Creditas’s lending rates start at 14.7% plus fees, although it is currently doing a promotion where they start at 9.9%. However, we believe the average all-in lending rates are closer to 30%. As a reference, the average auto loan rate in Brazil was 20.6% according to the central bank in March 2021. However, as with the case of home equity loans, a loan for car purchase is not the same as a quick, convenient loan backed by your vehicle.

Exhibit 5 shows some of the available numbers from Creditas. Despite the significant headwind of the COVID-19 pandemic in 2020, revenue nearly doubled, origination rose by 69% and the loan book grew 84%. The revenue growth number in US dollars was lower (at 37% based on our calculations) because of the depreciation of Brazilian real against the US dollar during the pandemic. It is possible that some of this weakness may be regained as the pandemic ends.

In the first quarter of 2021, revenue continued to grow at a strong pace despite the pandemic still raging on in Brazil. Revenue was up 55% y-o-y and 20% q-o-q, and origination was up 57% y-o-y and 34 y-o-y.

Creditas is still gaining scale, and currently its client acquisition costs and investments lead it to still be losing money (net margin was -52% in Q121). Asset backed loans, especially when they involve a home, are not necessarily cheap to produce in Brazil, particularly with regulation and bureaucracy. We would estimate that Creditas’s client acquisitions costs are probably running as high as 15% of loans and so Creditas might need to at least triple its loan book before it becomes profitable, or cut back its investments. However, this situation is not unusual for a fintech that is ambitiously scaling up and clearly Creditas management is thinking big.

Brazilian GDP contracted by 4.1% in 2020. The latest central bank collected consensus data show 3.2% and 2.3% forecast increases for 2021 and 2022. The incredible Brazilian real devaluation was a key driver in inflation spiking. The IPCA went from 1.8% in May 2020 to 6.8% in April 2021. The central bank policy rate has increased from a record low of 1.9% in 2020 to the current 3.4%, while the 10-year bond rate has moved from 6.8% to 9.5%. The good news is that collected consensus estimates show that inflation is expected to be only 5.1% at the end of 2021 and 3.6% at the end of 2022.

While the economic outlook in Brazil is not quite as rosy as before the pandemic, structurally the business opportunity for Creditas to grow remains in place.

Rupeek is an online doorstep lender providing loans backed by gold. Although 80% of Indians have bank accounts, more than 90% of Indians do not have access to formal credit. According to the Reserve Bank of India, 95% of household savings are in some form of asset and not as bank deposits. Gold is very popular and the World Gold Council estimated that in 2019 Indian households have stocked up 25,000 tonnes of gold worth US$15tn. It estimates that the gold loan book in India is currently US$150bn.

Rupeek’s loan rates tend to be lower than pawnbrokers and the lending is more convenient. The company is growing 15% month-on-month and lends c US$800m annually according to Rupeek’s CEO. VEF’s stake purchase price valued the company at US$500m. Rupeek’s aim is to expand into other types of asset backed lending, much as Creditas has done in Brazil.

VEF has known Minu management for some time and view this relatively small investment (only US$450k) as a step in the door that might lead to more significant investments in the future. Minu is a Mexican earned wage advancement lender, much like Xerpa as we have mentioned earlier in this note. Minu is the market leader in Mexico in this segment. It charges a US$2 flat fee per transaction. It has more than 100 large companies as clients including Telefonica, Scotiabank, Rappi, Manpower and Cap Gemini. In 2020, the number of transactions increased by 18x according to VEF.

When we initiated on VEF, its NAV had tripled since its inception in July 2015 on a Swedish krona basis. Now about seven months later, Q121 NAV has quadrupled since inception. The return has been 58% over the last three years, with a 47% increase in the last 12 months. As shown in Exhibit 9, VEF share price has generally outperformed the world, emerging markets and emerging market financials indices from MSCI. Only the MSCI emerging market tech index has kept pace and outperformed VEF over the years; however, the difference is small: a 6% outperformance over the last three years and 3% over five years.

Although VEF’s share price return has generally outperformed the it has underperformed on a 6 months basis. This is because share price overshot the NAV in Q420 and then there was a share price correction and once more the share started to trade at a discount to NAV. The NAV momentum itself as aforementioned has been strong.

VEF’s significant increase in NAV was driven by the success of its first two exits, Tinkoff and Iyzico, and by its two largest current investments, Creditas and Konfio. Exhibit 6 shows VEF’s current valuations versus invested money in the various portfolio companies. VEF valuations are above the invested value in nine of its 13 investments with an average 70% book gain over investment.

Since the NAV is only released quarterly and with a lag, the discount to NAV tends to be somewhat volatile, reflecting expectations of NAV progression. In Q420, the share price at the end of the year was actually above the disclosed year-end NAV. As of 8 June it is trading at a 14% discount to Q121 NAV.

Exhibit 10 compares VEF with Augmentum, a fintech closed-end fund peer. We also show some open-ended peers even though the capital structure is different. Even when compared to Augmentum, VEF is still relatively unique. Augmentum focuses on UK and European fintech, as opposed to VEF’s emerging markets focus.

On an NAV basis, VEF has outperformed peers in our sample over five and three years and was second only to BGF FinTech E2 over the last 12 months. We note VEF’s ongoing costs are below its one closed-end peer at 0.84% and 1.55% of NAV in 2020 excluding and including incentive bonus scheme costs, respectively. In our view, the type of fintech investments that VEF pursues, which are almost akin to private equity, are more profitably (and safely) carried out using a permanent capital structure.

VEF’s current gearing is zero, unlike Augmentum, which has gearing of 91%. We note that Augmentum did recently pay a dividend and is trading at a significant premium to NAV, which might be understated (the one-year performance has been very modest).

VEF is currently trading on an FY20 NAV/revenue multiple of about 24x. This figure is pushed upwards by Creditas, which is on 27x. This may look like a high revenue multiple but the company, as mentioned, has been growing strongly to justify this type of multiple. Furthermore, we also note that the pandemic led to a steep devaluation of the Brazilian real, which lost a third of its value against the US dollar in 2020. The Russian ruble and the Mexican peso also lost significant ground. As pandemic fears subside, it is conceivable that some of this devaluation will reverse.

S&P Capital IQ and Morgan Partners estimate that the average trailing revenue multiple on developed market fintech mergers and acquisition deals in recent years was 7–9x for the data and analytics, banking technology and payments segments. VEF is trading at a premium to these ratios, but its ratios are coming down quickly as it continues to deliver on revenue growth. We estimate that the underlying revenue growth was 84% in 2019 and 62% in 2020, with the second year affected by the COVID-19 pandemic. Exhibit 11 shows VEF’s estimated portfolio NAV to sales revenue figures assuming growth of 50%, 100% and 150% pa. By 2023, under these assumptions the ratios would be 1.6x to 7.3x.

As we mentioned in our initiation, the key drivers for the valuation are delivering on growth, successful funding, value-creating new deals and profitable exit sales. The Creditas funding round in December was a recent significant success and a case in point. An IPO for Creditas would be very helpful for VEF’s valuation, since a big portion of its NAV would be listed.

Valuation transparency and risks: VEF follows private equity valuation guidelines and benchmarks against peers. However, there is still higher valuation risk than for listed, liquid assets, for which more operational information and metrics are published and accessible. The ongoing COVID-19 pandemic exacerbates these risks, although we note VEF did adjust the valuation of many of its investments. Furthermore, fintech has been attracting significant investor attention for some years and this has affected valuations.

Emerging and frontier risks: there is greater variability in both macro and political risk in emerging and frontier markets.

Competitive risks: many early and mid-stage tech companies end up disappointing investors and falling short of expectations. While growth opportunities do exist and are exciting, at the same it is a competitive market and market shares, profit margins and winning business models are in flux and subject to variation.

Corporate governance risk is higher in smaller, earlier-stage companies and particularly in emerging markets. We note that VEF mitigates this risk by often taking seats on the board of the companies it invests in.

Underlying companies may need cash: with the exception of Revo and Jumo, VEF has indicated that its companies are currently all loss-making and this tends to be common for fintech companies at this stage of growth. However, some companies may need more funding to grow. Further rounds of finance often lead to higher valuations so can be a good thing (as was the case of Creditas recently). But they can be detrimental if the prospects for a company have dimmed and investors or new cash are hard to find.

We also note that VEF’s shares trade on Nasdaq First North in Stockholm, which is a trading platform but not a fully regulated market.