Guest Interview, Giro Lino

Ex LatAm Hedge Fund Manager, with a rich expert network in the region, and author of Giro Lino

Good morning,

Today I am excited to share a discussion I had with the author of Giro Lino, a LatAm focused newsletter, authored by an Ex-HF manager with a rich expert network in the region. In today’s discussion, we discuss several sectors in the region (payments, commerce, traditional banking, macro), as well as individual companies (StoneCo STNE 0.00 , Mercadolibre MELI 0.00 , Amazon AMZN 0.00 , Sea Limited SE 0.00 , Etsy ETSY 0.00 , Elo7, NuBank). As well as diving into the nuances of investing in LatAm, which might be obtuse to most American or International investors.

I did get the pleasure to chat, at length, with Giro (pseudonym, by the way) several months ago, and have been in close contact ever since. I first reached out after having read his newsletter for some time. Today’s discussion is genuinely one of my favourites I have conducted thus far, partially because the area of focus (LatAm) is one we have not covered in great detail before at Investment Talk. But mostly, because the answers were of great quality and intrigue. I hope you enjoy this dip into the world of LatAm equity.

Conor: Hey Giro, thanks for taking the time to share some of your insight into investing in LatAm markets. Obviously, Giro Lino is a pseudonym, which you explained to me the first time we spoke over Zoom. I found it to be an interesting play on words, and was wondering if you could share the meaning behind that name for the readers and perhaps why you adopted it?

Giro Lino: Thanks for having me here. I created this Twitter account while working as a trader. As nobody was following me, I felt comfortable writing about my ideas. In Portuguese, the word violin is translated as “Violino.” So, I simply thought about a term we use in trading that someone is playing the market as a violin [buy low, sell high], or you got played in it, as a funny way to describe my profile. Also, I changed the “Vio” for “Giro,” as it translates to high stock turnover, such as a daytrader. Then, I had a picture of the Italian violinist Niccolò Paganini in my profile, which I personally appreciate. However, recently, I changed it to a corporate logo. 

It’s curious, but in Brazil, people see anon profiles as jokers or simply someone you should not rely on. Fortunately for me, I’ve got a different perspective from global investors. Like yourself and your sharp audience, global investors look much more receptive to someone who actually delivers good content. So, as people already recognize me as Giro, I’ll keep anonymous until I understand that it would be better for the business to reveal my identity.

Conor: So, we will hop into some more technical questions in just a bit. But first, you come from an institutional background, having formerly worked in the HF industry in South America. I was hoping you could provide the readers with some background as to that journey, and then maybe share with us what you are currently working on today, in Giro’s Newsletter, where you share research and commentary on LatAm stocks and macro. 

Giro Lino: Sure. So, I started my career as an entrepreneur, investing in the real estate market along with two partners. My business was buying houses in good locations, retrofitting them, and selling them after two years. We started operating in the country site, where local brokers poorly covered regions. Also, focusing on the countryside was good for us since we didn’t have much money, so we couldn’t spend a lot of our budget on just one asset. We did very well in the first couple of years, with an IRR to equity in double digits. 

Then, we decided to expand to the transportation business, where we lost money in every single transaction. It was a disaster. We operated a small fleet doing cargos for a few companies, which, theoretically, had an exciting IRR. However, we suffered an immense amount of unrecurring losses. We figured out later, but over 80% of our drivers were stealing from us, even though they didn’t know each other. So, I was a little disappointed with the business and decided to try a move to the financial industry. Eventually, I had to choose between going to a global bank and a small equity research firm growing like a weed. I decided to join the latter and work in a much smaller company. I stayed there for a couple of years, researching various companies and industries, from small to large caps and from commodity to financials. I learned a lot.

Then, I had the opportunity to move to HF, which traded only rates and FX. After six months, I became a PM focused on LatAm Equities and had a book for rates and BRL. Eventually, I had the prospect of leveraging my career by becoming a Fund Manager for another firm. Though this might seem like an obvious decision, it’s not. If you don’t have 20+ years of experience and colossal networking in the industry, it’s hard to assume you’ll get substantial seed money. So, your first two years must be a perfect track record. Otherwise, your business is dead. And that was in 2020, so not a good year to start a “perfect track record” fund. At one point, I had to decide whether I was willing to keep managing a tiny business or try something new. This was when I thought about Giro’s Newsletter. 

It was not an easy decision to make, though. I evaluated the blogging business, measured the TAM, estimated the business profitability and users' growth, and chose between writing in English or Portuguese. Also, there is a considerable risk of failure in a new venture and the risks associated with a career, so I had to go carefully over each topic. Despite all the risks, I saw a vast opportunity to write about LatAm equities as a generalist. Since nobody was offering truly high-quality content about LatAm markets, it looked like a plan. About the “nobody,” I just want to make myself clear. Nobody was writing about LatAm as we see a committed focus newsletter on Asian and US companies. 

Conor: Naturally, most investors tend to exhibit a home bias in their stock selection. Being based in Brazil, do you find that is true for you as well? And then secondly, it would be great if you could give us a synopsis of your overarching investment philosophy or style. 

Giro Lino: I believe there is a home bias for equity allocation everywhere, and I don’t think that is necessarily bad. For instance, if you only invest in the US, you’re investing in companies that perform globally. Usually, the biggest and most profitable ones. I don’t believe the US stock market thrives solely on luck. Americans are risk-takers and optimistic entrepreneurs. Combine this with capital abundance, and everyone is taking equity risk. In Brazil, on the other hand, our currency, the BRL, is more volatile than the S&P 500. So it’s hard to imagine someone investing only in Brazil to prevail. Honestly, in my opinion, if you are a Brazilian, where fixed income risk-adjusted return is superior to risk assets, why would you turn to it?

About my investment style, I’m a devoted value investor.  We talked about it before, but, in my conception, investing is not a science but a craft, and a craftsman needs tools. In the case of investing, the tools are primarily mental. So if we accumulate a few simple mental tools, we can start evaluating the claims of experts, salesmen, or simply well-intentioned management teams. The quantitative approach to investments isn’t complex. The most challenging aspect of investing is to not fall into the temptation of buying or selling assets as the crowd moves. I’ve never found an investment philosophy so focused on mental models as Value Investing is, though the quantitative approach is straightforward: the value of an asset depends entirely on the net cash it will generate from now to the hereafter.

Conor: Having read your work, you cover a considerable amount of macro as well as individual equity research. I guess this will be a two-part question, beginning with, what mistakes do you see most often with international investors conducting research into LatAm stocks, whether it be assumptions (or ignorance) regarding the macro/micro environment or some other variable? Moreover, what do you feel are some of the common misconceptions about investing in LatAm?

Giro Lino: In my opinion, the biggest misconception I often see is that it’s safer to invest in LatAm than in China. I’m not commenting about China, but LatAm is one of the most hostile regions in the world if you’re an entrepreneur. Yeah, we have the governments changing rules that are critical for companies every day, predatorial competition in several industries, and an extraordinarily volatile macroeconomic environment. For instance, barely one year ago, the Brazilian Federal Rates (“Selic”) was at 2%. Now it’s at 12.75% and heading to 14%. Also, it shouldn’t be like this. Still, it’s regular to see an FX devaluation of 30%-50% in LatAm (Chile, Argentina, Venezuela, Brazil, etc). 

Many value investors believe that the macro environment is unimportant because they’re invested in the US, where the country has been under stable political and monetary circumstances for more than a century. In LatAm, whether you consider inflation and rates, or you get lucky. It’s hard to think of another way to thrive in the region. Trying to make this statement more tangible, I couldn’t give you ten names of equity funds over 20 years old in Brazil. We don’t have many survivors.

Conor: And then the second part of that question, you are present in the region, and you also have your own expert network over there too. For most UK or US investors, we can tangibly see the businesses we invest in around us. A Square card reader, a Starbucks store, a Chipotle, or perhaps an intangibly present business-like Google or Facebook. I see a lot of these investors hold great conviction in names like StoneCo, or Mercado Libre, which is fine, but they don’t have the first-hand experience of how these businesses function in their domestic markets. Ears to the ground, as they say. 

Do you think that matters? I would love to hear you riff on that for a little bit, providing examples if possible. 

Giro Lino: That’s a good question. For US businesses, it’s much easier to become an investor. In Brazil, for example, we have a presence from companies such as Starbucks, Google, Facebook, and Microsoft. So, I agree that it is easier for me to invest in this company than for you to invest in MercadoLibre. However, my criteria for investing are the same for any company. First, I have to understand the assets that the company owns. Or how aggressive is the management in its accountant reports?  

Second, how good is management extracting value from those assets? The objective is to find businesses delivering returns above their cost of capital. Always. I’d rather pay expensively for a great business than cheap for a crappy company run by poor management. Third, is it possible to generate additional value by reinvesting the cash generated from operations back into the business? Those are hard questions to answer. For instance, it took me almost four years to invest in MercadoLibre. 

I didn’t have the knowledge to understand the business. I had to read tons of books, talk to industry experts, and, more importantly, think. I’d never buy a company based on multiples just because everybody is. For instance, it’s nearly impossible to differentiate a good and a bad company in times of abundance if they grow at the same rate. But, then, if you’re a long-term investor, you’ve gotta be really confident to deploy capital if the stock goes down. So, I see myself in the position to follow just a few companies but to understand them relatively well. Since I don’t believe in advice that I don’t follow, I’ll share what I do to invest in US and Asian companies. Let’s take Amazon, for example. For years, I held a 0.5%-1.0% position while holding a considerable position on Meli. 

I received pushback from partners for holding a meaningless position in a foreign company. However, personally, I only study companies that I own. So, quarter after quarter, I went through earnings calls, re-read 10Ks, and figured out the differences between Amazon’s marketplace and Meli’s. Finally, after a couple of years, the market presented an opportunity to increase my position this year. That didn’t happen in a week, though. For me, the process of buying stocks is steady and slow. In my opinion, the risk of reinvesting your capital after selling a stock is underestimated. Every time you decide to sell, you’re taking two risks, one associated with interrupting the compounding process and the other with investing in a loser. Buying slowly helps me to mitigate this risk.

Finally, diversifying globally is excellent for learning about different operating engines, corporate cultures, customer behaviour, etc. I highly recommend doing so, even if it’s just to increase your knowledge about a specific company you’re invested in.

Conor: Sticking to that theme, and with commerce and payments, two thematics you write quite frequently about. Could you possibly give us a rundown of how the LatAm (or Brazilian if you prefer) commerce and payments industries differ from, say, the US? I recall you wrote a great multi-part paper on the PIX payment system in Brazil. 

Giro Lino: It’s pretty funny, but as a portfolio manager in Brazil, you spend most of your time writing about incumbent banks and commodity companies, such as Petrobras and Vale, because they represent roughly 67% of the Brazilian Stock Exchange. So, even though I held a few of those companies before, I started writing about them only after my first post about Stone in November of 2021.

But about your question, I believe that competition in LatAm is extreme. Of course, that doesn’t mean that you don’t have competition in the US. Still, to thrive in LatAm, you have to beat inflation, poverty, and regulatory constraints imposed by governments. The eCommerce in LatAm is a good example of this. One consequence of a tight regulatory environment and tough macroeconomic conditions is the lack of innovation. So, except as it happened in Brazil, where the Brazilian Central Bank created an opportunity with Pix or lowering the regulatory burden for new financial institutions, it’s hard to innovate.

In the early 2000s, you could find big companies in the US selling online, so trust was not a problem if you bought your item from one of the big boys. However, in LatAm, we had retail populating the marketplaces as sellers, so it was not uncommon to buy anything and receive a brick instead. Seriously, a brick. It happened to me twice. So, Meli's first idea was to create a forum where people could talk to each other about their experiences and relate any problem. It was a collaborative space. Then, Meli came up with their feedback tool, a huge milestone. Now, all the information was organized, and rating a seller was straightforward. Finally, in 2004, Meli came up with the final solution for reliability, creating MercadoPago.

If customers were sceptical about buying and negotiating the payment process with an online seller, MercadoPago standardized the payment process internally. So, clients would have to trust Meli, not the seller. For instance, the seller receives the payment only after the buyer receives the order. If there is any problem, the buyer could open a dispute with Meli as the intermediary to get his money back. Nobody would predict that Pago would become bigger than the marketplace itself. Still, they’ve been practising and preaching innovation since ground zero. In my opinion, LatAm companies have an innovative DNA.

Conor: We have seen some American firms struggle to penetrate the LatAm market when it comes to commerce and payments. Etsy, navigated the issue by acquiring Elo7 in Brazil, as an example. Sea Limited, a notable exception from the South East of Asia, has had relative success, but what do you feel limits American companies from making their dent without having to acquire businesses?

Giro Lino: It’s interesting that you mentioned Elo7. I met with Carlos, the company founder, a couple of times before Etsy bought them. He’s another example of corporate culture turned to innovation. He understood the problem with this business in Brazil was not finding buyers but enough sellers. More critically, how to train this seller to send the package. It’s been years since we talked, but I remember one example he gave me the last time we talked. Elo7’s biggest problem was the seller giving up the sale after someone purchased the item. Though it sounds weird for Americans or British people, it’s completely okay in Brazil. After selling the item, the person realized he/she had to go to the post office to send the item, so they just gave up a few sales when they didn’t want to go there. 

Carlos and the team had to put a tremendous amount of effort into figuring out how to make the sellers’ life easier, so buyers could receive their purchases. I don’t have details about the transaction between Etsy and Elo7, but I bet it was something related to it. How the heck Etsy’s executives would figure this out, or at least understand what is happening if they could not think as locals. Even though this one sounds like an obvious deal, the process is complex, and in most cases, it fails. I believe we jump back to the same problem with multiple analyses: issues are not apparent during abundance. Integration issues, such as lower synergies in G&A, system failures after integrations, and a few others are usually in most cases. So, I look at M&A with sceptical eyes.

Unless you cannot develop that competence in-house, M&A probably isn’t a good fit for the company. In my opinion, SEA believes the Asian playbook fits in LatAm, so they don’t need to buy anyone. Particularly, after the 1Q22, I wrote about its monetization, and I truly believe they anticipated almost a year in this last quarter, so it looks like they’re right, for now. Also, SEA has very competent management. On May 2nd Sea Limited was granted a license to operate as a payment institution in Brazil by the Brazilian Central Bank. So they’re probably looking to replicate the SeaMoney strategy in Brazil. I know that Mr Forrest, Sea’s CEO, asked for authorization to join the payment company as a partner in November of 2021, indicating that SeaMoney should be operational in 2H22, though they could launch it only in the 1H23.

Then, again, we go back to execution and corporate culture. SEA launched its payment company in Brazil in 2020, so I bet they’ve been planning it since 2019. They used several payment service providers in the past couple of years, so I bet they’ve been learning how to adapt their product bundle for LatAm. They’re smart. 

Conor: The last one on payments now, I promise. StoneCo, the Brazilian payments business, perhaps known as being a holding of Berkshire, was quite popular during the hullabaloo of 2020, reaching heights of $93 per share. Naturally, as that excess and greed faded, so too did the share price, but there was more than fading excitement causing the stock to tumble. It would appear there were considerable fundamental factors at play too. 

You wrote a great piece back in November titled “what happened to Stone’s share price” where you outlined to readers what had gone on. Could you perhaps outline the conclusions of that report, and perhaps share any insights as to how things have progressed from November to today?

Giro Lino: Sure. That was the first time I wrote about a payment company. One of the primary reasons I did that was because I knew the sell-side (foreigners mainly) and retail investors were wrong, and I could help explain why. For years, investors paid 40x price to earnings multiple for Stone since the company delivery earnings, revenue grew, and all the bull market bla bla bla. Putting it under context, since its IPO, Stone went through a long tailwind period of lower than expected inflation and an easing cycle in Brazil – a dream scenario for acquiring companies. As a result, margin expanded, and revenue grew faster than anticipated. For investors, everything was running smoothly.

However, there were clear signs of inflationary pressure, and rates would go up. So I explained why fundamentals had changed and that investors should not rely anymore on historical multiples. Also, I flagged that the credit portfolio would prove tougher than management communicated to the market. Looking forward, about the stock, everything got crashed, so obviously it is cheap. About its fundamentals, Stone’s chairman returned to the company, and it looks like they’re focused on the core business, which is good. Nevertheless, we must not allocate capital based on stock prices but rather on value as capital allocators. So, for instance, unlike Stone, I believe Nubank and MercadoLibre generated more value to shareholders than expected. Meanwhile, Stone destroyed a lot of value, so the odds of owning Nu or Meli instead of Stone look better.

Conor: Besides subscribing to your own newsletter, which I would highly recommend to reads as a side note, what would you suggest to an investor that wishes to get deeper into the trenches in LatAm equities? Where can they start, what are some great resources?

Giro Lino: One of the reasons I decided to go full-time on the blog of the lack of content about companies in LatAm. There is a huge language barrier. For instance, I wish you luck learning about payment companies in Brazil using the Brazilian Central Bank website. But unfortunately, all the technical studies are Portuguese-only. Because I do that myself, I recommend reading the 10-Ks and looking for reference shareholders. Sometimes, they write letters to investors, probably containing cool information that you’d have difficulty looking for.

However, if you’re looking to understand more about a specific industry, such as Pix in Brazil, let me know if you find content such as mine because I truly never found it. I’m not trying to sound cocky, but you’d have difficulties finding this sort of granularity even if you were a Portuguese speaker. I read all the regulatory frameworks for the industry participants and talked to a bunch. I’m looking forward to writing more posts on different industries, such as Pix. 

Conor: Are there any particular sectors, trends, or things to watch out for, that excite you most about the LatAm markets? It could be an industry, a company, a macro trend, or anything that tickles your pickle?

Giro Lino: Well, it depends. I’ll stick to Brazilian companies listed in the US, the big boys. In that case, I enjoy it very much MercadoLibre, and, more recently, almost tripled my position in Nubank. I did it after discussing for hours with a few funds shorting the stock. It’s always fun talking to people who are short a company you’re long. Talking to someone who is also buying the stock makes it hard to come up with new ideas. Most short sellers are arguing the company is expensive under a price-to-earnings and price-to-book valuation and that management compensation is too high. I’ll write a post explaining why management compensation is not high, so I’ll not give you a spoiler.

I strongly recommend investors study Tinkoff, a Russian bank of which I’m a shareholder. There is a huge misunderstanding about Nubank's credit card operation. All investors I’ve ever met believe that Nubank doesn’t make money on the credit card. Nevertheless, it’s a negative working capital operation with a cheap funding cost. It’s very profitable if you draw a simple cash flow. Then, its accountability standard is different from incumbent banks. Nubank has to front-load the recognition of credit loss provisioning whenever a loan is booked. So, the faster Nubank grows the credit book, the more short-term pressure it brings to our gross profit margin. Nobody considers that.

Finally, Nubank isn’t just a beautiful app that never (ever) crashes, unlike its “neobank” peers. Ask any developer his/her opinion about Cognitect, a company that Nubank bought, though nobody really saw it. It’s a company whose founders created a programming language called Closure. In my opinion, it is unquestionably the best programming language for scaling an operation dependent on immutable data, minimizing friction and fraud risk. It’s a perfect fit for a financial institution. And if you ask me why isn’t everyone else doing this, because it’s hard. Freaking hard. Imagine that you’re gathering data from different sources in different formats. If you’re a traditional bank or fake neobank, it’s fine. You can live with that. However, suppose you pretend to implement Closure and create your own scalable bureau. In that case, you’ll have to reprocess all that data and “allocate” them in the right places. Man… except if you’re tech focus company, you’re not doing that. 

Conor: Before we conclude, what are you hoping to do with Giro Lino, are there 1,2,5 year goals you are aiming towards?

Giro Lino: Perhaps I’ll disappoint you here, but I don’t work with goals. Goals don’t work for me. Instead, I think about improving different processes.  So, I clustered my mind between communication, operations, writing (research), and reading. So, the biggest improvement expected for the 2H22 is related to communication and research. By the way, I’d like to thank you for the invaluable help you’ve been providing me. Only God, and you, know how many A/B tests I did in the past months, quantifying messages. So, improving communication would be great. I usually blame my ADHD, but my social skill is nearly zero. So, I spend 35% of my time working on communication. I expect to finally streamline a few processes in the 2H22 and save 5-10% of my time. 

About the research, there is a lot to improve. I see a lot of quality gaps I’m persistently working to fulfil, and the coverage number is too limited. I’m estimating the biggest improvement in the 2H22 will be Excel interactive models and, at least, double the coverage companies.

Conor: Lastly, where can readers find you and your work, and do you have any concluding items you’d like to say?

Giro Lino: I’d like to thank you for inviting me here today. It’s always great to engage in this sort of conversation. People can find me on Twitter (@giro_lino) and in my blog (giro.substack.com), in which I often write about many topics, not only LatAm Companies. 

Conor,

Author of Investment Talk