Tech stocks: invest in Latin America’s digital revolution
A region that was once an innovation desert is changing rapidly. Billions of dollars of venture capital funding and the impact of the pandemic are creating new tech giants. James McKeigue reports.
Covid-19 battered Latin America – it killed more people and caused deeper recessions than in any other region. Yet the massive disruption also forced people to solve centuries-old regional economic challenges. This is accelerating a nascent digital revolution that will eventually save more lives and drive more economic growth than was lost in the pandemic.
I first tipped Latin America’s tech sector back in August 2012, when I highlighted Mercado Libre, the region’s leading ecommerce platform. If you bought in then, congratulations, as the stock is up more than 1,100% in the last decade. But don’t worry if you missed out, because Latin America’s digital revolution is only just beginning. The region only saw its first unicorn – the name given to private tech start-ups worth more than $1bn – in 2017. Now those mythical beasts are a lot less rare, with 34 in the region today.
Latin America attracted more tech funding than similar-sized Southeast Asia last year and almost the same amount as the much larger Indian market. Venture capitalists are pouring billions into the region’s start-up companies, but a wave of tech listings on the New York Stock Exchange and Nasdaq means that private investors can also play the story.
Perfect conditions for a tech revolution
For a long time, Latin America was an innovation desert. A barren, bureaucratic, venture capital-starved landscape with few successful tech start-ups. Most international investors focused on the region’s incredible commodity resources and assumed that Latin America’s poor education, weak internet coverage and excessive bureaucracy would make serious tech innovation impossible.
In fact, the opposite is true. The terrible quality of local services makes the region a fertile ground for start-ups with good solutions. I live in Ecuador and I pay far more for my children’s education and hospital visits than I did in the UK. The local banks, which are among the most profitable in the world, are very expensive and offer limited services. Public transport consists of a few fume-emitting second-hand buses. Please don’t take this as a criticism of Ecuador – I love the place – but it helps explain why apps that offer people better mobility, banking, health and education services will do well.
Unfortunately, Ecuador is typical of the region. World Economic Forum analysis shows that Latin America has the worst-quality infrastructure of anywhere in the world outside of sub-Saharan Africa. Public education is shocking, with 50% of 15-year-olds unable to read properly. Even before the pandemic, health systems in many Latin American countries were at the point of collapse. As for the financial system, a World Bank study showed that nearly half of the region’s entire population did not have access to banking services even before the pandemic.
But being a bundle of needs isn’t enough on its own to foster tech innovation. Latin America also had several positive factors in its favour. Demographics play a crucial role in the region’s tech boom. The middle-class population expanded from 33 million households in 2008 to 46 million households in 2018. People are increasingly moving to cities. Latin America is the world’s most urbanised region: 260 million people – approximately 40% of the total population – currently live in the 200 largest cities and generate 60% of the region’s GDP. Meanwhile, internet usage in Latin America has exploded, reaching 450 million people in 2019 from just 200 million in 2010, making it the world’s fastest-growing internet population. Not only do Latin Americans have access to the internet, but they’re also taking full advantage of it. The region’s social-media use is higher than any other in the world, and almost double the North American average. Rising purchasing power, coupled with increasingly widespread internet access, makes people more willing to purchase products and services through new
However, a lack of venture capital meant Latin America was slow to find tech solutions to its long-standing problems. The region is dominated by family-owned firms, whose main aim is to preserve capital in a volatile political environment, not back exciting tech ventures. That gradually started to change a few years ago – venture investment into the region doubled every year from 2016 to 2019, according to analysts at the Latin American Venture Capital Association. Then in 2019 SoftBank, the Japanese tech conglomerate, announced a $5bn Latin America-focused tech fund. That helped Latin America attract $4bn of venture-capital tech funding in 2020. Meanwhile, a host of companies have successfully listed on the tech-focused Nasdaq stock exchange in the US providing another way for the sector to attract international capital.
How the pandemic changed everything
All of those developments were positive, but the pandemic was the gamechanger. In 2021, venture-backed companies raised $14.8bn across 772 deals in Latin America, according to PitchBook data. That’s more than the total tech capital invested in the region over the previous six years.
A lot of the focus is on financial technology (fintech), which makes sense when you consider that Latin American banks have higher profit margins than anywhere else in the world. Nubank, the Brazilian digital bank, listed on Nasdaq in December with a market value of $41bn. There are eight other venture capital-backed fintechs valued at over $500m, according to PitchBook, with a collective value of $11.6bn. Yet around 60% of the venture capital raised last year was for non-fintech companies.
That’s because the pandemic created a massive increase in demand for health, e-commerce, mobility and education services in Latin America. The region implemented some of the world’s longest and severe lockdowns and these restrictions pushed people into finding tech solutions. In Guayaquil, the bustling Pacific-coast port city where I live, you can’t drink the tap water. Before the pandemic it was easy to get drinking water delivered by motorbike, but when the pandemic hit the deliveries stopped as the drivers didn’t want to handle cash. I had to queue for hours at the shop and walk back – we weren’t allowed to use our cars – carrying my household’s water supply. Then I discovered an app that let me pay digitally and have the water left outside my house. That small experience was repeated across the region. “When you look at the metrics for e-commerce penetration, what was achieved in the last 18 months probably would have taken several years organically,” Nicolás Szekasy, co-founder of Kaszek Ventures, one of Latin America’s largest venture capital firms, told the Financial Times recently.
No wonder the shares of my old Latin American e-commerce favourite, Mercado Libre, rose to more than $2,000 during the peak of the pandemic (as with a lot of tech stocks, investors got a bit carried away – it has since halved again). Stats from Mastercard also capture the pandemic’s impact on tech. The need to avoid cash and make digital payments pushed 40 million Latin Americans to open a bank account for the first time between May and September 2020.
Education was also ravaged by the pandemic. Many state-school children in Ecuador have not had a lesson in person since March 2020. That colossal policy error is repeated across the region, which inflicted longer school closures on children than any other region. “Nowhere else in the world are so many children currently left without face-to-face schooling,” said Jean Gough, the head of United Nations Children’s Fund (Unicef) in Latin America and the Caribbean, last year. “This is the worst education crisis Latin America and the Caribbean has ever faced in its modern history.” Even when schools do reopen – in Ecuador the holidays mean that will not be until May 2022 – there will be a massive education deficit to make up. Educational technology (edtech) companies can help with that.
The region’s failing health systems are another obvious target for tech solutions. Barring some positive outliers – such as Costa Rica, Uruguay and Cuba – the region’s health systems are inefficient and underfunded. The Latin American average for health spending is less than 4% of GDP compared with 8% in Europe. Health tech can help in two ways. The first is that historically weak states mean that Latin American public services rarely reach remote rural areas. Technology offers a way for competent doctors to conduct virtual consulations with patients in isolated communities. The second is that by bringing down costs, technology allows poorer Latin Americans to receive a health service that isn’t available in the public system and is too expensive in traditional private hospitals. A great example is Dr. Consulta, a venture capital-backed network of low-cost clinics, which is now the biggest private medical service provider in Brazil. It started out as a bricks-and-mortar clinic in a favela in 2011, but now complements its physical locations with a digital practice.
Political risks are overstated
I run LatAm Investor, the UK’s only Latin America-focused investment magazine, and that experience has taught me just how hard it is to persuade British people to invest in what many still see as a risky region. That task is no doubt made even harder when you are dealing with start-ups. And to be fair, there are certainly some risks worth highlighting – most obviously politics. Latin America’s coups and caudillos have always captured the imagination and in Venezuela, Nicaragua and Bolivia we still have plenty of present-day examples. But in the last 20 years, democracy has strengthened across most of Latin America in a way that is not fully recognised.
“Being a LatAm-focused investor for more than 20 years, I am often reminded by clients of the political volatility in the continent, which makes the region less attractive to investments compared with Asia, and specifically, China,” says Alfredo Mordezki of Santander Asset Management. “The latest crackdown on Chinese private-education companies and the wiping out of $70bn of market cap from Jack Ma’s companies should make investors think about the difference between stability and the rule of law. Institutions are hard to build, it takes a long time to make them resilient to tyrants and history shows that even the US may show some cracks over time. The landscape has become globally a lot more uncertain, but still democracies, even weak ones, have in place institutions that make arbitrary decisions harder to implement.”
Indeed, Latin American governments may actually help tech investors. That’s because the pandemic has forced many bureaucrats in the region to update antiquated processes – which typically involved queuing up to get documents stamped – that were impractical during the pandemic. On a recent trip to Panama, Carlos Urriola, the chief executive of a large local port, Manzanillo International Terminal, told me how Covid-19 has forced the government to streamline paperwork. “The government has digitalised processes at a much faster rate than its predecessors because it was forced to by the pandemic,” he says.
A long-term opportunity
Rising interest rates are perhaps the biggest threat to these tech companies, as is true with high-flying growth stocks everywhere. The appeal of buying into tech firms that dangle the carrot of big earnings ten years down the line may dwindle when interest rates rise. As safer assets such as US Treasuries start to offer higher yields, that will inevitably have an impact on stockmarket valuations. Some of this is already playing out in the market: many of the recently listed Latin American tech companies have fallen below their debut price.
However, good companies with solid earning potential will do well over the next decade regardless of current market jitters. For example, Mercado Libre survived the dotcom bust to become Latin America’s most valuable company. Indeed, the fact that tech firms are currently out of favour makes this a good time to buy into a great long-term story, as Julio Vasconcellos, co-founder of Atlantico, a Latin American venture capital fund, argues in the Financial Times. He notes that Latin America’s total tech market capitalisation stands at 3.4% of GDP, compared with 30% in China and 14% in India. If Latin America were to get to China’s level, then “we’re talking about the equivalent of over a trillion dollars of market value being created”, he says. Below, we look at the best ways to play this trillion-dollar investment opportunity.
The new wave of tech leaders
For many years, Mercado Libre (Nasdaq: MELI) was the main way to invest in a Latin American tech success story. It has been highly successful, taking around 30% of the Latin American e-commerce market, and the valuation reflects that. It trades on a price/earnings (p/e) ratio of 650, falling to 120 based on forecast earnings. However, a wave of initial public offerings (IPOs) in the last couple of years has given us a much wider choice. Most are high-growth prospects and are priced accordingly
Arco Platform (Nasdaq: ARCE) is a Brazilian online-learning provider. It serves more than 1.3 million children across 5,000 private schools in Brazil and provides live sessions, pre-recorded classes, teacher training and game-like educational programmes for students. Demand for its services rocketed in the pandemic, when many schools in Brazil struggled with the tech demands of providing virtual learning. Pupils in Brazil are now back at school, but the educational deficit means demand for edtech solutions will remain strong. The shares are on a p/e ratio of around 38 times forecast earnings.
Vasta Platform (Nasdaq: VSTA) and Vitru (Nasdaq: VTRU) are also based in Brazil. Vasta is similar to Arco, but about half the size. Vitru is a higher-education provider that focuses on small and medium-sized Brazilian cities. They are on forecast p/es of 135 and 43.5 respectively.
Afya (Nasdaq: AFYA) is a Brazilian firm that combines both education and heath technology. It is the largest private medical school chain in the country and offers digital training for doctors at all stages of their career. The pandemic put health at the forefront of Latin American politics; while some industries may fear the likely election of left-wing populist Luiz Inácio Lula da Silva in the presidential poll later this year, he is not going to cut health budgets. The shares are down by around 50% from the pandemic high and trade on a p/e of 29 and a forward p/e of 11.
Globant (NYSE: GLOB) was originally set up by four tech workers made redundant in Argentina’s 2001 economic crisis. It provides software solutions for large corporations, mainly in the US and UK – one of its first big clients was Google. It has dropped 26% since its pandemic high and now trades on a p/e ratio of 121, falling to 63 on forecast earnings.
E-commerce only accounts for 20% of retail in Latin America, compared with 50% in the US, but is expected to grow strongly over the next decade. Zenvia (Nasdaq: ZENV) is a nuts-and-bolts way to play this theme. This Brazilian firm helps businesses track their customers online and to communicate with them through chatbots, text messages and similar channels. As more of the region’s retailers invest in their online offering, they will need Zenvia’s solutions. The company is active in Brazil, Mexico and Argentina, giving it good regional exposure. It trades on 26.5 times forecast earnings. VTex (NYSE: VTEX) operates an e-commerce platform used by 2,500 online market places in 32 countries. Its direct corporate clients include Sony, Coca-Cola and Walmart. Growth is rapid, but analysts project that it will remain loss-making next year.