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Blogger. Voracious reader, workaholic. Former HF Manager.


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$MELI increase shipping for sellers
$MELI announced a new pricing policy for free shipping from July onwards and increased the free shipping for CPG from R$79 to R$200. In Apr, I highlighted that $MELI would increase monetization for its commerce biz.

Also, the company announced a significant increase in heavy items, such as fridges, TVs, and so on. Personally, I believe the company is on the right path to achieving substantial operational leverage.
Fuck yeah! Long runway baby! I am starting a position!

Any thoughts on their credit business? what do you think about the short term problems and the long term prospects?
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You Heard This Lie Before
=========================
### The Biggest Myth Related to Competitive Advantages

"Long-term consistency trumps short-term intensity."
Bruce Lee

To read the entire post, access our blog.

This quote embodies what many fail to realize, that being a successful and high-achieving person results from the consistent effort. Success is a marathon, not a sprint.

One of the most important, though undervalued, aspects of evaluating performance is the environment.

I think one of the reasons the environment is so powerful is that it communicates with your subconscious and has a conversation that you’re not privy to in your conscious mind.

This may sound ridiculous, but if I’m trying not to eat potato chips and I see them, it’s easy for me to eat them.

And so, nudging your physical environment can shape your behavior because it’s having a conversation with your unconscious self.

For instance, especially in the new year, we have these desires to set goals and achieve these huge goals and change our lives, work out more, start a new relationship, and travel to different places.

And we have to overhaul everything. Now, that takes a lot of energy. That takes a lot of attention.

And when you set out to do that, the moment you achieve something like that, you also sign up for the process that’s going to get you there.

You also sign up for the effort that will get you there. And what happens to many people who try to make these enormous overhauls of time and energy and introduce challenging habits.

And I think it is often misunderstood because people over-index its importance. And what I mean by that is they overestimate how important confidence is.

I have learned from talking to professional investors how many lack confidence. Considering their career, it’s something really awkward to hear.

If you ask them how they succeeded for years, they’ll tell you that they don’t care about how they feel. Instead, they focus on their actions.

Confidence is often misplaced. Instead of being placed on the ability to bounce back, to learn from failure, its belief is based on something that might not be there when it needs it.

In the market, we go across similar experiences a lot of times. For example, have you ever got in a position/trade extremely overconfident and ended up losing money?

On the other hand, have you ever got in a position/trade where you didn't feel comfortable but ended up making a lot of money? That's happened to all of us. Confidence isn't an accurate predictor of success.

### It’s all about it
I think the primary thing is that in any organization, the whole premise of organizational life is that together you can do more than you can do in isolation, but that only works if people are connected.

It only really works if they trust each other and help each other. But unfortunately, that isn’t automatic and requires effort from leadership.

I mean, obviously, it’s imperative who you hire. So the signals you send to them and the kinds of behaviors you want are really important.

I think that having kind of critical people who appreciate generosity is a business characteristic for thriving companies.

It’s not something you just save for out-of-work time. I think that’s a really fundamental yet rare characteristic to find in different businesses.

Suppose you really believe that the value of collaboration lies in the aggregation or compounding of talent and creativity.

In that case, you have to have an environment where people are really prepared to help each other.

People are only really going to be prepared to help each other if they feel they will be supported when needed. If you think that, not egregiously, but respectably, you might get some credit for your contribution because people don’t like to feel invisible quite widely. Stanley Milgram wrote about this brilliantly.

He talked about how when we go into an organization, our moral focus shifts from wanting to be a good person to a good job, and we implicitly assume that doing a good job is doing what we’re told.
The person you work with is not identical to the person you are at home, which is probably not entirely consonant with the person you are on the golf course or the gym.

Identities are not as absolute and fixed as we used to imagine, so we have to be very alert to how we change in different environments and pay attention to what we leave behind and what gets amplified.

Organizations are much more complex than a single human being. Dealing with people from different cultures, economic backgrounds, gender, and so on is challenging.

### Reduce Friction
After years on the road, interacting with different organizations, you figure that most companies are equally competent, though just a few thrive.

For Company A, even though they deliver good results, the management relies on complex and dizzy internal processes to make decisions. Company A just can’t keep track of what they need to do.

Meanwhile, Company B shows up knowing what they need to do, and they simply execute. Moreover, they deliver without any complex internal processes, which is excellent!

From Company A’s perspective, even though they’re competent, they see themselves in the position of not taking “reckless” and “hurry up” decisions.

From Company B’s perspective, they’re equally competent and wondered why investors compare them to Company A, as it was a close peer.

From investors’ perspective, they’re both valuable and competent firms, but not equally valuable. Company A is much more valuable.

This is interesting because it's a "what to add?" situation. Many employees believe the secret to gauging a career is delivering more value to the company.

This is not true. A substantial value could be collected using your boss's perspective, such as reducing friction.

You don’t need to learn any new skills for this; you have to shift your perspective to your boss’s point of view and see how hard it is for them to get you to do something.

Then, like in nature, which removes mistakes to progress, you can draw things to survive and thrive.

Think about it this way. The C-level management has a limited unit of energy throughout the day to accomplish something.

Suppose your internal process spends much more on delivering execution due to constraining internal processes.

In that case, it’ll always be significantly less than a company with streamlined internal processes, despite their diligence in executing the strategy.

When we think of improving our value to an organization, we often think about the skills we need to develop, the jobs we should take, or the growing responsibility.

But, in so doing, we miss the most obvious method: reducing friction.

### The first-entrant bullshit…
In the classic about corporate strategy, most start-ups advocate a competitive advantage being the first entrant and gaining scale faster than competitors.

To continue reading the post for free, access our blog.
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The Narrative's Power
To read the entire post, access our blog.

As we commented on Twitter on Saturday, we’re releasing a new post about Stone, its valuation process, and how each engine affects the overall picture.

So far, between updates, and deep dives, we have written twelve posts about the company, totaling over 180 pages in content.

Even though we’re proud of creating that amount of content in such a short time, we haven’t had such much about our thoughts on how to evaluate our writing.

Regardless of how careful we’re researching and reading someone else’s write-up, we might be charmed by a good storyteller, although we theoretically know how to shield our minds.

If you have been following us since our inception, you probably noticed that we are left-brainers (logical). More recently, we’ve been developing a new set of skills for storytelling.

For that, we see ourselves in the position of helping investors and equity research analysts to develop a set of soft skills when reading someone else’s writings.

We Are Irrational
We inevitably have to deal with various individuals who stir up trouble and make our lives difficult throughout our lives.

They can be aggressive or passive-aggressive, but they are generally masters at playing on our emotions. They often appear charming and refreshingly confident, brimming with ideas and enthusiasm.

Only when it’s too late, do we discover that their confidence is irrational and their ideas ill-conceived.

What inevitably happens in these situations is that we are caught off guard, not expecting such behavior. Often this type will hit us with elaborate cover stories to justify their actors or blame handy scapegoats.

We might protest or become confused and drawn into a drama they control. We might protest or become angry, but we feel somewhat helpless in the end — the damage is done.

We catch ourselves falling into self-destructive behavior patterns that we cannot seem to control in these situations.

If we really understood the roots of human behavior, it would be much harder for the more destructive types to continually get away with their actions. We would not be charmed and easily misled.

But why? What if we could see the source of our more troubling emotions and why they drive our behavior, often against our wishes?

Understanding that stranger within us would help us realize that it’s not a stranger at all but a very much a part of ourselves.

And with that awareness, we would be able to break the negative patterns in our lives, stop making excuses for ourselves, and gain better control of what we do and what happens to us.

Having a clear understanding of ourselves and others could change our lives. But first, we must clear up a common misconception: we believe ourselves as rational.

Look at greed, for instance. We usually identify a specific excuse or a group as the cause of this emotion. But if we were honest with ourselves, we would see that what triggers our greed has deeper roots.

We can discern the patterns if we look — when this or that happens, we get greedy. But at the moment, in getting greedy, we are not reflective or rational — we merely ride the emotion and take unnecessary risks.

Nevertheless, we like to imagine ourselves in control of the situation, planning the course of our investments as best as we can. But we are largely unaware of how emotions drive us.

To continue reading the post for free, access our blog.
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"Having a clear understanding of ourselves and others could change our lives. But first, we must clear up a common misconception: we believe ourselves as rational." <- THIS!. Thank you for this post. Love behavioral economics and constantly learning about why we do the things we do
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Clash of Titans (AWS vs. Azure)
Hi. Every week, I post a couple of my Daily Posts on Commonstock.

In the early days of the cloud IaaS (Infrastructure as a Service) market, customers ran workloads that consumed compute and storage resources with few constraints and little visibility into usage and costs.

As a result, many customers experienced bill shock. In response, the cloud companies introduced options such as i) reserved instances, ii) advancements in more powerful chip sets (read Graviton), and iii) more efficient storage.

The implication is that data platforms that position for the long-term budget opportunity can capture huge gains. At the same time, those who don’t strike the right balance will yield inferior returns with subdued investments.

In the 4Q21, Snowflake announced that hardware and software improvements would yield more efficient consumption of their data warehouse service resulting in a near-term headwind to revenue.

On one side, we saw service providers arguing the right approach to maximize long-term growth would be doing the contrary. Personally, we disagree.

We believe the companies are looking for products, such as analytics, data management, and monitoring services.

Since we believe the IT spending for companies will remain unchanged, penetration should increase better than expected. For companies such as Snowflake, if they genuinely own pricing power, this should result in better profitability.

It isn't clear who the winner is for cloud providers, such as AWS, GCP, and Azure. However, the discussion prevails that AWS or Azure should rank number one.

Again, we disagree. We believe each has its nuances, offering different solutions for customers. But, all in all, we believe both could co-exist.

So, in today’s post, we bring light to the discussion regarding public cloud service providers and the industry.

We explore the concepts behind IaaS and PaaS (Platform as a Service), moving to Azure’s architecture, limitations, and a brief comparison to AWS.

Brief Overview
IaaS and PaaS are the most popular types of cloud service offerings. IaaS is on-demand access to cloud-hosted virtual and physical servers, networking, and storage, while the backend infrastructure tun the applications and workloads.

> IaaS customers use the hardware via an internet connection and pay for that use on a subscription or pay-as-you-go basis.

> Typically IaaS customers can choose between virtual machines (VMs) hosted on shared physical hardware (the cloud service provider manages virtualization) or bare metal servers on dedicated (unshared) physical hardware.

PaaS, or platform as a service, is on-demand access to a complete, ready-to-use, cloud-hosted platform for developing, running, maintaining, and managing applications.

There is a misunderstanding that services are exclusionary. However, IaaS and PaaS are not mutually exclusive. Most SMEs and enterprises use them both.

'As a service' refers to how IT assets are consumed in these offerings and the essential difference between cloud computing and traditional IT.

In traditional IT, an organization consumes IT assets by purchasing them, installing, managing, and maintaining them in its own on-premises data center – without mentioning the expenses related to the IT team.

In cloud computing, the cloud service provider owns, manages, and maintains the assets; the customer consumes them via an Internet connection and pays for them on a subscription or pay-as-you-go basis.

So the chief advantage of IaaS, PaaS, or any 'as a service' solution is economic: A customer can access and scale the IT capabilities for a predictable cost, without the expense and overhead of purchasing and maintaining everything on its own data center.

But there are additional advantages specific to each of these solutions. Before breaking it down, we illustrate in the image below which steps of the process are managed by the service provider:

Research Amazon using Stratosphere

The Right Customer
Even though the PaaS and IaaS solutions offer similar solutions, a few nuances make each the right choice for specific industries.

For instance, perhaps, the most obvious usage for IaaS is deploying a disaster recovery solution to the cloud provider, which is easier to manage and cheaper.

Also, IaaS is an excellent option for clients looking for event processing, such as IoT, AI, eCommerce operations, and many others that don’t require real-time data processing.
Service providers make it a lot easier to set up data storage and computing resources for these applications that work with a massive volume of data.

Finally, the flexibility of increasing capacity and scaling up during high demand periods without losing service level is a huge advantage.

On the other hand, with its built-in frameworks, PaaS makes it easier for teams to develop, run, manage and secure APIs for sharing data and functionality between applications.

For clients relying on real-time data processing, PaaS is the place to go since its solutions support cloud-native development technologies, such as Kubernetes, that enable developers to build once, then deploy and manage consistently.

Azure VM Architecture
As mentioned, Azure began as an IaaS company, then it added PaaS solutions, so it’s essential to understand why, in our opinion, start-ups and larger customers than require a real-time data-processing end up picking AWS instead.

The easiest way to do that is by going through Azure’s VM instances, which the company offers two services, the subscription (which Azure calls spot VMs) and the pay-as-you-use.

Azure lets you buy spare capacity at a lower price—up to 90% less than the pay-as-you-go market price. However, once Azure needs this excess capacity back, your spot instances will be terminated, with an advance warning of only 30 seconds.

Using this Azure pricing model for mission-critical and production workloads can be challenging.

Because of their unreliable nature, spot instances are typically used for stateless applications, batch processing, or development and testing scenarios, where it is acceptable to have an application instance fail.

It is possible to use spot instances on Azure for stateful and mission-critical applications, but this requires careful management and automated cloud optimization tools.

Spot instances are a very compelling pricing option on Azure. The obvious pro of spot instances is their low price, which may be discounted at 90% of pay-as-you-go rates.
Also, you could run a spot instance to improve reliability for a specific service, which is a considerable advantage, especially for enterprises.

For instance, if you own a complex eCommerce operation, you could run a couple of pay-as-you-go VMs to guarantee the baseline capacity and add a spot instance for helping in a peak capacity situation, such as during Black Fridays.

However, spot VMs have a few limitations. For instance, Spot VMs don’t provide availability guarantees, and after a VM is evicted, it’s not automatically turned back on, then capacity is available, limiting reliability.


Limitations
If you read our previous topic about AWS, you’re probably connecting the dots on how Azure is inferior to AWS for PaaS.

Microsoft focused on creating powerful VMs, alongside storage services for its products, then the microservice functions in Azure, which led to several changes in the infrastructure.

So, even though Microsoft has all the technology, the scalability and the architecture of the AWS platform are excellent.

In our opinion, that’s why AWS is superior. Microsoft did it backward, presenting challenges around scalability and reliability.

We’re not saying that Azure is not a good solution. We’ve never heard it. However, it is a usual complaint with certain limitations and restrictions in the service, resulting in some trust issues for a few clients.

The complexity of implementing and running microservices on Azure is enormous. Except if you’re an enterprise, it’s hard for you to do so.

AWS, on the other hand, every start-up uses its service. So the answer is always easy to use, scalable, and reliable.

Distribution is Key
We believe that Microsoft distribution is one of its powerful, though underestimated, competitive advantages — or it was for many.

Even though most clients don’t realize it, there is a vast network effect in their products, and once you’re in, it’s almost impossible to get out.

Think that you’re a regular client, owning a complex SAP, looking at which cloud provider provides that exact specification for their SAP environment in terms of actual memory configuration.

That would be a good fit for them and at a reasonable price point. They'll take AWS over Azure or vice versa, depending on what they have on-premise and the workflow they’ll allocate on each.

We frequently heard that the cloud is about pricing, though I’ve never heard it from anyone who used it. Indeed, price is a huge factor, but it’s more complicated than pricing.

If you’re an enterprise and somehow end up moving to Office 365, I bet you’d migrate to Azure. They’ll offer a bunch of services nobody else could match because it’s Microsoft.

So, in 2020, many enterprises began migrating to the cloud, leaving their legacy data center. Since it could take years to migrate an entire operation, Azure has gained market share in the past years.

Sharing Scale
We gathered information with tech vendors. Since they all expressed the same opinion, we believe it may be how the market is configured.

Today, there are vendors focused on two different models: tech-first companies and those focused on enterprise IT.

In almost 90% of the competitive process, AWS wins tech-first clients, such as Twilio, Datadog, Twitch, ESPN, Netflix, etc.

On the other hand, Azure wins more than 50% of the dispute versus AWS and peers for having a considerable penetration of enterprise.

For us, it’s a consensus that AWS is the preferred solution for tech companies, while Azure is for enterprises. However, that doesn’t mean that one will thrive and the other will fall.

Also, as happened in the past couple of years, we believe that Azure and Amazon could boost their efficiency, pass through prices, and maintain high profitability on reinvested capital.

Even though we heard that would harm margins, several industries proved the benefits of sharing economies of scale with clients.

For instance, in 2021, Microsoft announced a useful life extension for its equipment, extending depreciation from 5 years to 6.7 years.

Even though that could be translated into a 13% gross margin gain for the specific year, we believe the company shared scale with clients, a practice we expect to continue in the following years.

Research Amazon using Stratosphere


Apples-to-apples
Bag a pardon, my readers, for I’ll switch to the first person again. Since the idea is to present a few calculations, objective sentences and images should work better.

Fine, I told you the qualitative differences between AWS and Azure so far. However, I recognize it’s essential to explore the quantitative stance a little more.

That was challenging since Microsoft is stricter in presenting Azure’s operational figures, so I had to figure out how to solve a few puzzles.

First, figuring out gross margin is the easiest. You can estimate it by calculating the gross dollar, then the gross margin dollar contribution.

Research Amazon using Stratosphere
The second is the SG&A. I must confess I didn’t consider the SBC. It became too complex. Then I had the idea of comparing the number of employees.

It doesn’t work. I believe Azure requires much fewer engineers than AWS, and the sales effort could overlay with different segments.

I did the following: go back to 2014, when Azure was nothing, consider that SG&A as ground zero, and deflate the forward SG&A to see the growth in expenses in real terms.

Then, attribute Azure accordingly to its contribution to the gross dollar margin. Then, add back the CPI. Why deflating first, then adding back inflation?

Not deflating the SG&A, I may, unnecessarily punish Azure if Microsoft’s SG&A grows below inflation. Even though that only happened twice in the past eight years, I would be transferring SG&A from a different segment.

Then, voilà: operational margin.

Research Amazon using Stratosphere
Going forward, I see an SG&A as a percentage of revenue flat, with efficiency gain boosting margins.

However, you cannot compare this margin to AWS’s. This is because the capital need for each business is different, and depreciation is a factor that must be considered.

For instance, in 2020, AWS reported a substantial benefit from increasing useful life, which hit its earnings, and, in 2021, an increase in the useful life of its equipment from four to five years
.
Personally, I believe they are overdepreciating their assets, suppressing o good chunk of profits. However, since they indicated an acceleration in AWS’ Capex, it will be hard to identify this in 2022, though we’re using 5.9 years in my cash flow.

Meanwhile, Microsoft is tougher. The company reported a five-year depreciation but recently reported a new “improvement”. I checked with people related to the industry and got a range between 6.2 and 6.7.

With those adjustments in the depreciation in mind, I set a 21% tax rate for both to maintain comparability. So then, this is what I got.

Research Amazon using Stratosphere
So, both companies present a ROIIC above 20%. That tells me that both are doing extraordinarily fine regardless of how much people yell that competition is increasing.
Let’s move on… We have a curious table ahead.

Even though I hate using tables, this one is interesting. I estimate the PP&E for Azure and AWS. AWS is helpful. There aren’t many personal inputs.

Azure is a problem. I applied a similar methodology to what I used for the SG&A to be consistent. The depreciation was tricky, though. I had to build a waterfall depreciation, considering changes in depreciation policy in 2021.

Research Amazon using Stratosphere
Yeah, when I finished Azure’s table, I instantly remembered AWS’. So I thought, “wow, that remembers AWS… wtf…”. Interesting, right?

Since AWS revenue is twice Azure’s, we may conclude that Azure’s business is more capital intensive than AWS’. So if both have similar operating margins, though Azure is more capital intensive, then AWS’ ROIC is superior.

The million-dollar question is, why? I’m not gonna lie; I haven’t found academic papers, experts, or comments in the transcript giving a hint.

However, I have a theory to share. I believe that PaaS is a business with higher barriers to entry, while IaaS is more capital intensive, considering storage and network investments.

This is a very logical theory, even though I can’t prove it because I don’t have the exact breakdown between IaaS and PaaS.

Finally, I was personally excited about writing this post. I had no idea what I would find, even though I knew it would be interesting. I hope to keep investigating and bringing more exciting content to my readers.

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Brazil May Wrap-Up
Hi. Every week, I post a couple of my Daily Posts on Commonstock.

Strong May

After a weak performance in April, the Brazilian Stock Exchange (“Ibovespa,” “Ibov”) was back in positive territory in May (up 3.2% in BRL and 7.8% in USD), remaining one of the top-performing equities.

Considering Ibovespa’s relative performance in the year, mainly to local peers in LatAm, we checked the market consensus and evaluated what was priced.

First, though, we’re over the 1Q22 earnings season, which is particularly strong for LatAm. Nevertheless, we highlight that most countries did well due to local currency performance, not local economic performance.

Earnings Season

1Q22 earnings season in LatAm was strong despite the disparity versus consensus estimates: 38% of companies beat the consensus(historical avg. is 27%) while 29% missed (vs. historical avg of 31%).

The net income expanded by 70% YoY in USD with robust numbers led by Brazil, Mexico, and Colombia, boosted by FX gains, while sales and Ebitda increased by 25% YoY.

Good numbers were supported by higher commodity prices. This season's highlights were Energy and Telecom, beating estimates by 64%, while Tech, Healthcare, Discretionary, and Staples missed by 50%.

We saw a clear reflection of this strong earnings season, coupled with currency appreciation, on consensus earnings expectation which stood at +18% for LatAm (from +10%) and increased significantly for Brazil at +16% (from +7%) due to stronger than expected currency performance.

Despite several companies reporting below consensus expectations, local currency performance leads to upward earnings revisions in the region.

In Brazil, 41% of companies beat and 37% missed consensus numbers. Ebitda for energy jumped by 56%, and materials fell by 19%. Only discretionary saw a contraction in net income YoY.

Despite the upward revisions, operational performance in local currency has weakened in relevant industries, such as retail and banks, leading us to believe that currency was the only upside surprise in the season.

Net Flow Equity Funds

Local equity funds suffered a sequential month of redemption, leading to forced selling in stocks with lower liquidity amidst a market with low liquidity and sequential sell-offs in specific names.

Put yourself in the context. In Brazil, you could buy a bond issued by a top-tier bank, such as Bradesco, paying 15% p.a. in local currency. The risk-adjusted return for fixed income products is superior, so why bother holding the equity?

Even though stocks may look cheap, we need to consider the greater context. We have populist candidates running for elections in Brazil, surging public spending, and a global crisis on our hands.


Context is Important

At a glance, Ibovespa looks like the cheapest exchange in the world, trading today at 112k, with the sell-side estimating a YE Target of 140k, implying a juicy 25% upside.

Looking at multiples, the Ibovespa is negotiating at 6.9x price to earnings for the next twelve months, a 2-st deviation below the 10yr average, which sounds like a screaming buy opportunity.

However, in our opinion, investors should consider the context:
  1. 33% of the Brazilian Exchange is composed of commodities companies, trading at contracted multiples due to higher commodity prices;

  1. Looking forward, the sell-side expects a contraction in earnings growth, assuming earnings normalization;

  1. Brazil is going through tough elections in 2022 that could change the entire space in the subsequent four years;

  1. By the end of May, real long-term rates in Brazil were trading at 5.7% versus a yield barely above 0% in the US, suggesting that something isn’t right.

Even though we understand the thesis that Brazil is partially shielded against a monetary tightening in the US, and a challenging geopolitical environment, for being a commodity exporter, that is partly true.

The above statement would be entirely accurate if Brazil was a rich country. However, Brazilians are eating less year after year, creating a fragile social condition to be dealt with.

For instance, from 2011 to 2018, the expenditure on food per capita dropped from US$3.4k to almost US$400 per year. In the same period, the household income collapsed from US$13.2k to US$9.2k.

Also, this is not useful only for Brazil. Most emerging countries face the same situation, with expenditure on food as a high percentage of household income.


That Matter

A reasonable question would be: why does it matter? The answer also explains the current valuation. As flagged in the previous section, real long-term rates in Brazil are at 5.7%.

First, Brazil is a populist country. Politicians are always waiting for their time to urge miraculous, though impossible, solutions and to blame someone for that.

Second, Brazil lived with higher than expected inflation in the past decade. So because public spending is misallocated and the productivity deteriorates year after year, we have a country with low growth and higher inflation.

Consequently, investors require a higher premium for financing the public treasury. So, do not believe that rates in Brazil are a non-brainer because the country exports commodities.

We’re not sure if the 2006 supercycle should happen again. But unfortunately, former President (and inmate) Lula wasted Brazil's most significant opportunity to increase public spending, create new companies, and subsidize companies that approved his government.

So, Brazil not only spent a relevant stake from the surplus, but also the poverty, corruption, and bureaucracy worsened during the period.

Perhaps, a new commodity cycle gives more oxygen to the Brazilian economy, though its effect should not last long.


Skeptical on Valuation

In our view, LT real interest rates at 5.7% imply significant political and fiscal risks. As most economists have advocated, there is room for improvement in the LT real rates.

That would take someone to win elections and commit to fiscal discipline. So naturally, falling LT interest rates are the critical trigger for stock prices in Brazil.

We constantly ask ourselves “why”. So, it's no different when we go over the sell-side consensus estimating almost 30% upside for the leading stock market in 2022.

Their pitch sounds good, but the math is entirely wrong. First, according to most sell-side analysts bull in Brazilian equities, the stocks look cheap, so we agree with them.

Second, they use a historical price-to-earnings chart with a 10-year average to demonstrate their point. This is a huge bias, but we could overwatch this.

Third, they imply a return to average, supporting their view that the market expects a 15%-20% ROE for the Ibovespa in 2022, trading below the 10x price to earnings multiple, so it’s cheap. This analysis is wrong.

They’re perpetuating a 20% ROE in a commodity peak cycle, which is stupid. Sorry, but that’s the word. This is ridiculously aggressive.

### How to Value the Ibovespa?

In our opinion, the conservative approach to evaluating the Ibovespa is not considering a re-rating. This is important because we do not know who will win the elections this year.

As mentioned, we do not take sides in politics. Instead, we examine the evidence, giving our best assessment of the situation. So, no comments about election odds or anything like that.

In the sell-side modeling, they are considering real rates 270bps below where it stands today. This is aggressive.

So, we built a comprehensive model for the Ibovespa, valuing only dividends and not considering multiple expansions, reaching 115k for the next twelve months.

We also estimated a few scenarios:
No re-rating
  1. Bear (95k): commodities rally is over in 2022, and Brazil replicates historical growth and inflation figures;

  1. Base (115k): the image above;

  1. Bull (126k): commodity still rallying in 2023 and partially in 2024, with a higher long-term ROE and payout.

Considering re(de)-rating
  1. Bear (117k): The same scenario, considering 200bps compression in real rates;

  1. Base (140k): The same scenario, considering 250bps compression in real rates;

  1. Bull (167k): The same scenario, considering 250bps compression in real rates;

Why not shorting Ibovespa? Easy. Check our bear case, considering the re-rating. Even though we’re pessimistic on fundamentals, we lose if the market gets optimistic for any reason.

If you’re shorting the Exchange in local currency, there is a 0.5:1 skew in this trade, which doesn’t sound good. However, we’ll likely sell coverage calls for our positions if the market goes up.

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Added heavy on $NU
After talking to a few local funds shorting $NU (billions under management) and hearing their bear pitch, know I'm convinced they are wrong. They don't understand the accountant differences that $NU has versus incumbent banks and how to read its balance sheet.

I tripled my stake on $NU throughout the week and still have more capital to deploy if needed.
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AWS is Unstoppable
Followed by my first post on Amazon, the discussion about Amazon extended from the eCommerce to the cloud business.
It was personally shocking to see people mocking AWS on Twitter. After years of following companies and talking to industries expert, AWS is one of the very few genuinely admired in the industry.
Regardless of the stock price, the business performance it’s admirable, especially considering how large the company already is.
So, I decided to write this post to explain why I believe that AWS enjoys a long-term sustainable competitive advantage versus its primary peer, Azure.
A fundamental characteristic is its architecture, making AWS a unique player in the PaaS industry. I hope you enjoy the reading.

### AWS, Azure, GCP?

When it comes to selecting which cloud service provider your company will hire, you’ll probably go for all of them.

Most companies and enterprises are multicloud, to begin with. Definitely two, and actually, quite a number of them are using all the big three: AWS, Azure, and Google.

However, there is a misconception about how the client switch between platforms. It doesn’t happen like this: “wow, today I’m going for Azure because we used AWS yesterday.” Usually, when your workflow is in the cloud, it stays there.

The companies' decision depends on the workflow they have to deal with. So, going forward, we’ll avoid mentioning GCP.

Some customers decide to go to GCP for their marketing analytics because GCP tends to have more developed, mature solutions for analyzing data from a marketing perspective.

Of course, they got the whole Google Ads and all those services. Some customers are already leveraging that. So, therefore, they'll move their entire marketing workload to Google.

Therefore, we see GCP as a way of strengthening Google’s dominant position in the Ads market, not necessarily competing against Azure or AWS.

Both Microsoft and Amazon have their own Ads manager platform. Even though they’re inferior to Google in many senses, processing the campaign data in a different cloud provider could jeopardize the company’s dominance.

### Clash of Titans
Except if the company is processing analytics related to marketing when they first make that move to the cloud, that's when they decide whether it's AWS or Azure.

Then, in our opinion, we have to sort of clients: enterprise, others. So let’s go over an enterprise in this topic. In some cases, they have complex SAP, then they'll look at which cloud provider provides that exact specification for their SAP environment in terms of actual memory configuration.

That would be a good fit for them and at a reasonable price point. They'll take AWS over Azure or vice versa, depending on what they have on-premise and the workflow they’ll allocate on each.

We frequently heard that the cloud is about pricing, though I’ve never heard it from anyone who used it. Indeed, price is a huge factor, but it’s more complicated than pricing.

Several variables influence which service provider you’ll go for. For instance, who the customer is, who are their clients, and their size as an enterprise?

Size is an underestimated factor. If the client uses an SAP, it is usually very sticky with various workloads. In the majority of our interviews, the interviewee laughed when we asked about how hard it was to move to a different cloud service provider after you’re settled.

So, yeah… Sticky to clients. Of course, if AWS or Azure is willing to give a substantial discount, the CTO will have a considerable challenge ahead.

Also, we noticed a parallel in enterprise clients with existing Microsoft .NET shops. It may sound like a legacy (and it is), but many enterprises are using it. Check out this link if you’re curious.

If you’re from Azure’s sales team and had access to that info — which you certainly did —it’s time to book a new client. Follow us…

If you’re running a .NET shop, your enterprise has a big chance to have a huge Windows 2008 installed somewhere there, even though you should have migrated a decade ago.

If you’re Microsoft, is there a better way of squeezing the client by telling him that you’re cutting his Windows 2008 support unless he picks up Azure?

Even though AWS may win the whole process, the enterprise will have some commitment to Azure and share the spending.

So, instead of going all-in AWS, let’s spend an amount on Azure and then move to AWS. This makes Microsoft a beast selling to enterprise clients and differentiating itself from AWS.

### So, Why AWS?
As we mentioned previously, considering its applications, Azure is focused on enterprise, and also because of its sales effort.

There are two general uses of clouds. One is what's it's called infrastructure as a service (“IaaS”), which Microsoft is an exceptional player.

That's more where the focus is on basically setting up VMs in the cloud-like storage. There are a few types of VMs, such as compute-focused, network-focus, and memory-focus.

So, if the solution is IaaS-based, it's more along those lines of typical storage, computing, and networking. That was more significant earlier on.

Nowadays, the trend is to leverage PaaS, a platform as a service. This makes the environment more cloud-native and cost-effective if they take advantage of the cloud provider's PaaS services.

That’s the winner model. You could have microservices functions in the case of Azure and Kubernetes. Then, you have the whole container movement where they want to break down an application to various components.

Initially, Microsoft decided to launch Azure Cloud, then came to infrastructure later. They went with the many services, and then they changed the infrastructure much later.

Microsoft focused on creating powerful VMs, alongside storage services for its products, then the microservice functions in Azure, which led to several changes in the infrastructure.

So, even though Microsoft has all the technology, the scalability and the architecture of the AWS platform are excellent.

In our opinion, that’s why AWS is superior. Microsoft did it backward! That’s why they have some challenges around scalability and reliability.

We’re not saying that Azure is not a good solution. We’ve never heard it. However, it is a usual complaint with certain limitations and restrictions in the service, resulting in some trust issues for a few clients.

AWS, on the other hand, every start-up uses its service. So the answer is always easy to use, scalable, and reliable.

The company started with the end goal of becoming a PaaS business, not just an infrastructure provider. Believe this is a brilliant and unique perspective that just a company like Amazon could possibly have.

Let’s remember that AWS was born to support the marketplace, creating microservices to improve Amazon’s business.

So, from ground zero, AWS was built as a microservice platform to solve the issues that a business such as Amazon had – this is possibly the best sandbox ever.

In our opinion, this advantage cannot be replicated. For instance, once Microsoft has spent over $60bn creating and allocating its clients in Azure, they cannot simply create a new one and plug their clients there.

So, we see AWS positioned in a privileged position in the competitive landscape, and considering the industry size, it’ll generate a high yield of durable returns for decades.

### Competition Isn’t a Problem, Yet
We bet there are thousands of ways to analyze the competition in a specific market. But, in our opinion, one of the most simple though effective ways is through a ROIIC analysis.

You can notice there is an incremental “I” in this ROIC. It’s right. The Return on Incremental Invested Capital is calculated by the Nopat generated by a specific growth Capex.

We define Capex as the properties expensed the depreciation plus the net working capital for the operation.

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So, AWS is yielding an incremental 25% return on all the capital reinvested in operation, ranking as one of the few companies at that size capable of doing so.

This is a strong indication that AWS enjoys one, or more, relevant competitive advantages, agreeing with the fundamental points we disclosed before.

Also, many investors are focused on reported sales and missing the big picture on AWS. Look at the sales backlog. There is an overestimated mismatch between backlog and actual sales that doesn’t matter for a business such as AWS.

Backlogs show information on goods that have been sold but cannot be invoiced yet, and, therefore, is an excellent leading indicator for sales.

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The industry has barely entered a competitive mode. Seriously, barely. Most companies are presenting growth Capex inferior to depreciation, yielding high ROIIC, which is a sign of no/low, competitive pressure or business exhaustion.

However, we believe that companies are being overly cautious, making all the fine-tuning needed before a higher Capex cycle. In our view, Amazon will debut the next leg up in the cloud industry.

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Finally, even though we recognize and critique the company ourselves, we must distinguish what noise and information. AWS is an outstanding business with unique competitive advantages.

Going forward 10 years, we have serious difficulties imagining a scenario where AWS will not be thriving.
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Earnings Preview $STNE 1Q22
With Stone’s earnings approaching, we decided to share our earnings preview for Stone’s 1Q22. Okay, so what you should be looking for in the earnings release?

Revenue, costs, operating expenses? None of those. Exactly, none. Earnings will be strong. Management has been looking for sell-side proactively, so this is obvious.

Instead, I’ll look for more information on the repricing strategy, take rate outlook, competition in the SMB segment, revamped credit business, and software initiatives.

Regarding pricing policy, my channel checks suggest that Stone is automating the process. I’d love to see management commenting about it.

It’s been annoying receiving most of my information through channel checks, not from the company itself. I understand that the company is going through a lot, and lately has been tough to create streamlined communication.

However, it’s not fair for smaller shareholders to receive news about the operation only after it was implemented. So the management has to choose between letting everyone know or nobody.

Usually, I leave industry channel check commentaries just for the premium section. Nevertheless, I’ll open an exception before talking about the numbers, given the lack of information.

The company said it will adjust prices as interest rates fluctuate going forward to maintain healthy spreads. However, price changes will not occur too frequently to avoid customer friction.

According to sources from marketing and Stone’s hub, the pricing strategy varies by segment. In the core hubs, competitors are setting the prices, with nobody undercutting — at least in high competitive spots.

Meanwhile, at TON, Stone launched a new product called Ultra TON, offering prices indexed to the Selic rate, and it counts for most of the recent sales.

Because of the cost structure, TON repricing doesn’t generate much churn because its CAC is really low, so pricing is competitive.

Repricing that began in 4Q21 and continued through 1Q22 is expected to result in somewhat elevated churn for 1Q22, as we anticipated previously.

We’ll update our readers about its credit strategy on the weekend, which we believe it’ll be back to being operational very soon.

Stone will present stronger than expected revenue growth. However, don’t get excited about it because there is evidence pointing out this quarter would be an outlier.

In the 1Q22, card transaction volumes grew 35.9% YoY, almost 100% above the previous years, meaning that Stone will present a more robust quarter, regardless of execution.

We expect that Stone will return to old habits, executing a solid quarter in the core business, regardless of the secondary companies, such as software.

For the 1Q22, we estimate a 153bps market share gain due to more substantial than expected TPV growth and printing a turning point versus the previous years, and because the 1Q21 was especially weak.

We believe that our revenue is optimistic versus the sell-side consensus. While the analysts expect sales from US$391 to US$423 in the quarter, we have US$425 due to higher than anticipated TPV growth.

However, we foresee a higher than expected headwind from financial expenses, as many market participants still do not estimate it appropriately.

Many analysts use a % of TPV for estimating their respective financial expenses, which is okay if rates don’t change much over time. That’s not true for Brazil, though.

Also, we’re curious about Stone’s D&A. Unline consensus, we expected higher than expected D&A due to investment in POS machines, although the consensus doesn’t consider it. It may pose an upside risk to our numbers, though.

Finally, we summarize our expectations in the table below. Again, we believe that the market will welcome Stone’s earnings if they come as expected.
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