Famous short selling hedge funder Jim Chanos spoke with Joe Weisenthal and Tracy Alloway on the Odd Lots podcast about gig economy and fintech companies. It’s worth a listen. Chanos has a vested interest since he’s a short seller in many of these gig economy, marketplace and fintech companies, so he’s biased. The whole “don’t ask a barber if you need a haircut” idea. But that doesn’t mean he doesn’t have something important to say.

I’ll first unpack a few of Chanos’ ideas, and then evaluate how his ideas might play out in Latin America.

Chanos Rule 1: Overearning: Companies that charge out of market fees will likely be susceptible to margin compression

Chanos likes to short companies that he views are over earning. Over-earning companies are likely to come under pressure from competitors who seek to earn those high margins that the over-earner is generating, which leads to lower margins, lower earnings and margin compression.

For example, Chanos shorted Coinbase “not because I don’t like crypto or thought crypto was going down,” but because he saw that Coinbase was charging “60x higher fees” on retail customers vs. their institutional investors. In his view, 60x the fees are not sustainable long term.

When a company is over earning, an investor has to believe one of the following to continue to underwrite these earnings:

• The company is so much more efficient/better than everyone else and that nobody will catch up and be able to compete
• Competitors won’t notice these margins/fees
• Competitors will use price fixing or informal cartels to keep margins high (which has been common in Latin America historically).

Overearning in Latin America: First an advantage for startups, now likely a risk

In Latin America, many fintechs have been beating banks because banks have been over earning. ROE for Latin American banks is generally 2-5x higher than US and European banks, and can be up to 20x higher than US banks.

Fintechs have filled the gap. Nubank is the best example, launching its original Brazilian product with up to 80% lower interest rates and 100% lower fees compared to banks.

Because banks over earn, while at the same time having huge legacy brick and mortar footprints and perks like executive dining rooms, it’s likely that fintechs can be very profitable simply by improving distribution, having lower costs by having fewer/no branches, and eating into Latin American banks’ over-earning ROEs they’ve had for the past 30+ years.

But as more fintechs compete in the market, will margin compression happen to the fintechs, just like fintechs have been doing to traditional banks? And will banks get with the program, improve services, and have slightly lower ROEs, but still be more competitive than fintechs? Which fintechs are the most exposed to these potential changes?

The neobank industry is one of the first places to look. If many of these neobanks didn’t run sustainable unit economics during a credit cycle boom, will they be able to do it now? Especially now that there’s more competition from fintechs, legacy businesses like Oxxo and traditional banks, which should bring fees/prices down.

Look at fees that Latin American startups charge users and compare them to the more competitive US. While the US market is more competitive than Latin America, US fees are likely directionally correct to where LatAm fees might end up when new competitors come into the market or decide to start competing on fees and interest rates.

In some industries, LatAm fintechs are charging 5-10x higher fees than their US competitors. Is that sustainable going forward? Or will these LatAm fintechs end up charging similar, or slightly higher fees as their US competitors?

To be clear, I’m not talking about comparing LatAm interest rates to US interest rates because of inflation, currency risks etc. I’m talking about pure commission or transaction fees. Startup fees might be lower than the banks, but are they sustainable with increased competition?

Startups that charge 5-10x what their US comparables do are likely to be under pressure from other Latin American startups that have figured out how to operate more efficiently, and the more well capitalized traditional financial institutions may smell blood and try to cut fees to try to crush startups that have been eating their lunch the past few years.

I look for the startups that are charging something that seems sustainable compared to US competitors, or startups that are charging “too much” but that could still thrive with 30-50% margin compression if over-earning stops or slows down.