As of now, MELI represents only a small portion of my portfolio and given the recent price decrease, I spent some time going through the recent 10Q to better understand the company’s financials in order to assess increasing my allocation. I think that in the long term, MELI will do quite well for the following reasons:
- E-Commerce in South America is way behind the US and will grow a lot over time. US E-Commerce has a long runway of growth, but South America is further behind and has an even longer runway. I expect this growth to accelerate as people start to recognize the convenience of buying online as we have here in the US. I know shipping in Brazil is a pain and if MELI has solved this problem, then I can see Brazil’s revenue growing a lot.
- The success of PayPal in the US shows that MercadoPago is a huge opportunity. Having a credit card is not as beneficial for Brazilians as it is for Americans. In the US, I enjoy getting 4% back on gas purchases, 3% on restaurants, 5% on Amazon and 2% for all other purchases. In Brazil, consumers do not seem to get these cash back perks and often have to pay a fee just to have a credit card. As such, many people do not use credit cards, so MercadoPago would allow users not to deal with credit cards and use MercadoPago directly. MercadoPago also allows for making money on loans, which is another growth opportunity.
- Brazil’s economy has been weak and their political situation is terrible with the last President being impeached, but things are likely to improve over time. Brazil has always had a high level of corruption, but the fact that politicians are being publically implicated and prosecuted shows that it is no longer being swept under the rug. It will take time, but the fact that all this corruption is coming out publically shows that Brazil is heading in the right direction and their economy will benefit.
After going through the 10Q (http://investor.mercadolibre.com/node/10926/html), here are my notes and questions:
The following shows the 3 month Revenue (R), Gross Costs (C), Direct Contribution (N) and Contribution % (N%) by segment:
Argentina – R = 88M, C = 50M, N = 38M, N% = 43%
Brazil – R = 180M, C = 120M, N = 60M, N% = 33%
Mexico – R = 20M, C = 43M, N = -23M, N% = -112%
Venezuela – R = 14M, C = 8M, N = 6M, N% = 40%
Other R = 14M, C = 13M, N = 1M, N% = 9%
Total R = 317M, C = 234M, N = 83M, N% = 26%
Given that Chile’s economy is pretty big ($247B GDP) at about half the size of Argentina ($546B GDP), I am curious why their revenues are so small. In fact, we don’t even know their revenues as they are part of the sub-group that makes up the Other segment (Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Panama, Honduras, Nicaragua, Salvador, Bolivia, Guatemala, Paraguay, Peru, Portugal, Uruguay and USA) and in total this is only $14M in revenue compared to $88M in revenue for Argentina. For those curious about the US piece, it is only made up of real estate classifieds in the State of Florida). I know MELI is an Argentine company (and will benefit from the recent election: https://www.reuters.com/article/us-argentina-election/macris…), but Chile revenues are still really small.
I also noticed that they have a lot of goodwill costs related to smaller revenue segments as follows:
Total Goodwill - $119M:
Argentina – 7M
Brazil – 30M
Mexico – 42M
Venezuela – 7M
Chile – 27M
Other - 5M
Even though Mexico only makes up 6% of the revenue, 35% of the goodwill is related to Mexico. Chile represents 23% of total goodwill, but their revenues aren’t even big enough to break out into its own segment. Goodwill comes from acquisitions where the company pays a price higher than book value, which means that MELI purchased companies in Mexico and Chile that were quite a bit higher than book value. Hopefully, this means that we will see faster growth in these two countries.
There has been discussion about how MELI is doing well in Mexico despite Amazon entering the Mexico market and competing with MELI. Although Mexico revenues are up 119% over prior year, their costs up 365%! I wonder if part of this is the price to compete with AMZN. Here is the explanation of the increase in Mexico costs, which makes it sound like it is mostly related to MercadoPago:
For the three-month period ended June 30, 2017 as compared to the same period in 2016, direct costs increased by 365.2%, mainly driven by: i) a 489.4% increase in sales and marketing expenses, mainly due to increases in online and offline marketing expenses and chargebacks from credit cards due to increase in our MercadoPago volume; ii) a 414.2% increase in cost of net revenues, mainly attributable to an increase in collection fees due to higher MercadoPago penetration, customer support costs and shipping costs; and iii) a 60.2% increase in general and administrative expenses. These increases were partially offset by a 0.6% decrease in product and technology development expenses, mainly attributable to depreciation and amortization and salaries and wages.
Considering the opportunity of digital payments, I wanted to learn more about the size of MercadoPago’s revenue. For Q2, revenue consisted of $196.7M for Marketplace and $119.8M for Non-Marketplace, which includes, among other things, Ad Sales, Classified Fees, Payment Fees, Shipping Fees and other ancillary services. Of the $119.8M, $75M is for Payment Fees, which is up from $50.6M in the prior year.
This is how the company makes money on MercadoPago:
- commissions representing a percentage of the payment volume processed that are charged to sellers in connection with off Marketplace-platform transactions;
-commissions from additional fees we charge when a buyer elects to pay in installments through our MercadoPago platform, for transactions that occur either on or off our Marketplace platform;
-commissions from additional fees we charge when our sellers elect to withdraw cash;
-interest, cash advances and fees from customers and merchant credits granted under our MercadoCredito solution; and
-revenues from the sale of mobile points of sale products.
-Although we also process payments on the Marketplace, we do not charge sellers an added commission for this service, as it is already included in the Marketplace final value fee we charge.
I am not sure if the $75M in payment fees is all related to MercadoPago given that they don’t make commissions when it is used for Marketplace transactions. If the $75M is mostly generated by non-Marketplace MercadoPago transactions, then that makes me pretty optimistic. Obviously, they could make much more by charging for its use on Marketplace, but that value is being given to customers to provide a better Marketplace experience, which should help to increase Marketplace sales.
Obviously, we know gross margins took a big hit this quarter mostly related to adding free shipping. Here is more detail from the 10Q:
During the past years, our business has experienced decreasing gross profit margins, as defined by total net revenues minus total cost of net revenues, as a percentage of net revenues.
Our gross profit margins were 57.7% and 64.0% for the six-month periods ended June 30, 2017 and 2016, respectively. For the three-month periods ended June 30, 2017 and 2016, our gross profit margins were 54.2% and 63.3%, respectively. The decrease in our gross profit margins resulted primarily from:
Higher penetration of our payments and shipping solution into our Argentine, Brazilian and Mexican marketplaces. For the six and three-month period ended June 30, 2017, total volume of payments on our marketplace represented 79.7% and 80.9% of our total GMV (excluding motor vehicles, vessels, aircraft and real estate), respectively; as compared to 62.0% and 66.6% for the six and three-month period ended June 30, 2016. Additionally, for the six and three-month period ended June 30, 2017, the total number of items shipped through our shipping solution represented 52.9% and 54.3% of our total number of successful items sold, respectively; as compared to 45.8% and 46.6% for the six and three-month period ended June 30, 2016. Transactions that include such services intrinsically incur incremental costs such as collection fees, which result in lower gross profit margins. In addition, our financing and shipping revenues are disclosed net of third party provider costs while sales taxes are paid on the gross amount of revenues, thus, decreasing our gross profit margins in terms of revenues. For the six-month period ended June 30, 2017, collection fees and sales taxes increased $40.5 million and $19.2 million, respectively, as compared to the same period in 2016. For the three-month period ended June 30, 2017, collection fees and sales taxes increased $19.1 million and $7.8 million, respectively, as compared to the same period in 2016.
Increased customer support costs of $10.5 million and $5.0 for the six and three-month periods ended June 30, 2017, as compared with the same period in 2016; mainly as a consequence of an increase in salaries and wages. The number of employees related to customer support was 1,957 as of June 30, 2017 as compared with 1,557 as of June 30, 2016.
Increased hosting costs of $6.4 million and $4.0 million for the six and three-month period ended June 30, 2017, as compared with the same period in 2016.
Increased costs of providing free shipping in Mexico and Brazil of $36.9 million and $32.6 million for the six and three-month period ended June 30, 2017, as compared with the same period in 2016.
In the future, gross profit margins could decline if the penetration of our payment solution and shipping grows faster than our marketplace or if free shipping volume increase.
Here is more detail on the revenue growth in the largest segments:
Marketplace revenues in Brazil increased 105.5% in the three-month period ended June 30, 2017 as compared to the same period in 2016. The increase was primarily a consequence of a 48.8% increase in local currency volume, a 26.4% increase in our take rate and a 9.2% average appreciation of local currency. Non-Marketplace revenues grew 41.0%, a $20.0 million increase, during the same period, mainly driven by: i) a 74.4% increase in the volume of payments transactions; and ii) a 50.6% increase in ad sales volume.
Marketplace revenues of our Argentine segment increased 24.3% in the three-month period ended June 30, 2017 as compared to the same period in 2016. The increase was primarily a consequence of a 14.7% increase in local currency volume and a 19.9% increase in our take rate, partially offset by a 9.5% average devaluation of the local currency. Non-Marketplace revenues grew 39.0% in the three-month period ended June 30, 2017, a $10.1 million increase, during the same period, mainly driven by: i) a 37.0% increase in the volume of payments transactions; ii) a 20.1% increase in the volume of shipped items; and iii) a 24.7% increase in classifieds volume.
Marketplace revenues of our Mexican segment increased by approximately 118.6% in the three-month period ended June 30, 2017, as compared to the same period in 2016, mainly due to a 52.7% increase in local currency volume and a 46.8% increase in our take rate, partially offset by an average local currency devaluation of 2.5%. Non-Marketplace revenues increased 19.4% in the three-month period ended June 30, 2017, or $0.9 million during the same period, mainly driven by increases in the volume of payment transactions and shipped items, partially offset by a decrease in our classified fees.
I am curious about the increase in “take rate” as it appears to be driving the much higher revenue. Brazil’s 105.5% MarketPlace revenue increase comes from a 49% increase in local currency volume, which is then supported by a temporary currency impact and a 26% increase in the take rate. It’s a similar story for Argentina and Mexico. I assume take rate means they are taking a higher percentage cut on MarketPlace transactions. This helps, but obviously we cannot expect them to keep increasing their take in order to show such high revenue growth, especially when competing with AMZN.
In terms of valuation, MELI is expensive, but I wouldn’t say it is overly expensive given the growth. Analyst expect 2017 EPS to be 2.82 (it was 3.22 a couple of months ago, but given the pressure on margins, analyst are expecting lower EPS) and revenue of 1.32B. That would value MELI at a PE ratio of 80 and Price to Sales ratio of 7.6. MELI had an EPS of 1.16 and 1.10 during the 2 quarters prior to the most recent 12 cent EPS, so they have the ability to make money. If you annualize the 1.10 EPS, you would get a PE ratio of 51. Alibaba trades at price to sales ratio of 12.5 while AMZN trades at a P/S ratio of 2.7. Given the size and anticipated growth of MELI, I don’t think the valuation is overly expensive.
Overall, I think I will likely buy a little bit more MELI at current prices, but still have the following questions:
Why is Chile and Mexico still such a small part of the overall revenue given their large economies and the very high goodwill costs incurred in both countries?
Is their significant growth in Mexico even while competing with Amazon, coming at a very high cost given their losses there? Or are these one-time costs that will help MELI compete profitably in Mexico?
Given Amazon’s entrance into Brazil, will we see similar cost increases?
Is the $75M is for Payment Fees that makes up $120M of non-marketplace revenue all related to MercadoPago? How much growth can we expect in these fees given that the bulk of the MercadoPago revenue appears to be coming from off marketplace transactions?
What is causing the increase in the “take rate” and is this a one-time benefit?
Given the significant costs of setting up the infrastructure in South America, why would Amazon not just buy MELI? Amazon does scare me given their focus on India, which gives them experience operating in countries with weak infrastructure. How much will competing with Amazon, impact future margins/profits?
Investing in MELI reminds me a lot of Amazon back in 1999 with the looming threat of competition from Wal-Mart, Barnes & Noble, Borders and the American Booksellers Association, which was launching BookSense.com. Now the roles are reversed and Amazon is the mature company while MELI is the younger company trying to establish a new market. http://www.barrons.com/articles/SB927932262753284707