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Mercado Libre (MELI) Stock | NASDAQ: MELI

Building an E-Commerce Empire

Founded in 1999, MercadoLibre's commerce segment includes online marketplaces in more than a dozen Latin American countries, display and paid search advertising capabilities (MercadoClics), online store management services (MercadoShops), and third-party logistics solutions (MercadoEnvios). Its fintech segment includes an online & offline payment-processing platform (MercadoPago), mobile wallet platform, credit solutions for buyers & sellers, and asset management.

Mercado Libre is at the centre of e-commerce and fintech in Latin America. Serving over 18 countries, the company strives to provide robust online commerce and payment tools to help serve various communities all over the continent. Mercado Libre’s main goal is to democratize commerce across the region, through their e-commerce platforms and payment ecosystem.

Growth

100

Valuation

71

Quality

80
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Where Are We Now

Updated on: 11/13/2021

Conviction Score

9

Mercado Libre’s e-commerce empire continues to dominate South and Central America. These regions have tons of room to expand with significant underbanked populations. As such, Mercado will continue to grow at astonishing rates. We love the company today but unfortunately cannot get on board with the valuation fully. If buying shares today, we would look to hold for no less than five years.

  • Total payment volume at Mercado nearly touched $70 billion over the last twelve months. This is up from $50 billion for the full 2020 year. Growth is an understatement.

  • Gross merchandise volume is over $7 billion for the quarter growing at an annual rate of about 30%. Revenues are up even higher, over 73% for the quarter versus last year.

Investment Thesis

  1. Mercado Libre is at the centre of e-commerce and fintech disruption in Latin America. Operating leading services in an online marketplace, e-commerce shop builder, logistics, digital advertising, and payments.

  2. Mercado Libre is a leader of large secular trends in the region of Central and South America posting explosive revenue growth across all segments. The market penetration of e-commerce and digital payments is still early days in the region providing significant upside.

  3. The business presents optionality and proven execution to capture share in enormous and fast growing addressable markets in Latin America.

  4. The business trades at expensive valuation multiples, but the opportunity and runway for growth ahead of them remains incredibly large.

The Basics

Mercado Libre is a company focused on providing Commerce and FinTech solutions to Latin Americans. The company operates under two major segments with six different businesses spread between them:

Commerce:

  • Mercado MarketPlace: a platform to help users sell products

  • Mercado Shops: a platform to help businesses build/run online stores

  • Mercado Envios: shipping services for sellers to distribute and store products

  • Mercado Clics: a platform to help sellers create advertising to promote on Mercado Libre’s sites

FinTech:

  • Mercado Pago: a payment system to help simplify payment options for consumers

  • Mercado Credito: a service to provide credit lines for businesses

These units are intended to provide as much coverage to consumers as possible. Mercado Libre aims to enable wider access to retail, digital payments, and e-commerce services while also democratizing (digital) finance in a region (i.e., Latin America) that is severely underbanked and growing e-commerce and internet penetration at astounding rates.

Mercado Libre Breakdown by Segment GraphicSource: TheOrg

Mercado Libre generates revenue from its Commerce and Fintech segments mainly by charging a percentage of gross merchandise value ("GMV") and total payment volume ("TPV"), respectively.

More specifically, Commerce revenues are generated by fees in the marketplace (flat fee below a certain threshold and percentage of final value on all other goods). Additionally, Commerce makes money from shipping fees, classifieds fees, ad sales up-front fees, sales of goods; and other ancillary fees. Most of these revenues are related to the Mercado Libre Marketplace aspect of the business. Therefore, GMV is the main driver of Commerce revenues.

Fintech revenues are mainly attributable to Mercado Pago. Mercado Pago charges various commissions, including those charged:

  • to sellers, representing a percentage of processed payment volume;

  • to buyers, when they choose to pay in installments through Mercado Pago; and

  • to sellers, for the withdrawal of cash and the use of credit products.

Financial Overview

Mercado Libre's segment take rates have been trending in a favourable direction. Coupled with the strong upward trend in GMV and TPV, we think Mercado Libre is a "dual-threat" contender in the e-commerce and payments space. We believe the rise in take rates is indicative of two imperatives:

  1. There is high and growing demand for Mercado Libre's services in Latin America.

  2. Mercado Libre can flex its pricing power rather early in its growth story.

Mercado Libre Revenue ($M) (Q3 2021)

Mercado Libre Quarterly Revenue by Segment ($M) (Q3 2021)

Source: Mercado Libre Investor Relations

Mercado Libre Segmented Take Rates (%)

Source: Mercado Libre Investor Relations

When it comes to Mercado Libre's cost profile, however, it's clear this is an expensive business to run with heavy investments required to grow. Its high valuation today appears to imply that Mercado Libre will be able to take control of its costs and expand its margins. However, management explicitly avoids providing any margin guidance, leaving us with uncertainty as to the timing and extent of being able to see healthy operating margins.

Most of the margin contraction over the years has come from rapidly rising cost of revenues. The cost of revenues have increased substantially due to:

  • Investments in free shipping and loyalty programs

  • Sales of mPOS and warehousing costs

  • Growth of its first-party commerce business

  • Expansion of the "managed network" (i.e., Mercado Envios's shipping carrier, warehousing, and logistics services)

Although this may appear concerning, building out a moat is expensive. If we use Amazon as an example, its gross margins are roughly 40% including its high-margin businesses like advertising and AWS. These margins are not outlandish; in fact, we are encouraged to see Mercado Libre make these investments to secure its future and provide compelling value propositions across its ecosystem.

Additionally, these are not costs that will continue to rise at these levels perpetually. These costs are largely the result of a pivot in Mercado Libre's business(es). Therefore, these are not impairments to its financial position, but investments for the future simply flowing through the P&L as opposed to the cash flow statement.

Looking a bit further down the income statement, we can see some operating leverage coming to life.

Sales & marketing costs are expectedly high. Mercado Libre is still growing and these costs will continue for years to come. However, its other operating costs are declining. Once Mercado Libre reaches some level of maturity with a solid holding of market share in Latin America, we would not be surprised to see sales & marketing costs drop off substantially and gross margins stabilize. Once these two financial events occur, we see a relatively clear path to margin expansion once again given the operating leverage already coming to life beneath the surface and the vast growth of the top line.

The Free Market

Mercado Libre in Spanish means “free market”, literally.

In 1999, Marcos Galperin, a Stanford alumnus, had an idea to help the growing demand for Spanish and Portuguese goods. Out of a garage in Buenos Aires, he created the now-known Mercado Libre Marketplace. This platform took inspiration from eBay, starting as an auction-type platform.

After initial success in Argentina, it expanded to other countries across Latin America, such as Brazil.

In 2001, eBay purchased 19.5% of the company to help the business expand even further to more and more countries. Meanwhile, eBay was also able to expand its own business, giving Latin American sellers the opportunity to sell on its platform.

By 2006, Mercado Libre took the continent by storm, being the largest online marketplace platform in Latin America, generating nearly $52 million in revenue. The company then went public under ticker MELI, being the first Latin American technology company to be listed on the NASDAQ.

Since the introduction of Mercado Libre Marketplace, the company has expanded its business model into a variety of functions, supplying all kinds of demand in the e-commerce world.

Competitive Advantages

Two-Sided Marketplace

Both of Mercado Libre's groupings of businesses (Commerce and Fintech) benefit from two-sided network effects.

On the commerce side, buyers and sellers meet in Mercado Libre's marketplaces to buy and sell goods. As the number of buyers and sellers increase, both parties have more compelling reasons to continue to shop and sell where they have a large market and variety of stuff.

On the fintech front, these effects would be similar. Mercado Pago benefits from its user base growing. As the platform is adopted by buyers and merchants, more new merchants and buyers will be attracted to using the platform. Additionally, existing users will experience a growing value proposition as the platform network expands.

As we have portrayed earlier, we can see the value of the network showing up as high and increasing take rates, particularly in the Commerce business.

Mercado Libre Unique Active Users (M) (Q3 2021)

Source: Mercado Libre Investor Relations

The Comprehensive Latin American Platform

Mercado Libre knows exactly what its target market needs, and it has created an integrated ecosystem of marketplaces and products to meet those needs.

Other e-commerce giants outside Latin America are faced with one major issue — about 50% of people in the region don't have a bank account or a credit card.

The population is severely underbanked and left out of the e-commerce equation without a digital payments solution. This is where Mercado Pago and Mercado Credito come into play. With these financial services, Latin Americans all throughout the region suddenly have the ability to buy and sell goods and services digitally on Mercado Libre, other online stores, and in-store with mPOS.

The integration of Mercado's financial services products with its other platforms, especially e-commerce, makes the ecosystem extremely sticky and it is highly unlikely residents will look to more difficult-to-use e-commerce platforms like Amazon or other local players over Mercado Libre.

Mercado Libre simply understands the needs of its Latin American customers better than anyone and provides well-integrated solutions that make the entire ecosystem highly attractive to merchants and consumers. It also has such vast operations within the region, competitors would have to spend obscene amounts of money and convince millions of users in a highly functional and comprehensive commerce and fintech platform to switch. Switching costs, therefore, are high.

Mercado's Website and App Visits by Major RegionSource: MercadoLibre 2021 Business Overview
Latin American Payments CultureSource: MercadoLibre 2021 Business Overview

Going Above and Beyond for Users

The company’s competitors, like PagSeguro, a payment company, or FLEXE, a logistics company, run their businesses in more of a siloed fashion in specific countries. On the other hand, Mercado Libre reaches customers all across Central and South America.

Consumers are more inclined to use Mercado Libre’s products over competitors because of their familiarity with the brand and the company's vast reach.

Besides its fintech solutions, Mercado Libre's innovations like Mercado Envios has helped the company build a moat around its competitive position in recent years. Starting a shipping & logistics service for Mercado Libre Marketplace sellers essentially monopolized the e-commerce market in Mercado Libre’s favour.

Instead of relying on external services to distribute goods, merchants using Mercado Libre can store and ship products using its in-house service. This has proven very beneficial as nearly 80% of products on Marketplace are shipped through Envios. Envios is efficient and effective, which together can be said to provide immense value to sellers.

Since the cost to open warehouses and other logistics infrastructure require high upfront investments, competitors face massive financial disincentives to try competing, and merchants are likely to rely on a third party — in this case, those operated by Mercado Libre — to provide the shipping and warehousing capacity.

Mercado Libre controls everything in the production line, from the platform and marketplace, to the final shipping services to complete orders. Merchants have it all with Mercado Libre, and consumers reap the ultimate rewards with a reliable and consistent e-commerce experience.

Mercado Envios Quarterly Network Penetration (%) (Q3 2021)

Source: Mercado Libre Investor Relations

Simple Growth Story

If we only had 30 seconds to explain Mercado Libre's growth story, it could be summarized with these two points:

  • Latin America is severely underbanked. As such, Mercado Libre's fintech solutions are incredibly important to the region, and

  • Latin American merchants and consumers are adopting e-commerce at high rates.

Mercado Pago, Mercado Libre’s payment service, was not meant to be a part of the company’s main business model. The goal initially was to focus on marketplaces and bolster the e-commerce sector. However, in 2007, the company introduced the new Mercado Pago service.

This was a payments solution to complement the Mercado Libre Marketplace by giving consumers a seamless experience when purchasing products on the platform.

Due to the remarkably low amount of bank accounts held by Latin Americans, this new service allowed consumers, regardless of their banking status, to access the platform.

The introduction of the service was successful as nearly 1/3 of Marketplace orders were done through Pago.

Through the platform, users can send and receive money, if both parties are users of the platform. Interestingly, the receiver of the payment does not need to be a merchant.

Consumers realized that the platform could technically be used as a Person-2-Person ("P2P") platform. Out of nowhere, an alternative P2P service that was not cash was born.

Mercado Libre's Total Payment Volume ("TPV") started growing from “off-platform” transactions. Mercado Libre introduced mobile point-of-sale ("mPOS") solutions to small businesses in Brazil. The mPOS were successful, and the company began its region-wide expansion, adding countries like Argentina and Mexico to the mix.

Mercado Libre Total Payment Volume ($M) (Q3 2021)

Source: Mercado Libre Investor Relations

About 50% of Mercado Pago’s revenue comes from these mPOS.

Despite not being the intention of the business, Mercado Pago provided a much-needed solution to those in the region.

Going forward, we expect demand for Mercado Libre's commerce and fintech solutions to continue rising at rapid rates. Latin America will see a surge in the number of small- and medium-sized businesses going online, resulting in the entire e-commerce market growing at a 30% compounded annual growth rate ("CAGR") from the end of 2021 through 2025. Mercado Libre undoubtedly has the most robust region-wide e-commerce network with an integrated fintech platform that could be used on and off the ecosystem.

We think Mercado Libre will lead the market and grow at rates at, or above this market e-commerce growth rate. Mercado Pago and its other fintech solutions will also face high demand. Without them, many customers would not be able to participate in the digital economy in the first place. Mercado Libre is a winner.

EBANX's LatAm E-Commerce Market Growth StudySources: EBANX Beyond Borders 2021 Report, AMI (Americas Market Intelligence), World Bank

Risks

Spread Too Thin?

Mercado Libre is a dominant force when it comes to the e-commerce world, but its diverse business model may be too much to handle.

Every one of its services has its own set of competitors. Mercado Pago is up against the forces of PayPal and PagSeguro, Marketplace is up against OLX and Amazon. Mercado Envios is up against FLEXE.

Despite being the Latin American leaders in these industries, can Mercado Libre continually protect its moat in each area? As the company continues to expand its business, it may not direct enough attention to specific services, leaving a blind spot open for competitors of which they can take advantage.

Geographic Woes

Investors should also be aware of the geographical climate of Latin America when evaluating the future growth of the company. Countries like Argentina have unstable currencies along with rising (hyper)inflation rates.

As a stock priced in USD, weakness in local currencies and / or strength in the USD would act as a headwind for the stock price and the region as a whole. Similarly, Mercado Libre is not valued cheaply — volatility in currencies and a worsening geopolitical climate could "de-rate" Mercado's stock by souring investor sentiment and devaluing earnings when looking at the USD-converted value.

As an example, Brazil is Mercado Libre's largest market. The Brazilian Real has devalued about 50% against the US dollar over the past five years. The Mexican Peso also has also experienced a multi-year decline against the US dollar. We cannot speculate on which direction Latin American currencies will go, but there is certainly a risk that they could go lower.

Brazilian Real to US DollarsSource: xe.com
Mexican Peso to US DollarsSource: xe.com

Financing Sources

Mercado Libre has been accumulating debt, albeit not to levels that are concerning to us yet. At about 3.0x net debt to EBITDA, we think Mercado Libre's strong growth profile and EBITDA should be enough to service this debt.

However, we are confused by Mercado Libre's recent decision to issue over $1.5 billion of common stock for "general corporate purposes", which we do not believe will be value-creating expenditures. Not only has this diluted current shareholders, but the choice of issuing equity instead of debt raises the cost of capital. When the cost of capital rises, a company's valuation is generally adversely affected.

While a one-time raise may not be a cause for concern, this could point to further equity offerings being made in the future. We are keeping a close eye on Mercado Libre's financing decisions.

Bottom Line

Mercado Libre is building a strong foothold in e-commerce and payments. Leading the marketplace with its platform and logistics service, along with successfully integrating Mercado Pago into society, this company builds a strong moat to ensure it dominates.

The company’s optionality allows every service offered to be relevant and in demand for consumers to use. Mercado Libre can continue to utilize its optionality in secular trends that emerge in Latin America.

Its evolving business model, along with the progressive growth of the online service industry will allow Mercado Libre to continue to build its e-commerce empire.

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