The Problemas We Found In MercadoLibre's Earnings

Nov.12.13 | About: MercadoLibre, Inc. (MELI)

On October 25th we published our short thesis on the ecommerce company MercadoLibre (NASDAQ:MELI), also known as "the Ebay (NASDAQ:EBAY) of Latin America", and wanted to give a brief update on some recent developments regarding its earnings and, most notably, its business in Venezuela.

Please note that the hyperlinks in this report will help you find some of publicly available sources we've used to form our thesis, and are meant to be helpful for you to form your own opinion.

Devaluation of Bolivar is not only a problem for Venezuela citizens, but also companies that do significant business in the country, such as MercadoLibre (<a href=Click to enlarge

As many of you know, the highflying company missed the streets' earnings expectations by 9 cents per share when it reported its 3rd quarter earnings. Although we are not of the thought process that a 3 month period can truly have as much significance on an actual business as the stock's fluctuations would imply, we believe this earnings report - and MELI's management conference call, followed by its 10Q filing - has shown quite a few systemic problems within MercadoLibre that have not received the proper attention. Rather than reiterate the earnings details that you can find in countless places on the web, let me highlight the few items that stood out the most for us.

During the quarter the company reported revenues of $123 million, a 26.5% ($25.8 million) growth over the same period last year. At face value, this sounds like the wonderful growth most investors could only wish for. What the company did not spend as much time elaborating was that nearly 70% ($17.8mm) of the revenue growth was from the two financially troubled countries of Venezuela and Argentina. For those who follow my @RonReuven twitter account, you probably noticed that the first thing I noticed during MELI's conference call was that management was steering analysts attention to what management called "local currency" revenue growth without mentioning the fact that the currency it highlighted underwent a drastic devaluation of as much as seventy percent. Of course MELI would generate a larger number of Bolivars and Pesos from Venezuela and Argentina, respectively - more is required to pay for goods after the value of these currencies continued to drop like a rock.

Venezuela Bolivar has been devalued drastically, and likely to get worse in immediate future before any opportunity to stabilize Click to enlarge

Further, the company continued to use the drastically flawed Venezuela currency exchange valuation of 6.3 bolivars per one US Dollar in their financial reporting to investors. As we noted in the previous report, this 6.3 bolivars/dollar conversion rate MELI is using is far from reality, as the unofficial conversion rate in the black market hit a low of 45 bolivars/dollar during October. To make matters worse, the (a website that tracks the value of the Bolivar on the Columbian border) just reported that the Bolivar hit a New Record Low of 60.88 bolivars per US Dollar on November 9th, 2013. This is no small difference. This means that while MELI is using an exchange rate that values each Bolivar at approximately 16 cents (6.3 x 15.873 = approximately $1.00), it is actually worth 1.6 cents, 90% lower than MELI is reporting. So what does this mean to Investors?

For starters, we encourage investors to go and see MELI's most recently filed 10Q SEC filing, which was black-lined for changes from the previous quarter, courtesy of the amazing technology provided by Factset. Here you will find many new fun facts about the company, including their ongoing legal situations and fines in Brazil, new bonus plan for executives, upfront fee arrangements, SICAD framework, fun times in with Argentina's currency, and brand new real estate bought in Venezuela. On page 57 of the 10Q, you'd notice a new section (highlighted in green) added by MELI management that gives a hypothetical analysis of the Venezuela Segment if the exchange rate of the Bolivar was cut in half from 6.3 bolivars to 12.6 bolivars per One US Dollar.

The table below provides specific sensitivity information of our Venezuelan segment reporting for the periods indicated assuming an exchange rate of 12.6 Bolivares Fuertes per U.S. dollar applied starting on January 1, 2013 to September 30, 2013.

Three months ended 9/30/13(*) Actual u$s

Three months ended 9/30/13(**)

Sensitivity u$s

Nine months ended 9/30/13(*) Actual u$s

Nine months ended 9/30/13(**)

Sensitivity u$s

Net Revenues





Direct Costs





Direct Contribution










Click to enlarge

(*) As reported.

(**) Computing a hypothetical devaluation as explained above.

Source: MercadoLibre 10Q SEC Filing November 8th, 2013

Be reminded of what we just went over in the previous paragraph, which is that the current New Record low is 60.88 bolivars/dollar, not the hypothetical 12.6 bolivars/dollar that MELI management has chosen to use. So mathematically, if a 50% decline in the exchange rate of the bolivar (from 6.3 to 12.6) shown by this hypothetical example (from MELI management) would imply a loss of $28,383,241 in revenues and $20,282,190 in gross profits over 9 months (aka Direct contribution), respectively, than an exchange rate that's in line with what's currently available would turn this part of the company into at least $50 million dollar in lost revenue, leaving with about $5 million in revues and turn the "gross profit" into a significant "gross Loss." When the entire company generated $337 million in revenues, losing $50 million is No Bueno.

Lastly, my favorite part of the conference call (and 10Q) was where MELI management discussed and elaborated on their plan to buy real estate in Venezuela, nonetheless, due to the fact that they cannot withdraw any of their own company's money from the country of Venezuela at this point, or in the foreseeable future. In fact, when an analyst from Stifel Nicolaus asked MELI Chief Financial Officer, Pedro Arnt if it's possible to get any dollars out of the country at all, Mr. Arnt showed some real honesty by saying "…your guess is as good as mine" in so many words.

Alex Chavdaroff

Analyst, Stifel, Nicolaus & Co., Inc. Q

Hi. This is Alex Chavdaroff for Jordan Rohan. Can you discuss the treasury policy change with regard to

Venezuela? Is it possible to get any dollars out of the country at all? And if not, how long do you think it'll be that

way? Thank you.

Pedro Arnt

Executive Vice President & Chief Financial Officer, MercadoLibre SA A

So I wouldn't say there's been a change in the treasury policy. We continue to have a fairly conservative and consistent treasury policies in countries where those are applicable, where the vast majority of our cash is stored in U.S. dollar balances in the U.S. The point you allude to is, over the last, I would say, since the beginning o f this year, even the small amounts of dollars that we were previously able to repatriate from Venezuela has not been granted. And so the profit that the Venezuelan subsidiary generates, all saved within Venezuela. So as an asset management strategy, what we began to do to preserve that value, in an asset that makes more sense mid-term than bolivars, is to buy either operational real estate, so our own offices, or more recently, commercial real estate as an asset value protection. In terms of understanding for how long Venezuela might continue to have restrictive policies on cash repatriation, I think your guess is as good as mine. I don't think it's anything that happens in the short term; and fortunately, we don't manage this business for the short term. So in the meantime, we continue to grow our business there. As I just called out, our Venezuela business continues grow at 25-plus percent units year-o n-year, despite the tough macro. And I think mid-term to long-term, when Venezuela finally turns around, we will emerge from that with a very strong competitive position in a sizeable market. And hopefully, we'll have an interest asset base in terms of real estate that we then will be able to repatriate back to the U.S.

Mr. Arnt also elaborated on the company's plan to buy real estate in Venezuela as a hedge against currency devaluation, and then rent the property out for income generation. Yes, that's really the plan. Here we have an ec-ommerce company trying to replicate and compete with Ebay and Amazon (NASDAQ:AMZN), yet somehow was led to believe that buying Real Estate with currency that's being actively devalued, in the very same country that's devaluing it, is somehow going to hedge the currency risk. I'm not sure I really need to explain why this is a ridiculous plan, but let's have a shot at it anyway. If you buy a piece of real estate for 328.2 million Bolivars, like MELI did recently, (which MELI equates to $52.2 million in their 10Q), and the value of the currency drops by 90%, you can't tell Venezuelan real estate buyers (or the company's investors) that your property is worth 10 times more just because you choose to use a difference currency from the rest of the country for your own valuation. MELI claims that they would not have this problem since these new real estate purchases (and possibly future purchases) are going to be long term investments, whereby they will rent them out until the country's economy and currency stabilizes in some unknown point in the future. Aside from the fact that I never heard of an ecommerce company going into the real estate renting business, what does the company say to a hypothetical renter paying 10,000 bolivars/month, after the currency devalues by 90%? Sorry Mr. Renter, the contract we have with you is voided and you now have to pay us 100,000 bolivars per month to make up for the shortfall the government caused? Is this really a legitimate plan or is there another hidden agenda motivating the company to take this ridiculous step?

Here's what I think is really happening here: Since MELI knows that the value of the Bolivar is being recorded incorrectly on their financial books, and they obviously don't want to report the real major loss caused by this devaluation, they are now going to be hiding the money in plain sight-an illiquid and hard to value asset that does not need to report a change in value on a mark to market basis. If MELI takes all of their bolivars and throws them away at some highly overpriced real estate in Venezuela, they would then be able to continue to mislead investors that not only was MELI's balance sheet never affected by the devaluation (which affected everyone else), but that they are actually prospering as a result of it. This illiquid asset will be carried on their balance sheet as a fixed asset based on a fictional valuation likely using the stable US Dollar as a currency (as they did in their 10Q) without ever changing it. So by avoiding reality, and legality, the company can avoid showing a $50 million loss of revenues, millions in gross losses, millions in balance sheet assets lost, and an inflated growth rate generated throughout a year they should have actually shown a huge slowdown, if not retracement. Oh, and by the way, it's now being investigated by the Venezuelan government for reporting false currency prices to customers, according to Bloomberg News.

The Road To A Short Sell of MercadoLibre (MELI)

Click to enlarge

This Blog is for the purpose of sharing of personal opinion and should not be construed in any way as advice. The information contained in this report or information provided does not purport to be complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The contributors to this blog and or their affiliates may directly or indirectly have active positions in the securities that are mentioned. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Past performance may not be indicative of future results. Ron Reuven is the Chief Investment Officer of Reuven Capital Investments, LP (long/short equity hedge fund).

Disclosure: I am short MELI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: RCI is short MELI