MercadoLibre (MELI) shares have plummeted 44% from their 52-week high of $80. We are buyers of this weakness.
- High-multiple-growth-stock vertigo rears its ugly head. Given the fact that a global economic slow-down is rapidly becoming consensus thinking, it's not too surprising that ultra-high-multiple growth stocks like MELI, Baidu (BIDU) and Alibaba have come under tremendous pressure of late. The market tends to price in Armageddon now and ask questions later, and the stocks with the highest multiples fall the furthest the fastest.
- A global de-leveraging is well-underway-and winners get sold first. A look at the recent price action in the JPY "carry trades" tells a powerful story: for many years now investment funds all over the world have borrowed Yen at virtually 0%, converted to Dollars, Euros, Aussie, Kiwi, Renminbi and Brazilian Reals, and invested in stocks and bonds. Those currencies are worth a lot less Yen than they were a month ago, meaning that these funds are not only selling their foreign stock holdings to protect their capital gains, but also to protect against further FX losses. This double-whammy is pulling the rug out from under entire markets, and winners tend to get sold first while losers are left on in the hopes of a "bounce" to a better exit level.
- "MELI economies" are far less dependent on international markets than they were in the past. There are two key reasons why Latin American economies are growing so rapidly: 1) a 5+ year boom in commodity prices (correcting presently but still very much in long-term structural Bull mode) and 2) the burgeoning of a heretofore non-existent middle class. Internal demand remains robust in these economies-even as it deteriorates throughout the developed world.
- Buy this weakness-or at least start nibbling. We know, the tape is pretty scary. In our view, however, MELI is now materially undervalued relative to its long-term growth opportunity. For those with an investment horizon longer than six months, we view the recent weakness as an attractive opportunity to establish or add to Long positions.
The Rationale Behind Our 18-Month Price Target Of $110
Investors often claim that the sell-side is too short-sighted. When it comes to a stock like MELI, we are inclined to agree. It makes little sense to take the same approach to a still-very-early-innings, multi-decade secular growth stock that one would take to Amazon or eBay-unless one is talking about Amazon (AMZN) / eBay (EBAY) circa 1999. On the other hand, we think it would be a bit careless to roll out pie-in-the-sky 2013 estimates and base our price target on those numbers. We are inclined to take the middle road, and have thus decided to go with an 18-month price target based on our 2010 estimates. We figure that 18 months from now, i.e. mid-2009, investors will be valuing MELI on 2010 numbers.
We get to $110 by taking the average of the results of our P/E and EV/EBITDA frameworks. On the P/E side, we apply a 92x multiple (2.3x our estimated 2010-2013 EPS CAGR of 40%) to our 2010 EPS estimate of $1.30-this yields a $120 target. Regarding EV/EBITDA, we apply a 47x multiple (1.2x our estimated 2010-2013 EBITDA per share CAGR of 40%) to our 2010 EBITDA per share estimate of $2.02-this yields a $100 target once we add back $4 YE2010 net cash per share. These two targets average out to $110. How do we justify a PEG of 2.3x and an EV/EBITDA/Growth ratio of 1.2x? After all, we are essentially asking investors to pay a 50% multiple-to-growth ratio premium relative to our normal PEG of 1.5x and normal EV/EBITDA/Growth ratio of 0.8x. We'll be the first to admit that this is a) highly aggressive and b) highly subjective. We can think of four reasons that (collectively) warrant such a premium:
1. Very little competition: MELI has a noteworthy competitor in Brazil (B2W), but outside of Brazil there is little if any competition that warrants mention. eBay and Amazon had to share the U.S. in their infancy and, over time, Europe as well. There was a smattering of smaller players too-Overstock.com comes to mind. MELI is raising the barriers to entry higher with every day that goes by without a major competitor (outside of Brazil, at least) to pester it. This alone warrants a material valuation premium.
2. Developed markets = dull, emerging markets = sexy: There's a reason that the acronym "BRIC" has become...well, an acronym. This market is, in our view, just beginning to reprice non-EM secular growth, so investors would do well to look outside of the U.S. and Europe for attractive 2008 returns. China has, of course, been by far the biggest beneficiary of the EM feeding frenzy. Latin American has taken a bit of a back seat thus far, and probably rightly so since the demographics suggest that the long-term growth opportunity is bigger in China than in Latin America. Growth in Latin America may not follow as steep a trajectory as China has, but unlike China the region is a net exporter of oil, copper, corn and lots of other "basic stuff that people need." Thanks to a 5+ year boom in commodities prices, Latin American exporters (and the central banks that tax their profits) have never been more flush with cash. Infrastructure is being built at a frenetic pace. A heretofore virtually nonexistent middle class is on the rise throughout the region-it is quickly learning the joys of disposable income. It's still early enough to hop aboard the Latin American E-Commerce Express, and MELI is the only USD-denominated ticket to ride.
3. A proven business model: We already know how this movie ends-the model has been proven to work extremely well. To wit, if you could go back to 1998, bringing with you the knowledge that eBay would go from less than $1B in GMV that year to $60B in GMV by the end of 2007, what multiple on 2000 EPS would you have been willing to pay? eBay did $0.05 in pro forma EPS in 2000-so EBAY shares currently trade at 660x 2000 EPS. Would you be willing to pay 300x 2000 EPS? 400x? You'd have made money if you did. We're not asking investors to pay anything like 300x a two-years-out EPS estimate. We're asking for 92x. It actually seems quite reasonable given the way this story played out in the U.S. between 1998 and 2000.
4. M&A: There is a high degree of likelihood that eBay (or some other 800 lbs Internet gorilla) will acquire MELI. It's fair to ask "why didn't eBay acquire MercadoLibre before it went public?" We think there are two reasons why: 1) eBay is "once bitten, twice shy" after the EachNet debacle in China (in other words, it is hesitant to take full control of a local player too soon); 2) its currency remains severely undervalued. eBay is far and away the most obvious potential acquirer, but Amazon, Google (GOOG) ($657.00, Buy/R. Sanderson) and Yahoo! (YHOO) ($23.16, Buy/R. Sanderson)-among others-shouldn't be ruled out just yet.
Risks to The Achievement Of Our Price Target
We highlight three in particular:
1) A material decrease in global demand for major commodities (copper, oil, corn, et al), which could lead to slower economic growth and a decline in currency values throughout Latin America
2) Slower than expected growth in internet adoption and/or broadband proliferation in Latin America
3) Geopolitical shocks with a direct adverse effect on one or more of the countries in which MELI operates.