MercadoLibre: Rules of the Game

Is it possible to talk a bit of sense about MercadoLibre (MELI)? Here are the rules of the game:

1. Stop listening to the inane chatter.
2. Stop reading the pumps.
3. Find the facts.

So, rule 1). Forget the shills and pump merchants (yeah, you know who they are) who scream “buy BUY BUY!” just because it’s internet, it’s growth, it has eBay (EBAY) as a minority shareholder and it kinda-but-doesn’t-quite remind you of Baidu (BIDU). The day that you stop believing the TV-sponsored constant hype is the same day you’ll turn into a better investor who isn’t chasing the crowd, chasing the market or wondering why they aren’t making the money they were told they’d make.

But wait up, that means you also shouldn’t give any time to the automatic knee-jerkers who will oppose a stock and then find a few after-the-fact reasons. In MELI’s case, the bashers just go “yeah well, it’s Latin America, isn’t it dude?” and trot out some BS about Hugo Chávez or inflation or cyclical growth or how ‘they don’t even have color TV down there’ yet without knowing what the hell they’re talking about.

As for rule 2), here’s just one example of another type of pumping going on round this stock. I read a piece on MELI in Forbes magazine last week, which typifies the second kind of trap to avoid [1]. Now, because it’s in Forbes you’d expect it to be well written, and of course all the facts and figures are correct, but I couldn’t help noticing how the figures have been cherry-picked to suit the occasion. Then I noticed the author Sramana Mitra saying “One that has really caught my eye is MercadoLibre” as if it was something new, then a little further on disclosing she was invited by MELI to do some consulting and advisory work for them last year (presumably remunerated). So two minutes worth of Googling later, it turns out that Ms. Mitra has written four different articles on MELI since late November. Well, I suppose it ‘caught her eye’ four times……….

Anyway, let’s leave the people with pre-set agendas to one side, find some facts about MELI and see for ourselves if it’s any good. The place to go is the SEC filings of course, and then you can whack a few charts together if you feel that way inclined. Then once you see how the company has been stacking up you can forecast how things will go in the future. First thing to note is that MELI is a growth play and net revenues are the beginning and the end of the story; if sales don’t keep growing at a good clip, this stock is toast. So here’s a chart mapping out what a decent sales growth should look like from here.

It shows how revenues grew as a percentage of the previous quarter in 2007, and then projects into the future what I think MELI has to do to keep up the good work.

So from that we can do this chart, and break down the three main components of net revenues, costs and the resulting gross profit per quarter.

Again, the projections are the important thing here, because if you don’t have a good idea of how MELI is going to perform in the future you are investing on a hunch. So note a couple of things here:

1. I’m assuming net revenues grow pretty well in the quarters to come.
2. BUT watch out, because costs are also forecast to grow. This is because of how things are in the real world. Once other companies recognize that MELI is the centre of a growth sector, it won’t take long for the competition to hot up and the market leader (MELI) will have to spend more (advertising, offers, higher salaries for key personnel etc) to stay top dog. And despite what the hype merchants have told you, there is already plenty of competition trying to eat into MELI’s sector lead in LatAm. If you don’t believe, plug www.deremate.com into alexa and see how many hits that site is getting.
3. This costs growth is inevitable, and even if I haven’t hit the exact numbers on the head here it’s foolish to think it won’t happen. This will therefore eat into gross profits. From there we can put together this next chart…

…which looks at how the quarterly net profit line develops. This is a statistic that the shills and pump-artists will often headline without mentioning EPS. But real analysis cares much more about the EPS than the absolute profit in dollars, because from there we can do a chart like this to see how the Price/Earnings ratio pans out:

And that looks pretty darn promising to me. If we presume MELI stays at U$38 per share until late 2009 (it’s U$36.35 right now), the PE ratio drops to a little over 20X. But the whole point of owning a growth stock like MELI is the growth in revenues driving the stock price higher (witness any of the hot tech stocks and how they higher PE ratios than established industries). So as the earnings grow, we can presume the stock will go up. This final chart shows the previous static-price PE ratio in red, and then another PE curve in blue that assumes the stock will grow steadily to a price of U$75 by 4q09 (represented by the dotted black line).

So what this suggests is that if revenues grow as forecast and the stock more or less doubles in the next two years, you’ll be looking at a trailing PE of around 45X at the end of the period.

For a growth stock like MELI, a projected 45X PE sounds about right to me. There’s a balance to be found between the continued growth at the company (which looks promising), the company maturing its PE from today’s very high levels (trailing PE is 173X right now), plus the greater risk of operating in Latin America rather than the USA or Europe. A company like EBAY can demand a higher PE than MELI because of the lower risk and more mature market in which it operates, but the MELI investor has to be taking a greater chance that the growth won’t suddenly dry up due to bigger issues like a sudden regional growth halt, a big jump in regional inflation, some kind of politically destabilizing event, etc.

To bottom line all this, if you’re long MELI you have to watch that net revenues number develop and continue its growth. If the company manages to growth quarterly revenues by around 17% quarter-on-quarter and costs grow but don’t suddenly rocket, then hold and look for a double in two years. But the moment revenues growth weakens, you should get the hell outta Dodge and not look back.

My personal recommendation on MELI right now is neutral. I’d say there are worse places for the speculative part of your portfolio, but there are better too (but hey... that’s just me). If you buy MELI, you’re betting that the whole region keeps growing the way it did in 2007, and you’re betting that MELI keeps up its good 2007 too. Neither of these things is the slam dunk that both the subtle and not-so-subtle pump artists would have you believe. So make your own choice, but block out the hype. It won’t do you any good in the long run.

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[1] Forbes

Disclosure: No position in MELI.

Comments

[User 167571]

Deremate.com, which you consider to be MELI's strongest "competitor,"... is actually owned by MELI.

Please read MELI's public filings before writing an article about the stock.

[ottorock]

User 167571, you're wrong.

Deremate was bought by MELI back in 2005 (i can also tell you the date, the price and who lent mercadolibre the money if you want), but then the deremate web was re-started late 2006 by the old owners under the name "dereto" and still uses all the deremate web addresses. Go to dereto.com, then click on Argentina (for example) and find out yourself. Or if you like, ask Galperin. He'll tell you the same as me.

I read the filings...that means ALL the filings, not just the ones that suit your own cause. I also read what's going on in Latin America.

You wrong. Me right. Goodnight.

[SramanaMitra]

Otto,

I cover about a hundred stocks, and since I came to know about them, it has become one that I cover, so pretty much every quarter, you will see me covering them, like I do the rest.

I wrote the Forbes piece because my Forbes editor requested that story. Because a good success story from Latin America is a rare thing.

Also, I said, clearly, that their stock price is more realistic in the $30-$40 range, not $80.

Finally, take a look at Cadence, a client of mine with whom I have had about 20 times the billing of MELI. I recommended that people not only NOT invest in the company, that they not invest in EDA, a segment that I think has serious structural problems.

You see, I write (with depth and insight) about what I know about. And the reason I know about things is because I do consulting.

I have no agenda vis a vis MercadoLibre or any other company, and if you read through my volume of contributions over the last year on SA, you'll see, that they offer considerably more depth than your unreasonable personal attacks withour appropriate research.

Sincerely,
Sramana

[TimothyPereira]

Perhaps you should visit the sites of Mercadolibre's "competition"... before you tell your readers to plug deremate.com into Alexa to get an example of how much competition Mercadolibre has. You also claim in your comment that the old owners under dereto still use "all the deremate web addresses". This is flatly wrong. Fully 10 of the 12 links from that page are now owned by Mercadolibre.

[ottorock]

thanks for taking the time out to reply to a such a small timer like me, ms mitra.

hey tim..it's tough to take someone seriously that can't even work out the share count at MELI.

[TimothyPereira]

That's fine, but when someone points out a mistake in my articles I am happy because it's much more important to get the facts right than to pretend to be omniscient.

[TimothyPereira]

Just to be clear, here is an example of one of the sites on deremate.com:

www.deremate.com.mx/

Do you notice the Mercadolibre logo at the top?

[User 168030]

I think this DeRemate issue is a good one for us to iron out. Obviously, ML bought these properties in 2005, I believe. Most are therefore owned by ML. However, the Chile and the Argentina sites are not. Any idea why? And any idea why ML still links to them if it controls deremate.com? The founders of deremate have also created dereto.com sites for Columbia and Mexico, but these sites do not generate much traffic.

[TimothyPereira]

Mercadolibre says this in their S-1 filing from January: "In November of 2005, we acquired certain operations of a regional competitor in online trading, DeRemate.com Inc., including all of its operations in Brazil, Colombia, Ecuador, Mexico, Peru, Uruguay and Venezuela and the majority of shares of its subsidiaries (except for its Argentine and Chilean subsidiaries, which continue to operate under the control of certain previous stockholders of DeRemate.com Inc.), for an aggregate purchase price of $12.1 million, net of cash and cash equivalents acquired. This acquisition increased our user base by approximately 1.3 million confirmed registered users and solidified our market leadership position in Brazil, Mexico, Venezuela, Colombia, Peru, and Uruguay."

[brazil]

otto, i was general manager of deremate in brazil for 2 years and know the story well. while your article is correct in 99% of the items, you will have to admit that the deremate comment is flatly wrong. MELI has bought deremate's operations in all countries except argentina and chile, which continue to operate outside MELI. there is no single direct competitor to MELI in all countries, especially brazil, in which i live. the competition comes from b2c e-commerce sites such as americanas/submarino (b2w is the name of the holding company), which is the online operation of one of the largest brazilian retailers. it is very strong, but not a direct competition.
regards.

[LatinAmericaJaJa]

There has been alot of talk about Mercado Libre lately and I think some points have to be brought into the discussion.

Yes, there has been alot of positive press coverage about the future of Latin America and Mercado Libre in particular as they are the only really known internet player in this region and the company’s valuation has been pushed north by a cool billion in the past 2 weeks.

The big 3 markets in Latin America are Brazil, Mexico & Argentina.
I am most familiar with Mexico – so I’ll use that country as an example – it is not so dissimilar to the rest of the countries where Mercado Libre operates.

Postal System: The postal system simply doesn’t work. It is notorious for lost/stolen mail. Credit card companies, banks and many large department stores deliver statements to their customers by private courier companies – because the government post office is unreliable.

This means that most any reasonably priced item has to be sent by private courier – thus pretty much wiping out the low ticket items – as the cost of delivery is going to be as much/more than the item itself.

Garbage/Treasure: In wealthy countries, there is a saying that someone else’s garbage is another’s treasure. In poor countries – and all Latin American countries can be considered poor – one person’s garbage is….another person’s garbage. Even if someone else values it – the problem cited above with shipping costs pretty much negates the item’s desirability –which was based in its low price.

Big ticket items: People with money in Latin America are going to spend their money at trustworthy domestic brick & mortar retailers or wait until they go on their annual shopping trips to the US where they buy everything they need in San Antonio/Miami/Las Vegas – which is much cheaper than at home. Why would anyone buy a used big ticket item from a stranger when they can go to Costco or the US and get a new one for less?

Ethics & Culture: There is a far lower standard of ethics in Latin America when in comes to business. The societies are rife with corruption, pure theft by their politicians and monopolies rule the private sector. With monopolies come the standard: high prices, bad products & poor service.

This is not to say Latins are any less ethical human beings - just that they have accepted that the average citizen is going to get ripped off and there is nothing he can do about it.

An American politician gets caught stealing from the cookie jar – he goes to jail. In this region politicians are multimillionaires, they know it, the public knows, that’s the way it is.

Oil has gone from $20 to $120/barrel in a few years and there has been no marked improvement in the lives of the average Mexican, in a country which is a major oil producer. Where has all the money gone?

The government can’t be trusted, the police can’t be trusted, most businesses can’t be trusted.

Mercado Libre, simply by having an auction site, is not going to change the culture of Latin America. You simply do not have the kind of trust necessary for a user to send alot of money to a stranger for a big ticket item. It will not happen in a big way in this region – ever!

Corporate Questions – why did Mercado Libre plan another issuing of stock and then suddenly withdraw it at the last moment? What was their motivation for issuing new stock – and who forced them to decide not to?

They are spending non-stop on marketing – it is an enormous percentage of their revenues – but even their almost universal brand name recognition in this region will not change the issues cited above.

Nothing changes the facts on the ground – no matter how the investment community spins it - Not more internet penetration, not more per capita income, not how smart their CEO is – nada!

Mercado Libre’s PE today is 333.
It is valued at $2.5 Billion – it had a net income of only $20 Million last year.

Ebay – Mercado Libre’s model (and largest stakeholder) – has a PE of 95.
They had a net income of over $1 Billion last year.

Everyone is talking about what a disaster it is at Yahoo.
It has a PE of 33 – not 333. They had a net income of $660 million last year.
A PE 1/10th as large and 30 times as much earnings.

Google, Lord Google, King Google, Maser of our Universe Google only has a PE of about 40.

How well can Mercado Libre do that their stock price is going to rise given that their PE Ratio is almost 9 times greater than Google’s, 10 times greater than Yahoo’s and almost 4 times greater than eBay which earned 50 times more than them last year?

I just can’t see any justification for investing in this stock.

My guess is that all the institutional holders are thrilled with this recent massive spike in MELI and will be happy to get out with a fancy profit.

Disclosure: I do not hold any position in MELI/eBay/Yahoo – long or short.

[LatinAmericaJaJa]

Sorry, a couple mistakes - but it doesn't change the premise of the argument..
MELI's net income was $10 million not $20 million last year.
Ebay's net income was over $1B in 2006 not 2007.