MercadoLibre: The Amazon Of The Amazon (For Now)

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About: MercadoLibre, Inc. (MELI)
by: Patrick Mayles
Summary

MercadoLibre enjoys substantial leadership, in a growing sector, in an emerging market.

It also enjoys a mammoth valuation of over 20x sales, despite 5 consecutive quarters in the red.

The company’s status as e-commerce leader in Latin America is nothing to sneeze at, and continued growth and revenue diversification are encouraging.

A tougher competitive environment and macroeconomic challenges make the company’s future an uncertain one, but it looks poised to dominate two high-growth industries in its region.

It's a testament to Amazon's (NASDAQ:AMZN) local dominance that few other e-commerce giants make it into the American lexicon. Much like JD.com (NASDAQ:JD) and Rakuten (OTCPK:RKUNY), MercadoLibre (MELI) is a regional market leader that most Americans have never heard of. Taking the lead of e-commerce behemoths before it, it has prioritized markets share over profitability, exciting investors with sustained growth, and by capturing nearly half of all online retail sales in Latin America. In MercadoLibre's 10K, it introduces its business as "the largest online commerce ecosystem in Latin America based on unique visitors and page views... designed to provide users with a complete portfolio of services to facilitate commercial transactions." It has earned such a distinction.

The Biggest Fish in a Growing Pond

In so doing, it has been crowned The Amazon of the Amazon, beating the king of e-commerce in all major Latin American markets, including Argentina, Mexico, and Brazil. That being said, the region is not yet the Eden of online sales that much of the world has become, as reflected by MercadoLibre's comparatively measly $1.4 billion in 2018 sales. The reason behind its hype and valuation is the growth it's enjoyed, the work it's done to diversify its business model, and the market growth that Latin America is set to experience in the decade to come.

This is a fine idea, and one that I'm tempted to subscribe to. However, some major challenges remain for MercadoLibre if it is to ascend to parity with the likes of Alibaba (BABA) and Amazon.

Shrinking Margins, Growing Reach

Chart Data by YCharts

Since 2010, MercadoLibre has undergone the arduous process of gutting its platforms and transforming its business model. In the process, margins have predictably suffered, as the chart above demonstrates. However, the company's labors seem to bear fruit. From decentralizing their systems to exploring new and lucrative service offerings, MercadoLibre has behaved like a rising tech giant, preparing its systems and business structure for a larger-scale, more competitive future.

Out with the Old...

One of MercadoLibre's most ambitious undertakings in this decade has been the steady reconstruction of its platform in favor of a more decentralized system of program-specific cells. In the process, they're also redesigning all front ends and constructing APIs for these cells to interact. This division into functional units makes for more focused, targeted services and systems, and has major security advantages as well. It's also not cheap. Per the 10k:

"We have been continuously working on a deep technology overhaul to switch from a closed and monolithic system to an open and decoupled one. We are splitting MercadoLibre into many small 'cells'... This effort has consumed a large amount of capital, people, and management's focus, and we intend to keep investing in this area".

As the company states, such efforts are expensive, but they pay dividends in the form of a superior user experience, better security, and the improved ability to quarantine system failures and bugs.

In with the New

MercadoLibre has segmented its business operations into two main areas: The Marketplace, which represents the company's traditional e-commerce and shipping platform, and Non-Marketplace Services, which comprises everything else. In recent years, the "everything else" category has caught up in terms of revenue share, an exciting harbinger of the future spaces which the company can occupy.

Some of the most exciting of these new offerings are the company's financial services. MercadoPago, MercadoFondo, and MercadoCredito represent a financial suite in a seriously under-served market. Roughly 70% of people in Latin America do not have a bank account. In response to this reality, the company has launched an aggressive campaign to provide payment, credit, and banking services to its customers, both online and offline.

MercadoPago, similar to PayPal (PYPL), enables users to make transactions and transfers both in and outside of the marketplace, and off-platform transactions warrant particular excitement. The company strengthens this area by selling its own mobile point-of-sale devices, generating income on the device itself and all transactions it processes. These measures help to modernize and empower commerce in a region whose finances are still largely outside of the digital realm. In Q4 2018, off-platform payments processed more than $2 billion in transactions, representing nearly 100% growth year over year.

MercadoCredito provides financing solutions to customers in the form of installment plans to pay for products purchased in the marketplace, and loans and lines of credit for merchants. The program totaled nearly $100 million in loans granted at the end of 2018. Importantly, this fills a major need in Latin America. Credit is much harder to come by in the region, and the program helps to democratize credit for both customers and merchants.

Confirming this is the fact that, according to company filings,

"In 2018, 2017 and 2016, installment payments represented 66.5%, 52.6% and 55.7%, respectively, of MercadoPago's total payment volume".

By reaching these customers, MercadoCredito offers the dual benefit of enabling greater sales and providing interest income. As part of the company's financial suite, it could see itself serving as a more general credit provider in the future.

MercadoPago provides a wallet, and MercadoCredito provides credit. MercadoFondo acts as a proper banking solution. Users are able to store and invest their MercadoPago balances, earning interest, and can use this cash balance for in-person transactions using QR code payments, prepaid cards, and even by withdrawing cash at ATMs. As a bank would, the company is able to invest these saved funds.

Non-Marketplace Revenue, Overtaking the Traditional Platform Source: Company Filings, Chart by Patrick Mayles

MercadoLibre has identified a major need unique to its market, accessible financial solutions and has taken major steps to fill this need. This move strengthens the company's core operations by increasing the accessibility of its marketplace and provides another major sector for MercadoLibre to lead in. The results are already positive. In 2018, MercadoLibre's non-marketplace revenues, comprised largely of its financial offerings, surpassed its traditional marketplace sales for the first time. While these developments are encouraging, there is no guarantee that MercadoLibre will continue to lead Latin America in e-commerce or fintech.

Macroeconomic Headwinds and the Competitive Environment

Stagnant Sales Argentina, A Full Exit from Venezuela Source: Company Filings

MercadoLibre's greatest strength is also its greatest liability: it dominates and operates exclusively in, the Latin American market. While it is able to capitalize on the local vacuum for its particular industry, it is also beholden to the region's famous financial volatility. This has been especially evident in recent years.

Argentina, one of the company's three major markets along with Brazil and Mexico, saw the peso depreciate roughly 50% against the dollar in 2018, stifling the country's appetite for consumption and chewing into the company's dollar-denominated sales. The result has been stagnant growth from a country that makes up roughly a quarter of total revenue.

Venezuela provides another illustrative example of how quickly giants can fall in the region. It was, quite recently, one of Latin America's richest countries. But this is no longer the case. Just last year, Venezuela comprised nearly 5% of MercadoLibre's total sales. In 2018, they had to divest completely from their operations there, at a considerable loss.

Financial instability or a capricious regulatory environment, especially in one of MercadoLibre's three main revenue-generating countries, would be a major hindrance to the company's performance. If things continue to sour in Argentina, we can expect the company's top line to get hit hard.

New Kids on the Block

In addition to macroeconomic considerations, we must give some thought to how MercadoLibre will adjust to a more crowded party, which seems an inevitability as the market continues to grow. Right now, MercadoLibre has a list of real but pint-sized local competitors, many of them limited to individual countries. As a dynamic sector that awards innovation and agility, any one of these challengers could give the firm a run for its money down the line. Amazon predictably enjoys a healthy market share in some countries, such as Mexico, but has not yet made a serious play for regional dominance.

MercadoLibre's massive market share and paltry sales reflect the nascence of the Latin American market for e-commerce and fintech, which may explain why big players like PayPal and Amazon have yet to wade into it with full force. This will almost certainly change as the market matures, and demand justifies the cost of entry. PayPal has shown a willingness, for now, to tap the market by investing in MercadoLibre, to the tune of $750 million. This relationship may be one of temporary convenience, as PayPal learns about the local market from the current hegemon.

Conclusion

MercadoLibre is in a dominant position within the Latin American e-commerce market and has made the right moves to ensure dominance, or at least leadership, in the emerging fintech industry as well. The company has sacrificed near-term profitability in the interest of developing a powerful business model and acquiring market share, taking a page from the greats on how to lead in an emerging industry.

The dust has yet not settled for the young company. It remains a small player from a global perspective with $1.4 billion in sales, despite a mammoth valuation and major deals with industry leaders, such as PayPal. It also operates in a risky region, and macroeconomic headwinds present potential and current setbacks for the firm. It also bears mentioning that as the pond it swims in continues to grow, new fish will likely enter the water, complicating what has been a rosy competitive environment.

MercadoLibre deserves the buzz it receives, and although it was an easier recommendation a few months ago at half the price, it still warrants a second look at its exorbitant market cap. The interested investor should keep an eye on its competitive and economic environments, and the evolution of its business model, to make sure the company remains the regional leader at an acceptable cost.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.