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Massive Loss For MercadoLibre Creates Opportunities

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About: MercadoLibre, Inc. (MELI), Includes: AMZN, PYPL, SQ
by: Tristan De Blick
Summary

Off-platform Total Payment Volume of Mercado Pago has surpassed on-platform TPV, while growing at 190%.

Total Merchandise Spending on the platform is seeing accelerated growth, now growing at close to 37%.

This, as management has ramped up its marketing expenses.

At the same time, a large valuation allowance deepened out the net loss.

As these are one-offs and investments in the business, I believe the drop of more than 6% makes the buy opportunity even more compelling.

MercadoLibre (MELI) shareholders lost 6% after Thursday's numbers made clear that revenue came in lighter than the $604.9M expected by analysts. Nor was the company able to continue being profitable, which was expected as well. In fact, the company suffered its largest quarterly loss ever. But how bad are the numbers really? Is this the time to take a position in the 'Amazon (NASDAQ:AMZN) of South America'? Let's examine.

User growth numbers

Quick note: it is important to make a distinction between the numbers on an 'FX neutral' basis and on a dollar basis. As Argentina is the second largest market for MELI, the rapid decline in the Peso hurts MELI's numbers on a dollar basis, while it doesn't on an 'FX neutral' basis.

Mercado Pago

Total Payment Volume of the payment services offered by MELI saw an increase of 94.5% y/y on a neutral basis and 66.2% in USD. Growth is coming from an increase in the number of transactions (+118%), which offsets the decline in the average amount per transaction. The largest growth driver is the off-platform payments segment, establishing Mercado Pago more and more as an independent business division.

In fact, the Mobile Point Of Sales business, which offers merchants in brick-and-mortar shops the possibility to let customers pay through Mercado Pago, continues to be one of the fastest-growing non-marketplace business units. On a consolidated basis, MPOS TPV grew 141.2% year-over-year on an FX neutral basis. You could say that MELI disposes of both the PayPal (PYPL) and Square (SQ) of the continent.

The growth in Total Payment Volume is accelerating, as the growth has been climbing from 82% in Q1, over 90% in Q2 to now 94.5% in Q3. This, as both the average transactions per customer and the number of customers continue to grow.

Image source: financial report Q3

Last, TPV off-platform has now exceeded the on-platform TPV. All the while growing at more than 190%.

The shopping platform

Shopping increased year-over-year by 36.8% on an FX neutral basis. This is an acceleration over the last quarter, which 'only' grew by 33% year-over-year, which on its turn was higher than the 27% growth in Q1. This growth is driven by a large increase in new customers: 25.7% new 'unique buyers', which is significantly more than only 20.8% in Q2.

'Free shipping costs' are down 42%, while down 40% in Q2 and 39% in Q1.

Financial Numbers

Revenue

Net Revenue (revenue after deducting free shipping costs) stands at 603 million USD. This is up 90.5% YoY, and slightly lower than the expected 604.9 million USD expected by analysts. Strong growth is coming from Mexico, while the continued tumble of the Peso is compressing the dollar growth in Argentina (on a FX neutral basis, revenue grew 119% there).

Image source: financial report Q3

Net profit

While the company turned profitable last quarter and was expected to generate an EPS of $0.01 this quarter, it did not. In fact, it made a net loss of no less than 146.1M dollars. I believe this is the reason the stock dropped so much, as it indicates that MELI's user growth could be unsustainable: it pays more to acquire its customers than that the newly acquired customer earns them in revenue.

However, when taking a closer look at the numbers, we see that the net income has taken a large hit due to 'a valuation allowance on deferred tax assets'. Indeed, the company reported an income tax loss of 79 million dollars. Important to ask, is: "Could this happen again?"

The answer is 'Yes'. If one takes a look at the balance sheet, there are still more than 108 million dollars' worth of deferred tax assets outstanding. This is down from 185 million dollars at the end of Q2 (thanks to the allowance). If the company fails to turn profitable over the coming years, it won't be able to make use of these assets and they will weigh once again on the net income.

Image source: financial report Q3

Then again, these allowances are not in the least 'recurring costs'. In my opinion, investors should thus make abstraction of them (even though they hurt the current profits).

Yet, if we account for these allowances, the company still made a net loss of around 67 million dollars. This is a lot, and enough to wash away the net profits of both Q1 and Q2 combined. What's driving this loss?

Sales and Marketing expenses are. These expenses are up 230% YoY and account for 45% of total S&M expenses for the 9 months ended.

Image source: financial report Q3

Management says this about the increase in marketing costs:

The step-up in marketing is explained almost entirely due to the launch of our branding campaigns in our main countries as we continue to strengthen our ecommerce brand, but perhaps most importantly, we begin to build the Mercado Pago brand and begin to communicate the benefits of our payments ecosystem to our users through more traditional marketing channels -- Q3 earnings presentation

This means that management is promoting Mercado Pago off-platform and in brick-and-mortar stores, the right move IMO.

Conclusion

While revenue came in lower than expected and net profits were dramatic, I think this was a strong quarter. Revenue growth is indeed weaker than in Q2, due to another decline in the Argentinian Peso.

At the same time, Mercado Pago is establishing its dominance in South America. As the off-platform TPV has grown by 190% YoY, it is now larger than the on-platform TPV.

Management is investing (read: marketing) heavily in this business division, and has ramped up marketing expenses. This has resulted in a fairly large operating loss, which does not bother me all too much as they bear a 1-time cost (marketing) to acquire a recurring income stream (new customer).

At the current price, below $500, the company is trading at 12 times TTM sales, which is reasonable for such a growth company.

Disclosure: I am/we are long MELI. 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.