Description

We think Mercado Libre (MELI) is a compelling long for truly long-term oriented investors. The company’s well-established position in LATAM and the winner take most or at least a lot dynamic in e-commerce and payments offer MELI tremendous long-term earnings potential, given the vast untapped opportunity in the region. While tremendous amounts of money and talent are spent in various battles around the world to become one of the few dominant e-commerce players in the particular regions, LATAM is currently still more or less left to MELI. Rightfully so, more recently MELI went into full investment mode and now wastes no time building on its important lead to capture more share of the opportunity in its region.

To address it straight away, the major threat hanging over MELI is obviously a massive entry by one of the big boys – primarily of Amazon. While this is certain to happen, we think it won’t be a disaster for MELI's investors because MELI is at a size and point where even an aggressive Amazon very likely won’t stop MELI’s development. Additionally, it will only entrench MELIs position as the logical asset to acquire by one of the other two players, (if Amazon gains success, then Alibaba and Walmart), of whom at least one, should have a major interest in acquiring MELI due to a lack of organic traction in the region and a resulting lock-out/defeat in this large part of the world. Alternatively, MELI could also decide to partner with someone like JD. For example, 10% equity stake for JD in exchange for logistics know-how/technology and the cash injection would go a long way to accelerate MELI's Logistics build out and entrench its leading position. 

At the current price, all of the big players could and we think would like to acquire MELI if one of the other players is successful in gaining a lot of ground against MELI organically. Walmart’s recent Flipkart investment and Amazon’s reaction to it, provide a blueprint of how well the downside is protected for MELI and what could play out in the next couple of years in LATAM. Even if Amazon really turns aggressive, it won’t succeed overnight. It took Amazon 5 years and $5 billion to catch up to Flipkart, all the while Flipkart continued to see massive growth. At a valuation of roughly $13 billion, all three players could afford to acquire MELI at a decent premium to its current price in 2 - 3 years time. Interest in the asset would likely result in quite a competitive bidding process. Thus, for the investment to work, MELI doesn’t necessarily need to be able self-fund its investments for a decade-long price war with Amazon. The acquirer also wouldn’t need to pay a silly price, since we think MELI's current price is attractive.

Talking about valuation, MELI is one of the more difficult companies to value given the uncertainty around growth and also some uncertainty about the long-term economics of e-commerce marketplaces and payments/digital financial services business. However, as long as the uncertainty is primarily on the upside - which we think is the case here - the uncertainty doesn’t turn MELI into a risky investment.

E-commerce at scale is a great business. Companies like Ebay, Alibaba, Etsy, Asos etc. (not saying that they are necessarily all great) provide us with undistorted financials (unlike examples like Amazon, JD or Wayfair that drive their earnings to or close to zero with 1P business) to easily see how profitable standalone e-commerce marketplaces are. Additionally, MELIs own past, before the company burdened its P&L with more aggressive growth investments primarily for shipping/logistics but also adjacent subscale businesses (like merchant credit, MPOS, setting up warehouses, etc.) also clearly shows the profitability of its core business. A net margin of 2,5-3,5% of GMV at scale seems reasonably achievable without heroic assumptions. Obviously, higher customer traffic/importance in a region and a broad selection of goods and services across all retail categories lead to higher "rental income for the virtual mall owner". In addition to the take rates to participate in the marketplace, high margin ad-dollars can be collected from brands who want more traffic, plus additional fees can be charged for services like analytics, customer service, financial services and supply chain solutions. 

At the end of 2017, MELI had over 210m registered users of which roughly 34m made at least one purchase in 2017. Q1 2018 showed growth in the number of buyers at +28%. Live listings ended the year at over 114m and over 270m items were sold during the year. Only 10% of those goods were secondhand and 95% were fixed price, not auctioned. Marketplace adoption is currently very strong on both sides with Q1 units sold up +50% YoY to 80m and live listings also up around +50% YoY to 127m items. MELI's GMV not only grew strongly but its composition also improved noticeably over time. While electronics made up over 70% 10 years ago, the mix dropped below 40% last year, with categories like apparel growing to 18% or auto parts and home & industries growing to 15% and 17% respectively. 

MELI should facilitate a GMV of $15-16 billion on its platform this year, which should provide an underlying earnings stream of around $0.4 - $0.5 billion prior to growth investments. The current GMV combined with MELI´s current strong growth already go a long way to justify the attractiveness of MELI’s valuation without taking the payments/broader financial services business opportunity into account, given that the e-commerce penetration in LATAM is still only around 3%. Combined with decent general retail growth in the region, MELI´s market could grow 15-20x over the next 15 years - or said differently still show mid-to-high teens growth after a decade of strong growth. With close to half a billion (and growing) of firepower to invest annually, MELI should be able to go after the opportunity quite aggressively. We don't see a reason to believe that LATAM should structurally settle at a lower e-commerce penetration than the rest of the world. We think the lacking penetration is only due to a lack of the necessary technology/business buildout compared to other regions.  

MELI’s fast-growing payments business which is rapidly gaining traction outside of MELI’s own marketplace can also turn into a fantastic business over the next 10 years. MELI should be able to continue to quickly drive merchant and user adoption, given its advantaged position with its leading marketplace business. Alibaba, Ebay or JD, again proof that having a successful e-commerce business is a very good starting point to scale a payments/financial business. MELI won’t stop with payments only and will certainly try to build a complete financial services business – again something that has worked quite well in other parts of the world, especially in China. The low credit card penetration, underbanked population and an easier regulatory environment are tailwinds for scaling such a business. MELI is already extending credit to merchants (current book @ $0,1 billion) something an e-commerce business is uniquely positioned to do. Additionally, MELI is already tipping its toes into extending consumer credit (in Mexico and Argentina) and building its scoring model. MELI is also quickly rolling out offline payment solutions to merchants - something that is key to really get strong network effects and adoption rolling. Close to 30% of TPV is off-marketplace and that business is currently growing with triple digits in local currency (+127% in Q1). MELI's TPV in 2017 was $13,7 billion, with marketplace penetration increased to 90%. Current growth will likely bring the value to or over $20 billion this year. Total TPV in Q1 was $4 billion up over 80% in constant currency and +60% in USD.

This business is even harder to value than MELI's marketplace. One can look at PagSeguro, Paypal, Square or recent acquisitions in the space, but that itself will only make the exercise a bit easier. The longterm economics are hard to piece together. One can certainly put an average comp. multiple on MELI's TPV for a  current figure. The exercise that would lead to a value of around $3-4 billion, or over $5 billion if one wants to be more aggressive. However, it won't tell one much about the value of the business in 10 plus years. However, we think the uncertainty here is again primarily on the upside and doesn't turn MELI into a bad investment at this price. Risk/Reward is favourable.    

Logistics is currently only an emerging business for MELI and will likely be a loss leader for several years, but we find the effort both necessary to drive e-commerce penetration higher and also promising long-term business opportunity. The overall opportunity extends as far as to providing a complete supply chain solution for brands/manufacturers for online as well as offline sales channels. At least that is where we think the market globally (with China leading) is ultimately headed long-term. A leading e-commerce player is in a decent position to build (in full or parts) such a supply chain given the precise data of the flow of goods to diverse endpoints and the knowledge about the endpoints themselves (namely us). Even though parcel companies currently have the scale in logistics, they generally don't have the data to help brands/manufacturers to become more efficient without a partner sharing precise sales information with them. They also don't warehouse the goods and lack the element where goods are stored in bulk but can be readily distributed to end customers in small/single quantities. The also won't get into a position to integrate inventory with offline stores, something that is already happening with strong e-commerce companies in some countries. Therefore the parcel companies simply aren't in a position to tell/inform a brand/manufacturer where to warehouse (and eventually even produce) how much of what in normal times and certainly not when a brand/manufacturer wants to perform various sales activities. The higher the e-commerce penetration (the flow of goods to us instead of consolidated retail locations), the more important "the missing information" becomes and the better positioned an e-commerce logistics company is to capture business from brands. It is also an area where ML can be very helpful and achieve new gains in efficiency compared to the traditional way of doing things.  

It is too early to tell how well MELI will be able to establish a logistics/supply chain business and if they will try to build it on their own or partner with someone to do so. However, they have at least already consolidated the shipping part for 70% of the business. With roughly 70% of merchants (based on items shipped) there exists at least a drop shipping relationship, with MELI handling shipping in a consolidated way. In Argentina, 40% is already cross-docked, with Brasil early in the mid-single digits. MELI knows it needs to quickly improve in this area, the customer experience is impossible to control and improve otherwise. It currently builds additional warehouses and is in the process to diversify its carrier mix further to reduce shipping costs and gain additional leverage over the carriers. It is trying to replicate what Alibaba has done with Cainiao. The very high urbanisation rate of roughly 80% across LATAM should be helpful to reach a large percentage of buyers relatively quickly. MELI recently introduced free shipping to entice growth and also change customer behaviour (customers across the world hate being charged for shipping, but not really if it is already included in the prices). Currently, roughly 50% of items shipped are shipped free.  

Another area where MELI needs to quickly improve is in building everything in its business around products and getting away from focusing more on sellers. Otherwise, MELI itself lacks knowledge about the products and only collects data on sellers, which is quite bad for both sides of the platform. Customers have a harder time finding the best/right products (no product reviews and poor search experience) and can't get decent customer service. The brands/manufactures, on the other hand, can't get decent analytics, and of course, can only be freed of customer service and logistics if the marketplace has those capabilities. Another risk is that MELI has no knowledge in running a retail operation which means much of what is needed going forward is new land for MELI which makes it a bit harder to assess their potential success. 

MELIs long-term strategic playbook is quite clear and if they continue to execute well the business will become much more valuable. They basically just need to look closely at developments in China, the US and India and copy what has worked in core commerce, financial services and logistics. The three areas supplement each other very well but don't necessarily need to be 100% performed and controlled by MELI itself. So, MELI can sell parts to raise capital/or partner with other companies in logistics and finance if it makes sense/is needed to get additional capital. A capital raise would likely be at very decent valuations, again reducing the risk of heavy competition. 

What coffee saw in 2015 still holds and MELI should continue to outperform over the long-term.  

Catalyst

no near-term catalyst, apart from potentially bad ones given the current macro environment and only more recently implemented heavy investments.