MERCADOLIBRE INC MELI
October 23, 2015 - 11:10am EST by
coffee1029
2015 2016
Price: 98.50 EPS 2.00 2.23
Shares Out. (in M): 44 P/E 49 0
Market Cap (in $M): 4,349 P/FCF 29 0
Net Debt (in $M): -50 EBIT 153 0
TEV ($): 4,367 TEV/EBIT 28 0

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  • Founder Operator

Description

 
Mercadolibre is a higher quality, earlier stage, faster growing eBay+PayPal, with
significant management alignment and two potential strategic bidders. Local
currency sales are growing 55-90% year-on-year, which should dominate current
macroeconomic challenges, and justify what appears an expensive valuation on
historic earnings.
 
 
Introduction
 
For a bunch of supposedly cheap value investors, VIC members over the years have
done a pretty amazing job of picking some of the long-term winners from
technological change. I am thinking of torico780 (AAPL), miser861 and olivia08
(GOOG), and charlie479 (AMZN: who in 2011 at about ¼ the current stock price was
patient enough with us mere mortals to explain why
I think Amazon is one of the most admirable companies in the world”)
http://www.valueinvestorsclub.com/idea/AMAZON.COM_INC/60325/messages/579
65
 
Each of these long-term winning companies shared great business economics; management that
was smart, driven and appropriately financially motivated by large equity stakes; and
product familiarity to VIC members through personal use. Valuations varied, but
were rarely obviously value territory.
 
Mercadolibre looks similar to me*. One reason that it has not yet appeared on VIC I
suspect is that few members are users, due to geography. The other reason could be
that it has never looked cheap. But if growth continues to follow what seems a
relatively predictable playbook, the current above-average valuation could
over time prove in fact to be lower risk and cheaper than a broadly rich market.
 
(*though it pains me to recognize that I do not look similar, even in writing, to any of
the VIC rock stars cited.)
 
 
Business quality
 
Network effect businesses, such as marketplaces and online payments, have been proven
elsewhere to be good businesses. The obvious comparison is to eBay, on which
Mercadolibre was originally based in 1999, and to PayPal for MercadoPago since
2004.
 
Evidence for historic business quality has been decent returns on capital: double-digit
returns on total assets since 2007 IPO, and 20%+ return on equity. Because working
capital is negative, and fixed asset requirements are light, returns on narrowly-defined
capital are almost meaninglessly huge.
 
When these attractive economics are overlaid on less-efficient, more fragmented retail
markets like in Latin America, profitability can be sustainably higher: MELI’s
consolidated operating margins have consistently outperformed EBAY (prior to spin)
 
 
by 10% annually since 2007, and should still exceed EBAY’s this year despite very
significant Latin American macro challenges.
 
Nor must this high profitability necessarily compress as competition enters. Latin
American e-Commerce is meaningfully behind the US, at just 2.7% of total retail vs
9.0-10% for US. Therefore the #1 player in each of its geographic markets should be
able to sustainably grow for many years, even with robust competition.
 
 
Valuation
 
This is not a conventional value investment. For me to argue that it is cheap on
current or historic earnings multiples would first require of me plastic surgery,
elocution lessons, plus a follicle and personality transplant. The closest I can get,
slipping on a pair of fabulous 1990’s purple Gucci loafers acquired from its US competitor, is
that Price to trailing FCF (CFO D&A working capital changes) is…29x. Would it
help if I tell you that with no net debt the balance sheet is at least safe?
 
So the valuation is all about future growth. Though macro effects might in future
have material effects on the business, recent rapid FX depreciation have caused
translation effects to obscure underlying growth. This answers why I think it has
become cheap now. Unit measurement metrics can be used to isolate the underlying
growth rates of the business. For example, number of items sold is running at 28%
(consistently 20’s or 30’s growth during the past decade) and total payment
transactions last quarter was 76% (never below 30% since Pago was introduced).
These impressive pre-inflation, unit metrics suggest a robustly growing business.
Sure enough, when measured in local currency, the half of total sales coming from
Brazil is still growing at 58% despite a clearly depressed consumer environment, and
the quarter of total sales represented by Argentina is currently growing at 90% year-
on-year. Bad neighborhoods can have some bars and restaurants that make the trip
worthwhile….
 
Both Brazil and Argentina would come close to bottom in terms of macro-economic
sentiment right now, for many good reasons best stated by people more eloquent than
me on the subject. Brazil’s decline in investor perceptions has been particularly rapid,
sinking from close to “most valuable player” status only a few years ago, to a market
that many investors currently appear to consider uninvestible. The feedback loops
from macro into this company’s earnings are real and many: significant currency
depreciation and inflation, higher cost of capital, depressed consumer sentiment. All
this translates into reported USD operating income actually declining, as some second
order metrics such as USD GMV should decline for the second consecutive year in
2015. It is hard to pay top dollar for a business that is likely to report horrible USD
numbers for several quarters to come. Yet at some point the FX should stabilize, and
meantime current local currency hyper-growth rates should continue during a
challenging economy. CFO Pedro Arnt has recently argued why:
 
1. Online marketplaces carry a deeper SKU count, allowing consumers to trade
down more easily.
2. Users approach the marketplace as sellers, trying to raise cash.
3. Consumers who would otherwise not come to the website approach the
marketplace due to excess time, or budget constraints.
 
 
Management
 
Co-founder Marcos Galperin continues to hold 9.6% of shares outstanding valued at over
$400 million. He has realized $160 million in cash proceeds over the years from
stock sales (last in August 2013 at $124), and restructured his remaining holding
exclusively into a family trust. He continues to be very involved in the business.
 
Senior management is local, long-standing, and long-term in approach. This is
important for playing both defense and offense. Wealth preservation, let alone wealth
creation, during macro-economic crises requires foxlike ingenuity. For example,
Venezuela’s meltdown in recent years, while not without pain, has been intelligently
and conservatively managed. Many multi-national companies simply withdraw in
order to curtail losses, but MELI has remained active while isolating it from the rest
of the group, hoping that reduced competition outweighs the macro-policy costs. On
offensive tactics, rolling out a PayPal-like product has required a nuanced local
understanding of the integral role of credit with consumer purchase behavior. Since
changing the Brazilian Pago product to match zero-interest credit terms (with
financing offset by other embedded fees), 92% of all GMV is now being paid through
Pago. Such local risks and opportunities have historically been hard for US
executives to manage remotely.
 
 
Risks
 
1. Competitive entry. Amazon entered Brazil with Kindle Store in 2012, but has
since not rolled out any further product in the country, despite frequent
rumours. When asked, Amazon typically cites a disciplined capital allocation
framework. Local risk free rates in Brazil are 14.25% and rising, but I
suppose the breadth of Amazon’s ambition and the size of the regional
population makes full entry inevitable at some point. Alibaba continues to
grow Latin American sales, though Brazilian unique visitors are still just 37%
of MELI.
 
2. Policy risks, which are hard to dimension or predict during economic and
political crises. E.g. Brazilian Central Bank Authorization of MercadoPago is
pending; therefore a key growth driver could conceivably be turned off
overnight.
 
3.Macroeconomic risks, most obviously measured by exchange rates.
 
 
 
Additional materials
 
The Evolution and Growth of MercadoLibre
- Founder presentation, 2011 Stanford Graduate School of Business
 
 
 
Header financials are TTM 2015 and consensus.
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 
Speculative: acquisition by Ebay (already largest shareholder at 18% of outstanding) or Alibaba.
    sort by    

    Description

     
    Mercadolibre is a higher quality, earlier stage, faster growing eBay+PayPal, with
    significant management alignment and two potential strategic bidders. Local
    currency sales are growing 55-90% year-on-year, which should dominate current
    macroeconomic challenges, and justify what appears an expensive valuation on
    historic earnings.
     
     
    Introduction
     
    For a bunch of supposedly cheap value investors, VIC members over the years have
    done a pretty amazing job of picking some of the long-term winners from
    technological change. I am thinking of torico780 (AAPL), miser861 and olivia08
    (GOOG), and charlie479 (AMZN: who in 2011 at about ¼ the current stock price was
    patient enough with us mere mortals to explain why
    I think Amazon is one of the most admirable companies in the world”)
    http://www.valueinvestorsclub.com/idea/AMAZON.COM_INC/60325/messages/579
    65
     
    Each of these long-term winning companies shared great business economics; management that
    was smart, driven and appropriately financially motivated by large equity stakes; and
    product familiarity to VIC members through personal use. Valuations varied, but
    were rarely obviously value territory.
     
    Mercadolibre looks similar to me*. One reason that it has not yet appeared on VIC I
    suspect is that few members are users, due to geography. The other reason could be
    that it has never looked cheap. But if growth continues to follow what seems a
    relatively predictable playbook, the current above-average valuation could
    over time prove in fact to be lower risk and cheaper than a broadly rich market.
     
    (*though it pains me to recognize that I do not look similar, even in writing, to any of
    the VIC rock stars cited.)
     
     
    Business quality
     
    Network effect businesses, such as marketplaces and online payments, have been proven
    elsewhere to be good businesses. The obvious comparison is to eBay, on which
    Mercadolibre was originally based in 1999, and to PayPal for MercadoPago since
    2004.
     
    Evidence for historic business quality has been decent returns on capital: double-digit
    returns on total assets since 2007 IPO, and 20%+ return on equity. Because working
    capital is negative, and fixed asset requirements are light, returns on narrowly-defined
    capital are almost meaninglessly huge.
     
    When these attractive economics are overlaid on less-efficient, more fragmented retail
    markets like in Latin America, profitability can be sustainably higher: MELI’s
    consolidated operating margins have consistently outperformed EBAY (prior to spin)
     
     
    by 10% annually since 2007, and should still exceed EBAY’s this year despite very
    significant Latin American macro challenges.
     
    Nor must this high profitability necessarily compress as competition enters. Latin
    American e-Commerce is meaningfully behind the US, at just 2.7% of total retail vs
    9.0-10% for US. Therefore the #1 player in each of its geographic markets should be
    able to sustainably grow for many years, even with robust competition.
     
     
    Valuation
     
    This is not a conventional value investment. For me to argue that it is cheap on
    current or historic earnings multiples would first require of me plastic surgery,
    elocution lessons, plus a follicle and personality transplant. The closest I can get,
    slipping on a pair of fabulous 1990’s purple Gucci loafers acquired from its US competitor, is
    that Price to trailing FCF (CFO D&A working capital changes) is…29x. Would it
    help if I tell you that with no net debt the balance sheet is at least safe?
     
    So the valuation is all about future growth. Though macro effects might in future
    have material effects on the business, recent rapid FX depreciation have caused
    translation effects to obscure underlying growth. This answers why I think it has
    become cheap now. Unit measurement metrics can be used to isolate the underlying
    growth rates of the business. For example, number of items sold is running at 28%
    (consistently 20’s or 30’s growth during the past decade) and total payment
    transactions last quarter was 76% (never below 30% since Pago was introduced).
    These impressive pre-inflation, unit metrics suggest a robustly growing business.
    Sure enough, when measured in local currency, the half of total sales coming from
    Brazil is still growing at 58% despite a clearly depressed consumer environment, and
    the quarter of total sales represented by Argentina is currently growing at 90% year-
    on-year. Bad neighborhoods can have some bars and restaurants that make the trip
    worthwhile….
     
    Both Brazil and Argentina would come close to bottom in terms of macro-economic
    sentiment right now, for many good reasons best stated by people more eloquent than
    me on the subject. Brazil’s decline in investor perceptions has been particularly rapid,
    sinking from close to “most valuable player” status only a few years ago, to a market
    that many investors currently appear to consider uninvestible. The feedback loops
    from macro into this company’s earnings are real and many: significant currency
    depreciation and inflation, higher cost of capital, depressed consumer sentiment. All
    this translates into reported USD operating income actually declining, as some second
    order metrics such as USD GMV should decline for the second consecutive year in
    2015. It is hard to pay top dollar for a business that is likely to report horrible USD
    numbers for several quarters to come. Yet at some point the FX should stabilize, and
    meantime current local currency hyper-growth rates should continue during a
    challenging economy. CFO Pedro Arnt has recently argued why:
     
    1. Online marketplaces carry a deeper SKU count, allowing consumers to trade
    down more easily.
    2. Users approach the marketplace as sellers, trying to raise cash.
    3. Consumers who would otherwise not come to the website approach the
    marketplace due to excess time, or budget constraints.
     
     
    Management
     
    Co-founder Marcos Galperin continues to hold 9.6% of shares outstanding valued at over
    $400 million. He has realized $160 million in cash proceeds over the years from
    stock sales (last in August 2013 at $124), and restructured his remaining holding
    exclusively into a family trust. He continues to be very involved in the business.
     
    Senior management is local, long-standing, and long-term in approach. This is
    important for playing both defense and offense. Wealth preservation, let alone wealth
    creation, during macro-economic crises requires foxlike ingenuity. For example,
    Venezuela’s meltdown in recent years, while not without pain, has been intelligently
    and conservatively managed. Many multi-national companies simply withdraw in
    order to curtail losses, but MELI has remained active while isolating it from the rest
    of the group, hoping that reduced competition outweighs the macro-policy costs. On
    offensive tactics, rolling out a PayPal-like product has required a nuanced local
    understanding of the integral role of credit with consumer purchase behavior. Since
    changing the Brazilian Pago product to match zero-interest credit terms (with
    financing offset by other embedded fees), 92% of all GMV is now being paid through
    Pago. Such local risks and opportunities have historically been hard for US
    executives to manage remotely.
     
     
    Risks
     
    1. Competitive entry. Amazon entered Brazil with Kindle Store in 2012, but has
    since not rolled out any further product in the country, despite frequent
    rumours. When asked, Amazon typically cites a disciplined capital allocation
    framework. Local risk free rates in Brazil are 14.25% and rising, but I
    suppose the breadth of Amazon’s ambition and the size of the regional
    population makes full entry inevitable at some point. Alibaba continues to
    grow Latin American sales, though Brazilian unique visitors are still just 37%
    of MELI.
     
    2. Policy risks, which are hard to dimension or predict during economic and
    political crises. E.g. Brazilian Central Bank Authorization of MercadoPago is
    pending; therefore a key growth driver could conceivably be turned off
    overnight.
     
    3.Macroeconomic risks, most obviously measured by exchange rates.
     
     
     
    Additional materials
     
    The Evolution and Growth of MercadoLibre
    - Founder presentation, 2011 Stanford Graduate School of Business
     
     
     
    Header financials are TTM 2015 and consensus.
     
     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

     
    Speculative: acquisition by Ebay (already largest shareholder at 18% of outstanding) or Alibaba.
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