2023-11-21 08:30:00 ET
Summary
- Today, I will start with an update on the meteoric growth of MercadoLibre's digital ads business.
- Subsequently, we will discuss the underlying infrastructure that MercadoLibre has built atop of which it's layered this ads business.
- We will discuss its competitive advantages, i.e., economic moats, whereby it's built a juggernaut tech platform in one of the most challenging operating environments on earth.
- With many of its regions still in the process of fully digitally industrializing and with decades of infrastructure and brand development as its foundation, I believe MercadoLibre has many years of growth still ahead.
- In short, I like MercadoLibre stock at ~$1475/share.
Obligatorily Starting With Digital Ads
The subhead suggests that digital ads are so central to the thesis , as well as so central to a handful of the companies I discuss with you, that I am forced to start with a consideration of this line of MercadoLibre's (MELI) business.
Revenue from our advertising services grew above 70% on an FX-neutral basis for the sixth quarter in succession, and is now equivalent to almost 1.7% of GMV. This high margin revenue had a positive impact on our Q3’23 gross margin, which was 3% higher YoY.
[I will further translate this for you in just a bit.]
MercadoLibre Q3 2023 Shareholder Letter
As you know by now, I have become fixated on what I believe to be a second "Google-like search engine ad revolution."
While I am sure I have at least a handful of Alphabet ( GOOG ) ( GOOGL ) millionaires that read my work, who took bold bets on the business in the 2000s and have held to this day, I am likewise sure that many of you, myself included, did not.
With this in mind, my hope in this brief introduction, in which I highlight MercadoLibre's rapidly growing ad business, is to articulate the idea that there is a second search engine ad revolution underway that is of equivalent scale and breadth to that we've witnessed from Alphabet over the last 25 or so years.
That is, we have the opportunity to buy the Alphabet of 2004 in 2023 via the purchase of MercadoLibre, Amazon ( AMZN ), Coupang ( CPNG ), and Sea Ltd. ( SE ).
While not a perfect science, I have been articulating this to you in sharing data such as:
Investment Ideas I Shared Recently
To put this "GOOG-like search engine ads scaling 2.0" into quantitative context, whereby I illustrate its likeness to the original Google search engine ads scaling 1.0, cumulatively, MELI, Amazon, Coupang, and Sea have grown their high margin digital ad sales from about $0 in 2015 to about ~$45B in 2023!
(I will henceforth refer to MercadoLibre as MELI and MELI, Amazon, Coupang, and Sea as "MACS.")
Google Grew Ads From $0 In 2000 To $22B in 2008
While Google only grew from $0 in digital ad sales to $21.8B over about 8 years, MACS has grown from $0 to about $45B! (most of which is, notably, from Amazon, which just reported $12B in digital ad sales in Q3 2023).
With this context in mind, we can see that MACS' digital ads scaling has represented a genuine GOOG-like search engine ads scaling.
It is no exaggeration to suggest that MACS has experienced a Google-like search engine ads scaling event, a 2.0 if you will.
In fact, I would say MACS has been in a league of its own in this respect, surpassing even Google at its own game, and I believe MACS has at least another decade to secularly grow at elevated rates!
Amazon's Ads Business Has Been Secularly Growing Through An Ad Downcycle
To this end, I found the following exchange noteworthy in highlighting the strength of MELI's digital ad business, the scale thereof, and the opportunity that, specifically, Coupang and Sea have still in front of them.
Analyst: And then the second one, if you could just talk a bit more about the advertising business in the quarter. I didn't -- I may have missed it. didn't see the absolute amount. But if you can just talk about how that's trending and how you're thinking about the ad business longer term.
Ariel Szarfsztejn: Scott, Ariel here. So ads continue to grow well. We grew above 70% in revenue this quarter for the sixth consecutive quarter, with no major changes in strategy. We continue improving our product with feedback from advertising and promoting our solutions to different segments of sellers and brands. Product ads continues to be the main driver of growth, specifically the self-service sellers , but we are seeing more and more traction from other segments as well.
Overall, we had a quarter with 1.7% of penetration of ads as a percentage of GMV.
Q3 2023 MercadoLibre Earnings Call
In Q3 2023, MELI generated $11.36B in total GMV, and MELI generated 1.7% of that quarterly GMV in 70-80% EBIT digital ads.
This implies that MELI's ad business is currently doing about $772.5M in annualized, very high margin digital ad revenue, and this is growing, FX neutral, at over 70% and has grown at this rate for the last six quarters consecutively!
For the sake of brevity and focus, I will not delve into the ad businesses of the rest of MACS with you today; however, for instance, Amazon reported $12B in digital ad sales in Q3 2023, growing at an accelerated pace of 25% (!), and this grew from ~$2.5B in quarterly digital ad sales in the same quarter in Q3 2018.
Incredible stuff here.
After tracing Amazon's ads growth throughout 2018 , in 2020, my central MELI thesis was that it would experience a likewise incredible scaling of its ads business, and we've seen as much in the last three years.
In short, there's currently a Google-like search engine ad scaling 2.0 underway, and this has been the case for years now.
In closing, I believe the digital ad businesses of MACS, and specifically, MELI, have many years of secular, elevated growth still ahead of them.
Yet More Acceleration
When MELI reported its exceptional sales growth, I suspected it was being largely driven by the inflation that Latin America has been experiencing and specifically the inflation that Argentina has experienced lately.
While there was certainly some truth to this thinking, the reality was that MELI accelerated its business growth via selling more items and via capturing more customers. Good old fashioned growth.
During Q3, in the commerce business, we saw acceleration in GMV and items sold growth in the three main geographies where we operate with higher items provider. This higher user engagement come from continued experience improvements, especially on the logistics front where we reached 48% of fulfillment penetration and offer better delivery promises, improving conversions and further development of categories to technology.
As a result, we have a record of 50 million buyers and market share gains, especially in Brazil and Mexico. Mercado Pago off-platform TPV accelerated in all main countries. We saw an increased number of users and higher engagement metrics as we position Mercado Pago as a comprehensive financial service provider.
Martin de los Santos, CFO, Q3 2023 MercadoLibre Earnings Call
As further evidence of the MELI's business accelerating, sans inflationary growth, MELI shared a host of KPIs for each of its major regions. For instance:
Mexico’s performance in Commerce continues to excel, and we believe our Q3’23 results show how well positioned MercadoLibre is to take advantage of the country’s long-term growth potential. GMV growth remained strong at 34% YoY on an FX-neutral basis, with growth of items sold accelerating to 38% YoY (from 34% in the prior quarter), its highest level since Q1’21.
MercadoLibre Q3 2023 Shareholder Letter
As can be seen below, MELI accelerated its items sold for the fourth successive quarter.
MELI Items Sold By Region
And this growth was driven, in part, by growth in total unique buyers, which grew by 18% in Q3 2023.
MELI Total Unique Buyers Grows
Like many of my other companies that have reported thus far, this acceleration is incredible and is indicative of a business that is growing within secularly expanding industries and is, more specifically, indicative of a competitively advantaged business growing within secularly growing industries.
I've now covered for you:
- MELI's attractive and very rapidly growing digital ad business, which is part and parcel of
- MELI's attractive 1P and 3P ecommerce business, which has recently accelerated growth in Latin America.
MELI's digital ad business would not work without the success of its ecommerce business, in which MELI displays its digital ads (among other places, to be sure, within its conglomerate), and MELI's ecommerce business would not work without its differentiated logistics network that has been built over the last 25 or so years.
Let's now explore MELI's logistics network; after which, we will review its cash dynamics, its margins, and its valuation.
MELI's Economic Moat
I could spend a great deal of time discussing MELI's various moats; however, today, we will focus on its ecommerce moat.
Without MELI's ecommerce moat, its items sold would not be accelerating. Its digital ad business would not exist. This is the tangible infrastructure that requires boots on the ground in each of MELI's respective regions to execute, and it is arguably the foremost barrier between MELI and its various competitive threats.
Over the last 25 years, MELI has experienced an almost endless series of competitive attacks from a variety of competitors; most recently Sea Ltd. and Temu.
Notwithstanding decades of competitive pressure, as we reviewed in the previous section, MELI is the strongest it's ever been, and not only that, it's accelerating its growth from this position of strength.
So it's worth asking: How could MELI be accelerating growth as more and more competitive attention is directed at Latin America?
In short, MELI's logistics network is the key source of differentiation for the business. As Amazon so often notes, delivery speed, reliability, and price ultimately determine whether a consumer is likely to purchase from an ecommerce platform vs a brick-and-mortar platform or from a rival ecommerce platform. Speed is often highlighted as the most important variable among the three.
To this end, MELI has built its logistics network via tens of billions of dollars in investment over the last 25 years, and this acts as one of its economic moats, fending off competitors attempting to take pieces of its market share and/or margins.
Logistics is another area of investment.
In Q3’23, we opened our first regional fulfillment center in Rio de Janeiro, which enabled us to increase our same-day shipping promise in Brazil’s second largest ecommerce market.
We also announced that another facility will open early next year in the state of Pernambuco to increase capacity in the northeast region. Furthermore, we expanded one of our facilities in São Paulo and are preparing to add new fulfillment centers in Mexico in the coming quarters so that capacity keeps up with our volume growth.
These long-term investments are designed to maintain our logistics competitive advantage , which was apparent in Q3’23 as we hit a record level of fulfillment penetration of 48% of shipments (up from 40% in Q3’22) - with Brazil leading the gains, helped by sellers’ NPS for fulfillment reaching a record high.
Moreover, on-time deliveries hit record levels in Brazil, Mexico, Chile and Colombia at the same time as we improved the delivery promise on our product pages in all geographies, which positively impacts conversion .
MercadoLibre Q3 2023 Shareholder Letter
Over the last 30 or so years, many investors have marveled at the incredible ascendence of the MACS franchises (not all were started 30 years ago of course). I would wager that, even for those that have benefited from this incredible ascent, it's not been immediately obvious as to what has created the immense, secular growth of the last few decades.
Yes, ecommerce is obviously more convenient, and the convenience creates consumer surplus that often outstrips that of brick-and-mortar "commerce platforms," and, combined with lower costs, this consumer surplus increases further.
I believe that investors have intuitively understood this, even if they would not articulate it in this fashion.
However, I believe most have missed the nuance underlying this better value proposition.
By which I mean MACS has created respectively vertically integrated, highly autonomous (and getting even more autonomous), AI-driven commerce platforms within massive, multi-trillion dollar TAMs.
These vertically integrated, highly autonomous commerce platforms have gradually, and, in some periods such as the pandemic lockdowns, rapidly, consumed market share within their commerce TAMs.
In the case of MACS, their vertically integrated (including the website, the product recommendation engines, the logistics networks, the fulfillment centers, the robotics, the labor capital, the digital ads, the payments, etc.) commerce platforms have created meaningfully differentiated consumer experiences that have created consumer surplus that has outstripped legacy commerce platforms, such as a Sears department store or a physical Walmart location (of course, not universally).
I recently used Coupang as an example to demonstrate the above dynamics. In the below example, simply substitute "Coupang" for "MELI".
Coupang Eating Away At Its "Inverse Bubble"
- It's "Inverse" because Coupang's value (Market Cap) is small relative to the Industry/TAM in which it's growing; therefore, Coupang collapses the bubble into itself by consuming market share and, commensurately, expands as the bubble collapses into Coupang's revenue and profits.
- Conversely, in a regular bubble, Coupang's market cap would dwarf the industry in which it consumes market share, making the entire situation an unsustainable bubble where the business' value is set to collapse down to the size of the actual market.
On MELI's call, management echoed my above thoughts in the following insightful exchange:
Marvin Fong: So in Mexico, I think your shareholder letter cited you grew very strongly there, which is interesting because I think Temu only recently entered the country, is also seeing some strong adoption. So could you just discuss how you see the cross-border market in Mexico evolving? Is it that Temu's entry is actually growing the pie for everybody?
And the second part of the question is, how might this inform your strategy in Brazil, as I understand your cross-border penetrate – or the mix relative to your GMV is very low, but that presents an opportunity for you?
Ariel Szarfsztejn: So I'd say, before going into the details, first and foremost, over the last 24 years, we've been always competing with players from all over the world. So in a sense, we are used to having new entrants trying to get a pie of Latin America. We've seen Temu get into Mexico, in particular, in May, more or less. We've seen them making progress in app downloads and monthly active users. They seem to be spending a lot of money on marketing on social media, directed consumers, has been trying to download their app.
We are, obviously, monitoring that closely. But our data suggests that there is a bigger overlap between that business and the one with other cross-border platforms. Our business in the meantime continues to perform really well, as shown by the acceleration of items sold to 38%. Unit growth has been strong across the board, including categories where some of those players are focusing on, and all ASP ranges.
And our competitive advantages remain untouched, I would say, particularly logistics, which enables us to deliver fast shipping and payments, which allow us to provide attractive financing to our users.
Q3 2023 MercadoLibre Earnings Call
Later on the call, the following exchange further highlighted the value of MELI's logistics network and how it creates a moat for the business against 3P competitors like Sea and Temu.
Neha Agarwala: First, on the 1P business, we talked earlier in the year about some acceleration, gradual acceleration in the 1P business. How is that going? And what is the vision going forward?
Ariel Szarfsztejn: Hi, Neha. This is Ariel. So 1P grew 58% year-over-year on a consolidated basis. If you were to look at this by country, Brazil actually grew considerably more than this. So the way we think about it is that 1P remains a strategic priority for us. We see this as a key lever to compete and gain market share in certain categories, consumer electronics being one of the clearest probably examples of that.
We are very happy with the transformation of our 1P business over the last 12 months. We've had major improvements in our ability to manage pricing, promotions, stocks with the help of technology.
We have also seen significant improvements in the way we connect and relate with suppliers and the way we negotiate with them. We think that all these progress are structural gains that will put the business on strong footing for long-term growth and market share gains. So we remain optimistic and keep investing behind that business.
Q3 2023 MercadoLibre Earnings Call
So let's review what we've covered:
- MELI's digital ads business now generates about $750M in annualized sales and is growing 70%+ and has grown at that rate for six consecutive quarters.
- MELI's digital ads business is nested within MELI's accelerating ecommerce business,
- And these two lines of business could not exist without MELI's scaled logistics network, which has required decades to build and which creates substantial consumer surplus in the form of fast delivery speeds and great economic values on consumer products.
In some sense, this is the essence of the MELI thesis, and it is what creates the cash dynamics and margins we will review next.
Cash Dynamics
Like all of our companies, MELI has a truly massive cash hoard.
MELI's $3.256B Cash Hoard
As I've been mentioning lately, we're nearly done with the economic setbacks related to The Great Inflation, though we may have one last hurdle (emphasis on "may," as nobody knows) to overcome, and that hurdle may be a recession.
The companies I share with you, MELI included, have truly massive cash hoards with which they could weather anything the macroeconomic environment may throw at them.
With this as our platform, let's now turn to a review of MELI's valuation.
Valuation
Below, we will perform a valuation exercise for MELI. To substantiate the assumptions I will make, I'd like to start with a consideration of MELI's margin profile.
Below, we can see that MELI generates about 53% gross profit margins.
Generally, for most companies, this would imply that it could generate about 30%+ in operating margins and about 20%+ in free cash flow margins, though MELI has not been generating such high margins over the last half decade due to a very aggressive investment cycle on which it embarked in the late 2010s, which coincided with Amazon's aggressive investment cycle, somewhat notably.
MELI's Margin Evolution
However, MELI's margins have been once again expanding, as have Amazon's, as we were recently informed, and it looks as though they could return to their former highs of ~30% or more.
This level would make sense in light of MELI's gross profit generation.
As we can see, MELI's net income margin, which is roughly a proxy for free cash flow margin has doubled year over year and is trending upward in line with its operating margin.
Using this data, let's now begin our valuation exercise.
Assumptions
TTM revenue [A] | $14 billion |
Potential Free Cash Flow Margin [B] | 15% |
Average diluted shares outstanding [C] | ~50.21 million |
Free cash flow per share [ D = (A * B) / C ] | $41.83 |
Free cash flow per share growth rate (reasonable) | 15% |
Terminal growth rate | 3% |
Years of elevated growth | 10 |
Total years to stimulate | 100 |
Discount Rate (Our "Next Best Alternative") | 9.8% |
And here are the results of the valuation exercise:
As we saw in MELI's cash dynamics graphic, it repurchased a few hundred million dollars worth of shares, resulting in a 1M decline in total shares outstanding year over year.
With the company's margins rapidly expanding and with the company returning to a focus on free cash flow generation, I believe MELI will continue to reduce its share count via buy backs. Over time, I believe MELI will be a serial acquirer of shares, as management has demonstrated a disciplined approach to capital allocation, which should leave ample cash left over for share repurchases.
Turning to projected returns...
Considering the runway for growth that still lies ahead of MELI as Latin America matures from a digital industrialization perspective, I believe I used fairly conservative numbers.
I believe a 15% long run free cash flow margin is more than achievable, and I believe an average annualized growth rate of 15% is probably conservative considering MELI currently grows at about 40% currently and Latin America still has a long runway for ecommerce adoption as well as FinTech adoption.
I will say that this "easy 15%" return profile is about equivalent to the risk profile of MELI. I don't see this as an exceptional asymmetrical bet, as we're being properly compensated for our exposure to a more politically unstable environment, known for a disdain for "long tails of financial success," which America conversely embraces and celebrates.
That said, I think it's attractive nevertheless, and CEO Marcos Galperin has been through the worst the world has to offer over the last 25 years or so.
Concluding Thoughts
My goal in this review was to enhance your understanding of the fundamental drivers of value creation within the MELI conglomerate.
The MELI conglomerate is interesting insofar as it is a vertically integrated platform, and each product on the platform can also be sold as a standalone product.
In short, I like MELI at these levels both qualitatively and quantitatively.
Thank you for reading, and have a great day.
For further details see:
MercadoLibre: Understanding The Mechanisms Of Value Creation