Increasing Red Flags Appearing on Latin eBay, Mercadolibre

By: SumZero Staff | Published: October 25, 2013 | Be the First to Comment

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MercadoLibre (MELI) is a Latin-American e-commerce company which many bulls consider the "eBay of Latin America. " This perception has led to the severe overvaluation of this approximately $400 million in Revenue Company— being valued at approximately $6 billion at its current price of $135 per share. EBay, on the other hand:

• operates the world's largest online marketplace in over 40 different markets,
• is expected to grow revenues 20% and generate $19 billion with $4 billion in operating income next year,
• Has a proven mainstream retail Buyer Protected platform that's safe and unlike any other company in the world.
• Has a very transparent and clear financial statement that rarely gets questioned
• Oh, and let's not forget they also own PayPal and a few other very lucrative businesses along with an 18.4% stake in MELI.

So let's see how MELI compares. To start, there's a "slight" difference between eBay's business plan and MELI's, whereby MELI's customer base have a significant focus on selling/buying "grey market" goods that are illegally imported. Oddly enough, this is being ignored by investors today. Since this strategy is impossible to execute with significant scale (at least not without having the feds setting up office space in the company's headquarters), growth will hit a big wall in the near future, which could cause the growth rate of the $400 million MELI to actually be lower than the $19 billion EBay. This by itself should eliminate the "smaller, but faster growing" premium that is being applied to MELI shares in comparison to EBay.

On the business front, we believe that bull investors are not only significantly overestimating the growth potential of this company, but also ignoring the inherent risk of doing business in countries like Argentina and Venezuela, which account to over 50% of the company's earnings. The two countries have inflation of over 25%, and have consistently devalued their currency. The problems in Venezuela are even more troubling than Argentina in some regards. The Venezuelan government has devalued their bolivars' currency 5 times in less than a decade. The most recent devaluation occurred in February, 2013 where the value was cut by 32%, to a fixed amount of 6.3 bolivars'/dollar. This pegged "official rate" is the one that MELI uses to report its financials. The only problem is that even this 6.3 conversion rate is imaginary. As if that weren't enough, the Venezuelan government is also restricting MELI's (and everyone else) ability to withdraw their money from the country's banks. At first the government set limits to how much money can be taken out, but a complete rejection of any withdrawals has become a common event. This has led to unofficial conversion rates of as high as 45 bolivars'/dollar in some parts of the world, meaning it would take 7 times more bolivars to buy a US dollar than the rate MELI uses in their financials.

When I asked the company during one of their conference calls in February about these currency issues, the company said that they may be investing their Venezuelan currency into real estate in Venezuela. I am not sure how going from "somewhat inaccessible money that is depreciating regularly" to "completely illiquid investment that can only convert to somewhat inaccessible money that is depreciating regularly" is going to help MercadoLibre shareholders, but apparently someone thought this could work.

To finalize the currency issue in Venezuela, the company insists on using the 6.3 bolivars/dollar conversion rate in their earnings, which is clearly inflating earnings and revenues. This means that even their $400 million in revenues and growth generated are not what they seem, due to their selective accounting practice. Unlike hard to value assets that barters use, MELI has its revenues and gross profits come in the form of cash. Therefore, the only conversion rate that should ever be used for "cash" is current conversion value. To clarify, by current conversion rate I mean how much can MELI realistically get right now if they wanted to convert all of the currency? What it should be worth, and what it could be worth is a nice gesture by management, but misguided to say the least. Just imagine if someone tried selling you a house based on some future projected value, or what I like to call "wishful thinking value."

Another potentially problematic issue that MELI has is a pending regulatory lawsuit in Brazil—where nearly 50% of the company's revenues come from—relating to their payment processing unit, MercadoPago (their version of PayPal). According to the company's August 2013 10K filing, if the new law becomes enacted in its current form, it could force MELI to shut down the MercadoPago business indefinitely in order to avoid paying penalties for non compliance, as well as the infrastructure investment needed to comply with new regulation. Since the company does not have business liability or disruptions insurance coverage (per company's Annual report filed February 2013), any litigation costs or business disruption caused by this lawsuit [or any other] could materially harm this company's viability. Our sources tell us that over 70% of MELI buyers use MercadoPago to fund or to finance their purchases. Since the company typically deals with "subprime-type" customers, which have limited payment method options, this payment system is a critical part of the company's infrastructure.

The more we dig into this company, the more red flags we find. In addition to competing the likes of EBay and Amazon—which is tough enough—the company has so many internal issues being ignored by investors that it's hard to understand why the market is pricing their stock at such a premium of 12x projected sales. One thing we do know is that if trouble starts knocking on their door, none of their executives or key technical personnel will have to think twice about bailing out. Since none of them have an employment agreement with the company, and almost all option grants have become fully vested, there is little incentive for any of them to stick it out, or even keep the stock. Insider sales have run rampant by management across the board, with the CEO, Marcos Galperin, selling $37 million in stock just this past August.

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