Why MercadoLibre's Moat Has Widened
We think the company’s network effect has strengthened.
We recently raised our economic moat rating for MercadoLibre (MELI) to wide from narrow based on the firm's increasingly capital-efficient online marketplaces and payment solutions and buyer and seller metrics that indicate a strengthening of its network effect moat source, which should help solidify its market leadership across Latin America.
We had anticipated much of MercadoLibre's 2016 momentum to continue into 2017, with total users (up 20.3%) and unique buyers and sellers (up 20.3% and 14.3% year over year, respectively) pacing consistent with our expectations in the first quarter.
However, we believe engagement metrics among MercadoLibre's buyers and sellers suggest a material strengthening of the network effect. Items sold per unique buyer increased 15%, live listings grew 58% (including a 39% increase per unique seller), and nascent verticals such as fashion and apparel (where gross merchandise volume increased 50%) as well as auto parts, home, and garden (each of which grew more than 30%) are gaining traction. This engagement led to a sharp acceleration in gross merchandise volume, which was up 31% on a reported basis and 61% on a currency-neutral basis in the first quarter, compared with 11% and 48% last quarter.
We also raised our fair value estimate to $270 per share from $190 to reflect more aggressive growth and profitability assumptions and extended the duration of the second stage of our discounted cash flow model. Based on engagement metric trends, we now expect 45%-plus growth this year and 26% average annual top-line growth through 2021, driven by low teens user growth and low to mid-20s average annual gross merchandise volume growth, versus earlier revenue growth estimates in the low 20s. Management will remain in investment mode the next few years, with a prudent emphasis on mobile commerce, customer engagement, and shipping solutions, but we expect this trend to moderate over time followed by increased operating leverage. Our model calls for adjusted operating margins to come in just under 24% in 2017--up from 23.1% in 2016--and approach 28% by 2021.
Why exactly is buyer and seller activity accelerating on MercadoLibre's marketplaces? Breaking down the numbers in greater detail, we believe there are two catalysts: (1) recessionary conditions in many Latin American markets, which have driven users to MercadoLibre's various marketplaces, and (2) changes that have enhanced the platform for both buyers and sellers.
We believe economic downturns over the past decade have been conduits for e-commerce adoption in many markets across the globe because of the competitive pricing, rapidly expanding product selection, and convenience of expedited shipping that these platforms generally offer. While e-commerce engagement and volume trends do typically slow during the onset of a recession, we believe value-seeking consumers flock to these marketplaces as economic headwinds persist--something we've seen in Brazil, Argentina, and several other MercadoLibre markets--allowing them recover before other consumer cyclical companies do.
For comparison, Amazon's (AMZN) active customer base was growing at a high teens clip in the years leading up to the Great Recession of 2008-09; this pace slowed at the onset of the recession. However, we believe it is important to note that Amazon's active user base reached an inflection point before the recession ended, with active users significantly accelerating following the 2008 holiday shopping season. These trends persisted in the years following the recession, with active user growth remaining in the low to mid-20s in the three years following the recession because of its competitive pricing, expanded product assortment, and reaching critical mass with its one- and two-day shipping. Based on MercadoLibre's accelerating listing and gross merchandise volume trends across new verticals, payment solutions, and shipping solutions (items shipped by MercadoEnvios increased 59% year over year to 27 million units in the first quarter), we believe we are seeing a similar recessionary bounce for MercadoLibre in many markets.
While the market appreciates MercadoLibre's 20% confirmed user growth the past three years, we don’t think the positive impact of improved seller tools has received nearly enough attention, including upgraded interfaces making it easier for sellers to upload larger catalogs more efficiently, the elimination of placement fees (mitigating seller concern about paying up-front fees for products that may not sell), and moving to a simplified "freemium" final value fee structure in many markets, which promotes engagement from larger sellers and encourages the use of financing, shipping, and advertising services. While we still believe there are opportunities for greater engagement among larger sellers using official store pages, we believe an expanded portfolio of seller tools have made MercadoLibre the marketplace of choice for many large and well-established vendors and should keep the firm’s blended take rate around 12% over the foreseeable future.
Our model assumes that MercadoLibre will serve almost 320 million consumers by 2021, adding support to the network effect source behind our wide moat rating; this is a function of favorable Internet adoption trends (just over 60% of the region's 630 million-plus population are Internet users and a third are Internet shoppers) and market share gains, which we expect to drive low to mid-20s annual gross merchandise volume growth over the next five years on a constant-currency basis and steadily increasing take rates for marketplace and payment services (we forecast an average of almost 12% the next five years).
More important, we've long believed that once an e-commerce platform amasses more than 10% of its operating regions' population as active users, it becomes very difficult for competitors to unseat it and can lead to a multidecade period of excess economic returns. With MercadoLibre already boasting more than a third of the Latin and South American population as active users, we would not be surprised to see the company looking to lock in these customers through membership and other subscription-based services while leveraging its leadership position into new growth categories such as mobile payments, cross-border trade, third-party fulfillment, and online-to-offline services such as restaurant delivery. Some of these businesses extensions are already cash flow contributors for MercadoLibre, but we expect these endeavors should drive improved profitability over an extended horizon.
R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.