Business Breakdowns
· Daniel Wu
[00:00:00] S1: So if we put everything together. So all these business lines that we just discussed, we essentially have a company that has grown top line by 55% CAGR since 2019, which is pre-COVID, and then by 43% CAGR since the COVID peak of 2021. So there's barely been a growth hangover. Commerce revenue growth has been underpinned by very healthy double-digit growth in the number of items sold, the rise in share of first-party sales and also the take rate expansion from advertising and Envíos net shipping fees that we talked about. And on the fintech side, growth has been driven increasingly by off-marketplace merchant acquiring, which as we said greatly expands Mercado Pago's serviceable addressable market beyond just marketplace transactions and has also been driven by credit revenue which since the launch of credit cards in 2021 has grown at 65% CAGR. And I'd say that one of the remarkable things about the Meli ecosystem is that it has three opportunities to earn revenue on the same dollar of marketplace GMV. So firstly, you've got the marketplace fee from the transaction itself and then there's the prepayment fee if it's a credit card transaction. And finally if it's a Mercado Pago credit card, Meli also owns the interchange and potentially net interest income on that transaction as well. So it's a pretty attractive model.
· Matt Reustle
[00:00:00] S0: Absolutely, yeah. I find these businesses very interesting when there's complementary layers that can be stacked on top of one another. And that would certainly apply from a margin perspective as well. How would you frame whether you want to take it at a gross margin level or immediately go down into operating margins? How do you think about it on a consolidated basis in any of the key drivers, whether it's mix shifts or whatever it might be?
· Daniel Wu
[00:00:00] S1: Yeah, so I'd say gross margin is probably not as relevant for Meli, just given the growth of that credit business, where defining gross margin for credit is very different from gross margin for say, the marketplace business. So let's just go down straight to operating earnings. The first thing I'd say is that the company doesn't disclose operating income by segment, which is unfortunate because it would be very interesting to see how those operating earnings shake out between the two segments. But working with what we have, company-level operating margin is essentially a tale of two halves. So from IPO through 2013, Meli was a mid-30% margin business. And then from 2014 to 2016, there were some hyperinflationary issues in Venezuela, which was Meli's highest margin country, and that caused margins to fall down to 21%. And then with the launch of free shipping in 2017, margins got absolutely crushed, down to just 5%. And then they turned negative in 2018 and 2019. So since that 2019 trough, operating margins have made a steady recovery back to the mid-teens level in 2023, before the company embarked on another reinvestment phase. And with the free shipping changes that we mentioned earlier this year, we think the margins remain under pressure for this year and next year as well. But what I would say is that from this timeline of events, it's a good demonstration of Meli's long-term reinvestment strategy. When free shipping was launched in 2017, growth of marketplace items sold was still very healthy. So it wasn't like Meli was responding to a slowdown of the business. And yet we're fairly confident that without turning on free shipping in 2017, Meli wouldn't have been in a position to capitalize on the COVID disruptions and it would have a smaller share of a smaller e-commerce pie today.
· Matt Reustle
[00:00:00] S0: And you referenced a bit in terms of lighter capital intensity than you might see at somewhere like Amazon. But how would you think about that margin flowing down into earnings, free cash flow and just some of the capital allocation framework in terms of how they think about it? You mentioned the reinvestment into the business that can happen a few different ways, but just thinking more from the below the line and then free cash flow dynamics.
· Daniel Wu
[00:00:00] S1: So I'd say in terms of the incremental operating margins, they can be relatively high for the marketplace business depending on I suppose where the reinvestments are being made. Because obviously with the third-party merchant business they're just collecting a fee. So any growth and penetration of advertising or when they eventually start monetizing logistics, that should all fall through to the bottom line at a pretty high rate. But of course the company is also investing more into its first-party sales as well and I think that's pretty important for expanding the different categories that the marketplace is able to address, especially around the higher-value consumer electronics pieces and then the much lower-value grocery business as well. On the fintech side, I think as we discussed, the biggest driver is going to be that compression of the NIM (net interest margin). But that of course ends up being offset by faster dollar growth of the fintech operating income. Our understanding is that the company doesn't really manage the business through margins either, so they're much more focused on the long-term opportunity and they will basically sacrifice short-term profits if they can extend the long-term growth runway or just position the business to have stronger growth in the long term. Just lastly on free cash flow and capital allocation, free cash flow defined as operating cash flow less capex, is distorted by the credit and digital wallet businesses given the non-cash charges, the changes in credit receivables and customer deposits. The company started reporting an adjusted free cash flow number last year which strips out the impacts of the fintech business and that figure was $1.3 billion for 2024 and $1.4 billion for 2023. You also need to make some non-cash adjustments to net income to approximate a conversion ratio which falls between 60 and 80% for the two years we have available. As for capital allocation, the priority is very clearly organic reinvestment, which includes funding the credit business as well. Since the 2007 IPO there's been just over $1 billion in buybacks and just over $200 million spent on M&A. So the majority of the reinvestment has been back into the logistics business and also the expansion of the credit business.
· Matt Reustle
[00:00:00] S0: And I think we've laid out the risks throughout the discussion and there's some fairly obvious ones. But sitting in the investment seat, what stands out the most to you in terms of the risks to the business that you would maybe worry about the most or the market worries about the most?