Mercado Libre. More than Amazon! Equity Research! Part 1/3.

Facilitating trade and transportation of goods!

Jul 25, 2024

For as long as humanity has existed, people have been trading with each other. Apple for an orange, fish for bison, labor for shelter. As we evolved from hunter-gatherers to farmers, to urban city dwellers, the way we traded goods and services changed. People realized that by specializing in what one is best at and trading the output, we could drastically improve our lives. In corporate speak, people found their “core competency”. Miners were mining ores, cooks were cooking, and lumberjacks were cutting trees.

People and organizations that enabled this trade of specialized goods and services became extremely important. The Dutch East India Company became exceptionally wealthy trading goods between Europe and Asia. Cornelius Vanderbilt was one of the US railroad pioneers during the late 1800s. His railroads enabled the transportation of goods from manufacturers to customers at a never-before-seen speed and efficiency! John Pierpont Morgan empowered money to flow through the booming US banking system.

What if I told you that there is a single company doing all 3 of these things?

Facilitating trade of goods!

Enabling the transportation of goods!

Empowering the flow of money!

If you read the title of this report correctly, you know I am talking about Mercado Libre, the e-commerce giant of Latin America. Established in 1999, the company is listed on the Nasdaq, founded in Argentina, with a head office in Uruguay. Mercado Libre means “free market” in Spanish. The company has ambitions to become the ultimate commerce and technology champion for 650+ million people in Latin America. Try finding a company whose name matches their goals more than Mercado Libre, I will wait.

During the last two decades, founder and CEO Marcos Galperins lowly but steadily worked towards that goal. However, since 2019 the growth has just exploded, Mercado’s revenues grew by 530%. Understandably, the stock is up over 400%.

Is Mercado Libre really, “the Amazon of Latin America” or maybe it is even more than that?

Let’s dive in!

1. Facilitating the trade of goods

2. Enabling the transportation of goods

3. Parts 2 and 3

1. Facilitating the trade of goods

Globalization has made us more connected than ever. No longer are we “forced” to be satisfied with local products. Goods from all over the world are now available quickly and cheaply. That wasn’t always the case and still isn’t the case in all parts of the world. Mercado Libre is working to bring fast, cheap, and reliable e-commerce services to an underserved part of the world!

Mercado Libre Marketplace

Marketplace is their flagship product, an online marketplace that facilitates the trade of products.

Customers can easily browse the marketplace for millions of products in thousands of categories. The platform has become extremely popular with sellers and customers alike. Mercado Libre is primarily a technology company that strives to deliver the best experiences for all its stakeholders.

“Our main focus is to serve people in Latin America by enabling wider access to retail, digital payments, and e-commerce services, and by providing compelling technology-based solutions that democratize commerce and money, thus contributing to the development of a large and growing digital economy in a region with a population of over 650 million people and one of the fastest-growing e-commerce and internet penetration rates in the world.” Mercado Libre 2023 10K

Technology first approach has enabled the company to create one of the fastest-growing e-commerce platforms in the world.

GMV growth has been parabolic. Last year GMV grew by 30% to $44.7B.

Since 2012, GMV has grown by 685%, a CAGR of 21%!

In my view, the marketplace is the backbone of the company. The more it’s used for commerce, the easier it is for Mercado to upsell various other services. GMV growth can be a great barometer for the overall growth of the company.

There are two main direct ways the company monetizes the marketplace. First-party sales (1P) and third-party sales (3P).

When Mercado sells products independently to customers it acts as a first-party seller. In this scenario, Mercado sources goods directly from the manufacturer or the distributor and handles the transportation and storage. The company is in full control of pricing and recognizes the entire sale as revenue.

However, 3P is when a product purchased by the customer is sold by an independent seller. Mercado charges the merchant a fee for using the platform and recognizes said fee as revenue. For instance, in Mexico the fees range from 12.5% to 22.5% depending on the product category, and whether sellers use any extra services. In other countries, fees might be different. All the shipping costs, insurance, warranty, returns, and COGS are paid by the seller.

The economics of these transactions are quite different. 1P profitability depends on Mercado’s ability to negotiate a favorable price with a supplier and their chosen markup. In 1P gross margins are low, sometimes as low as 10%-20%. Furthermore, as variable costs are high, the profitability of each incremental sale doesn’t increase significantly.

However, in a 3P sale, the independent merchant is responsible for his own expenses, so Mercado only incurs the costs of maintaining and managing the platform, enabling a superior gross margin. Additionally, each incremental sale is more profitable than the previous one as there are very limited direct variable costs associated with the sale.

The platform has all the features of a sophisticated e-commerce platform. Reviews from thousands of other customers, detailed product descriptions, pictures, videos, customer support, a broad set of payment options, delivery information, and more.

In 2013 83 million items were sold on the marketplace. Since then, growth has been astronomical!

Almost 1.5 billion items were sold in the last twelve months as of Q1 2024. That’s a 10-year CAGR of 32.5%!

Mercado Shops

Mercado Shops empowers sellers to quickly, cheaply, and efficiently create an e-commerce website. This offering is similar to Shopify.

This is a sophisticated platform with hundreds of different features and integrations not only with all of Mercado’s services but also with various third-party apps. Website creation used to be a difficult, expensive, and long process. One needed to hire a web developer to build all the desired features. Shops has a website-building portal with lots of templates that enable people without technical skills to design a website.

Inventory management software, marketing, social media management, payment processing, and loans to customers are just some of the features one can easily use to build their business.

Screenshot Mercado Shops Appstore Mexico

However, in stark contrast to Shopify, Mercado doesn’t charge a fixed monthly subscription. For example, in Mexico, the use of the platform is free and there is no cost per transaction.

Mercado monetizes shops by feeding all their other business lines!

Clients will use Mercado’s logistics to store and deliver products. Mercado advertising solutions are quite useful for increasing sales. Various financial products can be used to finance inventory and other expenses.

Sellers can build their brand using social media and other channels outside of Mercado’s ecosystem. As they continue building a brand and increasing sales, Mercado benefits as the provider of services. At the same time, sellers are not excluded from Mercado’s massive marketplace.

There is full integration with the primary marketplace, so sellers don’t have to choose between selling on their website or on the marketplace!

Conventional wisdom dictates that this cannibalizes marketplace sales. Logically as sellers don’t need to pay a commission from website sales, they might prioritize this channel. While it might be true in some instances.

I believe that in the long term, this approach actually increases marketplace sales!

Mercado is interested in the financial success of its sellers. By offering a comprehensive set of tools to help them, the company entrenches merchants in their ecosystem. If Mercado didn’t offer the Shops product, many sellers would use Shopify or other platforms. Happy and profitable sellers invest to grow their businesses to sell more goods, supporting GMV growth.

Mercado Libre Classifieds

Classifieds is a separate service that allows people to list real estate, cars, and various other local goods and services. The platform is similar to Craigslist and Facebook marketplace.

Mercado charges sellers a placement fee for advertising on the platform. The company itself doesn’t sell goods. Mercado wants to create an independent ecosystem for real estate agents, car dealerships, and other professionals, so they trust the platform.

Classifieds serve as a great way to further monetize its active client base!

Mercado has been working hard to build a brand that is trusted by its customers. Thus, Mercado is incentivized to have a fair and honest platform. If scams proliferate the classifieds customers will invertedly blame Mercado. Furthermore, by advertising on this platform, sellers want to benefit from this additional layer of trust.

The platform in itself is not a significant revenue driver, its main objective is to generate traffic for Mercado’s other businesses. A customer who purchases a vehicle is more likely to buy accessories such as a phone stand, feet mat, air refresher, and so on. Additionally, Mercado can upsell various financial services such as a car loan and insurance. Similarly, with real estate, new houses require TVs, blenders, coffee machines, paintings, and other products.

Mercado Classifieds is leveraging technology, scale, and customer trust to offer a superior product at a lower cost!

2. Enabling the transportation of goods

Mercado Envios is the company’s logistics arm. For any E-commerce company to gain scale a sophisticated logistics network is a must. If one wants to buy sneakers, they are willing to wait if it’s cheaper, however, if the wait time is too long, they will just go to a brick-and-mortar store.

Simply put, people love convenience and are not very patient!

However, delivering packages is expensive and takes time. If E-commerce is to take market share from brick-and-mortar stores it must offer a superior customer experience. Customers want quick and cheap delivery, however, there are too many middlemen in the process. Various distributors, warehouses, customs agents, trucking companies, cargo airlines, last-mile delivery providers, and so on. Each involved party delays the process and adds an additional cost.

E-commerce platforms realized that to deliver packages quickly and at a low price, they must take logistics in-house.

That is what Amazon did in the US, Alibaba in China, Coupang in Korea and that is what Mercado Libre is doing in Latin America!

“The logistics services we offer are an integral part of our value proposition, as they reduce friction between buyers and sellers, and allow us to have greater control over the full user experience. Sellers that opt into our logistics solutions are not only able to offer a uniform and seamlessly integrated shipping experience to their buyers at competitive prices, but are also eligible to access shipping subsidies to offer free or discounted shipping for many of their sales on our Marketplaces.” Mercado Libre 10-K

The more of the logistics Mercado can take in-house, the better the economies of scale. Higher scale allows Envios to acquire, store, and deliver packages for a lower price. The logistics arm is crucial for Mercado’s flywheel, which will be discussed later in the report.

In 2013 1.8 million items were delivered using Mercado’s shipping service, 2.2% of all sold items. Since then, Mercado has significantly enlarged their capabilities.

Almost 1.5 billion items were shipped in the last twelve months as of Q1 2024, that’s a CAGR of 92%!

Mercado Envios grew its share of platform deliveries from 2.2% to 98%, a huge indicator of the incredible success of Mercado’s logistics efforts.

One of the biggest issues in E-commerce is product warehousing. To prevent long wait times products must be stored in sufficient quantities and close to where customers are. Mercado is solving this issue by building a network of warehouses. A sophisticated network of warehouses enables the company to service customers where they are. Each warehouse is monetized by charging sellers various fees.

As of 31. December 2023, around 2.9 million square meters of warehouse space are used in their network.

Mercado is investing heavily in logistics in most of the countries it operates in!

When a customer places an order, a package leaves the warehouse on trucks. Apart from using large logistics companies such as FedEx, DHL, and UPS, various local logistics companies are involved as well. However, being fully dependent on 3^rd party logistics providers would result in bad customer experience. Meli is in the business of delivering superior customer experience, thus building their own last-mile delivery networks that are faster and cheaper could be beneficial.

Not all customers want to receive packages at their house. People are not always home as they have jobs, hobbies, kids, and families. Meli Place is a neighborhood business that has partnered with Mercado Libre to store packages. Customers can pick up and drop off packages relatively close to their homes and at a time that fits their schedule.

In 2020 Meli started cargo flights in Brazil and Mexico. Latin America is a mountainous region full of jungles and deserts, with a less developed road and rail network.

Thus, the need for airplane deliveries there is higher. In an interview last year Director of Transportation for Latam at Mercado Libre said that in Mexico they operate a fleet of 4 planes that move 50 thousand packages every day, 1.3M packages per month. In Brazil, the company operates 6 planes. Mercado Libre will likely continue expanding its aircraft delivery network.

Logistics reduce friction!

Some investors don’t understand why Mercado invests so heavily in logistics. It’s a difficult low-margin business with lots of well-capitalized competitors. All of that is true, if one looks at logistics as a separate business, but that’s not what it is. Envios is a crucial piece of the value proposition. Envios is not being built because Mercado thinks it can be a great business on its own, the main goal is to enable all other businesses to flourish. Getting a package to a customer’s doorstep is the most important step of the process. If customers are not confident in the arrival of their orders in a predictable set of time, no orders will be made. If there are no orders, Mercado can’t collect the platform, advertising, payment processing, and other fees from sellers.

As a business, you want to reduce the “processing power” required in the purchase decision-making process. The simpler it is for customers to use your services, the more likely they are to use it. As a customer, if you know that you can get a new coffee machine by tomorrow, the probability of ordering it increases. However, if it takes 1-2 weeks, and you are not certain that you will be home on the day of the delivery, then it’s a “hassle” to reschedule or you might need to ask the neighbor to pick up the package, etc. All this additional “processing power” in decision-making leads to delays and changed minds.

Evios is an important moat for Mercado Libre!

Competition can kill even the strongest of businesses. Moats protect companies from competition. By building a large and sophisticated logistics network, Mercado increases the barrier to entry for new entrants. If Mercado spends a decade and $ billions in building Envios, competitors would have to do the same. Physical assets are not that easily disrupted. Let’s say that a competitor with a better website, and clever marketing enters a market Mercado operates in. All of those things won’t matter if customers must wait 1-2 weeks to receive their order.

Convenience and price trumps uniqueness and novelty!

3. Parts 2 and 3

Financial services are increasingly becoming a significant part of Mercado’s business. In Part 2 of this deep dive, we will explore Mercado Pago. Pago is an insanely popular product that has achieved massive adoption within and outside Mercado’s network.

Additionally, we will look at risks. Mercado is a Latin American business, that comes with its set of risks and issues.

While there are certainly risks in Mercado’s business, the opportunities are extremely attractive, they will be explored in Part 3. The last part of this deep dive will also include a full analysis of Mercado’s financials and a valuation model.