MercadoLibre, Inc.
Q3 2010 Earnings Call Transcript

Published: 4 Nov 2010

[Operator:]

Good day, ladies and gentlemen, and welcome to your MercadoLibre Q3 earnings conference call. (Operator instructions). And as a reminder, this is being recorded. I would now like to introduce Mr. Diego Escobar. Please begin.

[Diego Escobar:]

Welcome, everyone, to MercadoLibre’s earnings conference call for the quarter ended September 30, 2010. The company management presenting today are Marco Galperin, Chief Executive Officer, and Hernán Kazah, Chief Financial Officer. Additionally (inaudible) Hemenes, Senior Vice President of MercadoPago, will be present during today’s Q&A session. This conference call is also being broadcast over the internet and is available through the investor relations section of our website. I remind you that during the course of this conference call we will discuss some non-GAAP measures. A reconciliation of those measures to the nearest comparable GAAP measures can be found in our Q3 2010 earnings press release available on our investor relations website. In addition management may make forward-looking statements related to such matters as continued growth prospects for the company, industry trends, and product and technology initiatives. These statements are based on currently available information and our current assumptions, expectations, and projections about future events. While we believe that our assumptions, expectations, and trajections are reasonable in view of currently available information, you are cautioned not to place undue reliance on these forward-looking statements. Our actual results may differ materially from those discussed in the call for a variety of reasons including those described in the forward-looking statements and risk factors sections of our 10Q, 10K, and other filings with the Securities and Exchange Commission, which are available on our investor relations website. Now let me hand the floor over to Marcos.

[Marcos Galperin:]

Thank you, and welcome everyone to today’s conference call. Let me begin by summing up Q3 as a good quarter for us with sustained trading momentum on our platform even as we continue to dedicate resources to longer-term initiatives that have limited immediate impact. Throughout Q3 we continued to observe the positive dynamics which I have described over the last few quarters characterized by increasing levels of engagement by our users with our different service offerings. This increased complementary usage of marketplaces – classifieds, payment, and other (inaudible) – guarantee both improving user appearance for our customers as well as (inaudible) financial models for our company as we move forward. In the meantime secular trends in technology remain steady and under line of strong future (inaudible) commerce in the region where we operate as growth in internet and broadband penetration continues to be fortified by improving infrastructure, access to computers, and quality of connection available. New consumers are spilling onto the web at a rapid pace, and in Q3 alone we added 2.8 million new users to our community of buyers and sellers, surpassing the milestone of 50 million users and ending the quarter with 50.2 million total confirmed registered users. This figure represents a 25% increase over last year. The convergence of these internal and external factors allowed for a record gross merchandise volume of $888.1 million in the quarter, a 12% increase year over year and 26% higher than last year when measured in local currencies. Items sold, possibly a better reflection of the stable rate of growth for our business as it eliminates distortions brought about by currency fluctuations, grew even more robustly at 30% versus 2009. Growth in volume is transferring over to growth in revenues at an ever faster pace as we are monetizing our gross merchandise volume more effectively than last year, mainly on the basis of our expanding payments service which has added value to more transactions than a year ago. Due to payment volume, penetration has returned to 21% in Q3 versus 14% at this time last year. That’s a strong jump in the number of transactions that are opting for frictionless payments, credit card purchasing, and the possibility to buy in installments. I will share more on that with you in just a moment, but first, let me highlight the growth of some of our key metrics. In the Q3 our company generated the following year on year growth in operational metrics

[Hernán Kazah:]

Thank you. As Marcos just mentioned, the Q3 of 2010 was another strong quarter for us, as our combined businesses generated solid results. In the quarter we generated net revenues of $56 million, a gross profit margin of 79.5%; income from operations of $19.3 million, leaving operating income margin at 34.5%; and net income of $18.8 million, a net income margin of 3.6%. Resulting EPS for the quarter was $0.43. As Marcos mentioned, I would like to provide you with greater clarity on two changes in our operations which have taken place in Q3. It’s important to highlight that these adjustments occurred as we have answered our users’ needs and captured opportunities to enhance our business. Neither of these changes had any impact on our net income or EPS. The first of these operational changes is the consolidation of our segment reporting

[Operator:]

(Operator Instructions.) Our first question comes from Imran Khan from. JPMorgan.

[Imran Khan:]

Yes, hi. Thank you very much for taking my questions. A couple of questions. First, I was wondering how is your view about comparative conditions of Pago as Paypal is considering to increase its presence in the Latin American market? So that’s question number one, and question number two is items growth rate was 30% and I think local currency GMV grew 26.5% if I’m correct. Can you talk about the driver of the ASP decline? Thank you.

[Marcos Galperin:]

Hi Imran, how are you doing? This is Marcos.

[Imran Khan:]

Good, how are we doing?

[Marcos Galperin:]

Very well, thanks. Let me answer the first question on and that and Hernán will take the second. So overall MercadoPago and MercadoLibre operate in a highly competitive environment, as you know, with many existing players and new players. And we expect that situation to continue to be like that for many years to come given the effectiveness of the market. We have always operated in a very competitive environment and we have done pretty well thus far, and we expect to continue doing very well.

[Hernán Kazah:]

The second question, Imran, about gross merchandise volume, that metric in constant dollars increased 26%; in US dollars it increased 12%. What we mentioned is that ASP in Brazil, particularly went down when you look at what happened last year, the Brazilian Real appreciated considerably over a short period of time and in Q3 and part of Q4 last year sellers did not adjust their prices immediately. So in a way we had some benefits last year in terms of gross merchandise volumes were measured in local currencies that they’re now explained against that. But I think an important metric to look at in Brazil is the growth of successful items, of items sold, which grew 25% versus Q3 of last year.

[Imran Khan:]

Thank you Marcos, Hernán, and Pedro.

[Operator:]

Our next question comes from Gene Munster of Piper Jaffray.

[Gene Munster:]

Good evening, and just another follow up on the GMV question. As you mentioned, 26% local currency growth, down from 35% last quarter but up against a really tough 52% comp a year ago. Is there any just general thoughts you can help us with in terms of thinking about GMV growth over the next year? I’m not asking for guidance but is this a number that you think would go down over time in terms of local currency growth rate, relatively stable? Any thoughts on that and then I have a follow-up question.

[Hernán Kazah:]

Yeah, in terms of local currency gross merchandise volume growth we maintain the same position we maintained in the past, which is we think that ecommerce in the region will grow somewhere between 20% to 30% over the next few years and we should be able to at least maintain our share there. So that’s more or less what we’re forecasting locally going forward. When you look at that in US dollars you have the currency playing there a role. This time around we still have some headwinds. As of Q4, we’re going to be benefiting from that scenario if things remain as they are today, so we think that now with a more stable horizon of currency and exchange rates we should see in local currencies the same long-term growth that we expect to see for US dollar gross merchandise volume.

[Gene Munster:]

And just my follow-up question is we’ve gone through and kind of done a back of the envelope in terms of your take rate based on the new numbers, and it seems to be going up about 30 basis points per quarter over the last couple quarters. Is that kind of what you’re seeing and how should we think about the rate and the pace that you start to increase take rate, especially now that you’re accounting for Pago as a platform plate? Does that change ultimately how you think about take rate? And then lastly just what a long-term take rate goal might be.

[Hernán Kazah:]

Yeah, our main focus continues to be on growth, and whatever we do on pricing is what we think is best to ensure that our users get a good value for the services they are paying for and we ensure also future growth. We’re currently doing lots of initiatives. On the one hand we’re bundling MercadoPago; our intention is to try to expand penetration as much as possible. On the other hand we’re also, as Marcos mentioned, expanding listings throughout the site. And that in the short-term also may produce a decline in take rate. So while the calculation you did is correct, if we were to account for MercadoPago financing revenues as we did in the past, you would have seen an increase of around 30 basis points on our take rate. But it’s not that we are working against that target. Again, our target is to continue growing, and with all the changes we’re doing on the platform and with the bundling of MercadoPago in Brazil and hopefully in new markets soon, we’re trying to see what’s the best (inaudible) for us to keep on growing, for us to capture more users, and not that much managing the business to a certain take rate.

[Gene Munster:]

So we may see a decline in take rate in the near term and then move up over time?

[Hernán Kazah:]

You might see them going up or going down. As long as we see revenues growing in a healthy manner we won’t care much about our take rate.

[Gene Munster:]

And do you think it could get to 12% in the next five years or ten years? Any thoughts on that?

[Hernán Kazah:]

Not really. At this point we don’t have a long-term view on what the target is for take rate, though we’ve been saying for a long while that assuming Latin America is a more inefficient retail market, you could argue that there’s lots of upside for us to try to have a higher take rate than whatever would be considered and equivalent take rate in a more developed retail market.

[Gene Munster:]

Alright, thank you.

[Marcos Galperin:]

Sure.

[Operator:]

Our next question comes from Robert Ford from Bank of America.

[Robert Ford:]

Hello, everybody, and thanks for taking my question. I had a question with respect to payments, first of all, and you mentioned that the Brazilian off-platform payments was up 98% quarter on quarter, which is phenomenal. And I was curious, you know, what the total payment volume was that’s associated with that, and then the number of total Pago users you have in Brazil. And where do you stand in terms of your PCI certification?

[Marcos Galperin:]

Hi, Bob, how are you? This is Marcos. So definitely off-platform volume is growing very fast from a low base as you know, but both number of users and volume is growing very fast and starting to gain some scale. We are not opening up those numbers as Hernán mentioned in his prepared remarks. We are eventually going to be opening up the off-platform revenues from MercadoPago as they become more significant, but we are very, very happy and encouraged with the results we’re having with MercadoPago in Brazil, both on-platform and off-platform. And obviously we believe we have key competitive advantages there.

[Robert Ford:]

And in terms of PCI certification in Brazil and other marketplaces, do you know where you are right now?

[Marcos Galperin:]

Yeah, we’re extremely advanced there. We are in good shape.

[Robert Ford:]

Okay. And out of curiosity, I know EBay has 2 million users right now in Brazil, right – kind of the individuals that typically buy for imported items. I’m curious as to why you didn’t decide to joint venture with Paypal and go it alone.

[Marcos Galperin:]

That’s an interesting question, Bob. Perhaps you should ask EBay, but obviously it’s not a question that we can discuss at this point. But as I said earlier we’re very excited with the way our business is going and we think we have very solid competitive advantages. We don’t particularly focus on any one competitor at any given point in time, so as I said before there are many competitors, some new. Probably other new competitors will be coming on board later on and I think the best thing we can do for us and our users and our shareholders is to focus on providing great value to our users and having great technology.

[Robert Ford:]

Okay. And then just one last question. That is, I notice you began offering free listings in Brazil. You started that in Argentina and I was curious what kind of traction you were getting in Argentina to expand the initiative out to Brazil.

[Marcos Galperin:]

It’s going great. I mean we really like the philosophy which is the premium philosophy. So you shouldn’t be surprised if down the road we have a free listing option in every country where we operate. And we believe that we will have many millions of new users enter into the marketplace, the internet and ecommerce in the next three to five years, and we don’t want to have any barrier preventing these new users from trying out our platform. And the results in Argentina were very good. We saw growth in listings and in revenues, and that’s why we have decided to roll this out to every other market.

[Robert Ford:]

Thank you very much, and congratulations.

[Marcos Galperin:]

Thank you.

[Operator:]

Our next question comes from Stephen Ju of RBC Capital Markets.

[Stephen Ju:]

Good afternoon, everybody. So Marcos, we’re seeing some of the other marketplaces’ platforms around the globe starting to offer fulfillment services to its sellers if they follow the Amazon model. Is this a business that MercadoLibre could think about offering someday? Thanks.

[Marcos Galperin:]

Hi, good afternoon. Obviously there are two major friction points in ecommerce. One is payments, the other one is fulfillment. We are extremely focused in solving payments and as I mentioned in my prepared remarks we aim at having 100% of payments flowing through our platform. And obviously fulfillment is going to be our next focus, and we’re starting to look into it as we speak. We’re not, having said that we’re not stating whether or not we’ll be doing fulfillment ourselves as of yet.

[Stephen Ju:]

Okay, so theoretically you could pick a logistics partner to handle some of the warehousing but it’s still too early to really say anything.

[Marcos Galperin:]

When we have our strategy that ensures that fulfillment is speedy and adequate for our users.

[Stephen Ju:]

Okay, understood. Thank you.

[Marcos Galperin:]

Thank you.

[Operator:]

Our next question comes from Jordan Rohan from Stifel Nicolaus. Jordan, if your line is on mute, will you please unmute?

[Jordan Rohan:]

Thank you so much. So my question is really one of direct contribution margin in the Brazilian market which (inaudible) as compared to, it looks like it fell from 51% to 38%. But I just wanted to clarify that the decline is due to the inclusion of installment finance costs in the direct line which correlates to the changing accounting you discussed. Is that right? And what would it have been otherwise? Would it have been flat, up or down slightly, something like that?

[Hernán Kazah:]

Yeah, what you’re saying, Jordan, is in the right direction. With this change in the operation of MercadoPago where we are re-selling the receivables before we even get them, we’re basically eliminating the costs that we used to reflect in the financial expense line. And those costs are directly subtracted from the revenue line, so that effects the redistribution level, the margins. And without that change it would appear to have some fluctuation because of the combination of MercadoPago with MercadoLibre fees, but not (inaudible) as the one you’re seeing.

[Jordan Rohan:]

Okay, one follow up question and it’s a bit long but I’m going to do my best to keep it tight, but essentially when you raise the take rate charge to the merchant in order to offset for the inclusion of MercadoPago services, you would have had to assume some kind of adoption rate by consumers in order to maintain revenue neutrality. So let’s just say that you raised it by 200 basis points and that covered you up to 40% TPV as a percentage of GMV. So my question is with the big increase from 33% to 39% in TPV, if I heard that correctly, in Brazil, are you at the point where you have to institute another price increase in order to maintain revenue neutrality on that bundled approach? I hope that makes sense.

[Hernán Kazah:]

Yeah, what you’re saying makes lots of sense. If we were to try to maintain take rates and profitability on a gross margin level at both businesses we should be doing the math that you’re doing. That’s not necessarily the case. On the one hand, as MercadoPago grows we see that we can keep on constructing some scalability of that business and better negotiations with credit card processors, and at the same time we might want to offer a better pricing to sellers and to buyers, and discount a little bit the pricing we are charging them. So if we were to maintain everything else equal you are right but again there are some savings that we’re getting, and at the same time we might want to be a little bit aggressive as long as again our revenues keep on growing at a healthy rate. We don’t want to extract too much value out of them. We think that the current margins we have are quite large, so we might try to pass on some of that, of those points to the seller.

[Jordan Rohan:]

Alright, thank you very much.

[Operator:]

Our next question comes from Steve Weinstein from Pacific Crest.

[Steve Weinstein:]

Great, thanks for taking my questions. A couple questions for you. One, it seems like the level of competition in Brazil has really increased over the last couple of quarters, and you talked about 25% growth in items sold. I’m wondering if you think that that is keeping up with the ecommerce growth in Brazil particularly right now or if you think you’ve lost any share or gained any share as the competition has gotten more intense. Also I think you talked before about a mid-30’s or low-30’s operating margin. I’m wondering if you could kind of update that based on kind of the new accounting where you’d want that to be. And then kind of a follow-up on Jordan’s question

[Marcos Galperin:]

Okay, Steve, let me take your first question and then Hernán will take the following questions. With respect to competition in Brazil, let me just clarify that. In the marketplace business we continue being far and away the leaders there. We don’t see significant competition from other marketplaces. With respect to the classifieds business we see our cars, our motors vertical gaining share very strongly as I mentioned in my prepared remarks with very strong growth in listings and in revenues. So in the marketplace business we believe we are extremely well-positioned. Our growth rate of 25%, we don’t know exactly where the market is growing. We don’t think that is a bad growth rate to have. We’ve seen this growth rate higher and as I mentioned also in the prepared remarks we’ve been very focused in developing our new software architecture and that implies that many of the things we could do to accelerate growth in the short term have been on the back burner. So this is a growth that is okay with us, we’re not worried with our growth right now, we’re not worried with our competitive position. We believe we have an amazing competitive position and with respect to our payments business it grew 98% off-platform but it also grew very fast on-platform, 120% year on year on the number of payments. So we believe we’re doing quite well there as well.

[Hernán Kazah:]

For the other two questions, on the one about our margins and the targets we have there, we’ve been saying for a long while that our operating income margin target was about 30%, and even with the growth of MercadoPago we thought we could maintain that. With this new operation in discounting MercadoPago receivables that might change a little bit, but nothing changes at the net income level. So you can translate that to a more normal tax rate versus the great one that we had this quarter, and that should be a net income margin of about 20% or around 20%. So that should be the target. In terms of final value fees and the impact of MercadoPago assets penetration growth over gross merchandise volume, certainly there are some direct costs that we need to cover as MercadoPago keeps on growing, but as I answered in the prior question we think that there are some savings that we can get from the growth of MercadoPago, some efficiencies that we gain also in the business in terms of bad debt and those types of things that disappear whenever we are using MercadoPago. And also we might want to pass on some of those savings to the users. So net, yes – there’s some pressure in terms of direct costs as MercadoPago participation grows, but we will be misusing that again to make sure that revenues keep on growing at a very nice pace but not necessarily a take rate.

[Steve Weinstein:]

Thank you.

[Operator:]

Our next question comes from Aaron Kessler from Bank Equity.

[Aaron Kessler:]

Just a couple of housekeeping questions. On the tax rate, can you clarify what you view the tax rate for Q4 and also maybe going into next year? And also the interest expense – I think you ended up at $500,000, $600,000 for the quarter. Just if you can give us an explanation of that what that was for. And then also on the G&A, it looked a little higher. I guess there were some onetime costs there?

[Hernán Kazah:]

Yes, so one question was tax rate. The last one was G&A. The one in the middle I didn’t get.

[Aaron Kessler:]

Interest expense. You still have about $500,000 of interest expense, just what that relates to.

[Hernán Kazah:]

Oh sure. Oh sure. So tax rate, the normalized tax rate that we should expect for our businesses will be below 30%. This quarter in particular we could use some (inaudible) allowances that we had from acquisitions, from the companies that we did in the past. We still have some other initiatives that might help us maintain that below the normalized level, but for modeling purposes I think that assuming something close to 30% is a sound rate. In terms of interest expense and our financial expenses, the most significant change there is that in the past there we used to reflect the cost of discounting MercadoPago receivables in Brazil, and now with the new operation that we have that we are re-selling those receivables to the finance institutions we no longer carry that cost, and basically that was discounted from the revenue line. So…

[Aaron Kessler:]

No, I understand that. I guess my question is there was about $600,000 of costs in the quarter. I’m just trying to figure out what’s left in interest expense.

[Hernán Kazah:]

We have some taxes that are recorded there from the MercadoPago operations.

[Aaron Kessler:]

Okay, great. And then G&A?

[Hernán Kazah:]

Yeah. G&A, we are having, we are moving our office in Brazil. We’re also moving our office in Argentina to new buildings, and that has increased that line. And as I mentioned also we had a few subsidiaries that we were not using that had some accumulated tax benefits that they were basically going to give them away, and we rescued that in that line. So we got like an extra, over half a million dollars in that line that are one timers. And also when you look at G&A as a percentage of revenues you have to bear in mind that now revenues from the financing part of MercadoPago revenues, they are discounted a little bit versus what they were last year.

[Aaron Kessler:]

Great, thank you.

[Hernán Kazah:]

Sure.

[Operator:]

I’m not showing any other questions at this time.

[Marcos Galperin:]

Okay. Thanks, everyone, for your time and for your questions, and we look forward to further questions in the next quarter. Thank you very much.

[Operator:]

Ladies and gentlemen, that does conclude today’s program. You may now disconnect and have a wonderful day. Copyright policy