Don't Believe the Hype About the "eBay of Latin America"
Investors have gone nuts for foreign stocks tied to social networking applications. Note:
- The sterling debut for Youku.com (YOKU) -- the "YouTube of China"
- The fanfare accompanying the introduction of Yandex (YNDX) -- the "Google of Russia,"
- The incredible rise in Sina (SINA) -- the "Twitter of China" over the past six months.
And then there's the "eBay of Latin America" -- MercadoLibre (MELI). (Oh and let's not forget that MercadoPago, the company's payment transaction service, could become the "PayPal of Latin America.")
No doubt, the MercadoLibre bulls see this stock as a second chance to invest in eBay before it became the $40 billion e-commerce juggernaut that it is today. Not me.
At the right price, you could talk me into buying a soccer jersey from Brazil or even a used car from (gulp) Venezuela. But at $80, I wouldn't touch MercadoLibre with a 10-foot pole.
Hot Air and High Hopes
MercadoLibre has been a tremendous success story since its initial public offering in 2007. Annual sales have nearly tripled over the last three years, while profits have grown from less than $10 million to more than $60 million. It now runs online marketplaces in 12 countries, including Argentina, Brazil, and Mexico.
That type of growth and the thought of millions of new potential customers as a result of improving economic conditions and Internet connectivity have gotten investors giddy about MercadoLibre's potential. That's led to a nose-bleed valuation. At close to $80, Mercado trades for 15 times annual sales and nearly 50 times 2011 consensus earnings expectations -- more than three times what rival eBay (EBAY) currently commands.
Ebay of Latin America
Youtube of China
Twitter of China
Google of Russia
Facebook of China
Facebook for Job Seekers
That said, shorting MercadoLibre over the past six months has been like sitting on a bunch of firecrackers being lit one by one. Just ask my portfolio. I'm down more than 15% on my MercadoLibre position since I decided to short it under $70. Painful. Yet, I'm confident in my short because think MercadoLibre's meteoric rise since mid-March was built on a lot of hot air.
Results Are Less Bubblicious Than They Seem
Mercado's move higher was timed almost perfectly with a sharp rise in the Brazilian real versus the U.S. dollar. This makes some sense because Mercado derives almost 57% of its revenue from Brazil (Argentina, Venezuela, and Mexico make up almost all of the rest), yet reports its results in U.S. dollars. Thus, a lower dollar and a higher real means more revenue for Mercado.
That being said, the company's first-quarter results weren't too shabby. Revenue of $61.5 million was up 44% over last year, and operating profits surged 50%. And gross merchandise volume, the dollar value of all transactions completed through MercadoLibre's marketplaces, grew 30% to $954 million.
But you have to appreciate just how much of an impact foreign currency changes had on Mercado's results. On a constant currency basis, Mercado's GMV grew a less-bubblicious 23% -- in Brazil, Mercado's largest market, GMV grew only 16% on that basis. The currency impact becomes even more apparent when you take into account that the exchange rate used by Mercado's Venezuelan subsidiary, which accounts for almost 10% of Mercado's revenue, was 23% higher against the dollar in the first quarter.
I'm not interested in shorting MercadoLibre as a play on a stronger dollar, but a sharp reversal in the Brazilian real and other Latin American currencies versus the dollar would certainly take a bite out of Mercado's operating results.
Digging further into Mercado's latest quarterly filing, I also note that the company continues to suffer in terms of earnings quality. Mercado's EBITDA (earnings before interest, taxes, depreciation and amortization) exceeded the company's operating cash flow in four of the last five quarters. That means the quarterly profits Mercado is reporting to investors aren't translating into the same level of cash flow, a strong sign of poor earnings quality. If you read my recent series on financial shenanigans, you'll know why you should always favor operating cash flow over reported earnings.
Back to That Inflated Price Tag
Ultimately, however, it comes down to price. I don't believe Mercado's results, while strong, justify a share price of $80 per share. At that price, investors are paying close to 15 times Mercado's annual sales, and more than 60 times annual free cash flow.
Compare that to Amazon.com (AMZN). It's a larger, more powerful company with a gigantic moat, and its 51% sales growth last quarter was actually much faster than MercadoLibre's 34% growth. Yet Amazon's shares trade for less than 3 times annual sales!
As for those who think this is an opportunity akin to investing in eBay in the beginning, be careful. The flaws I pointed out in Mercado's growth plans could cause investors to drastically dial back their expectations in the months to come. When that happens, MercadoLibre will come crashing down to a more realistic price, giving us the chance to profit by shorting today.
Motley Fool senior analyst Matthew Argersinger is short MercadoLibre. You can click here to see the rest of his holdings and a short bio.