MercadoLibre, Inc. (MELI) Earnings Call Transcript & Summary

So good afternoon. My name is Irma Sgarz. I cover the Latin American retail and Internet space. I'm here with Pedro Arnt. Pedro has been with MercadoLibre since '99 and for more than 20 years -- or exactly 20 years, pretty much. And he's been the CFO of the company since 2011. So Pedro, welcome, and thank you very much for being here.

Thank you. And it's been a while. So glad to be here again.

So MELI is in the midst of a multiyear investment cycle that's arguably even deepened into the second half of 2019. You just reported your fourth quarter numbers this Monday. Can you just help us understand what the main areas of investment are? Where you are in that cycle, when you think about some growth in the -- specifically the margin cycle going forward?

Yes. So because our business is also diversified so much, and it really is an ecosystem of very multiple complex payments products and also commerce, I think we need to start thinking and trying to understand the way we're deploying capital as a matrix, which, in a way, you have on one side, the FinTech world, which is a much earlier stage. The addressable market there is really enormous because it's not constrained by online with our wallet initiatives and our mobile POS initiatives. We've really moved off-line. And I would say that part of the business is certainly in full investment mode still. Even within that, I think we keep talking about the older generation products that we're distributing to base and middle of the pyramid consumers. So traditional financial services, MPOS devices, asset management products, consumer and merchant credit. I think those have established business models with, I think, better understood profit models. So in a way, those are profitable and generate cash. But then there's a lot of investment in what we call the next-gen or the new-gen FinTech products, which are the ones that excite us the most. So digital wallets, QR codes, eventually the distribution of insurtech, and those are in all out investment mode. So I think all in, when you combine that, you still have a FinTech universe, where we're investing very, very aggressively. And then on the commerce side, I think you need to look at the other axis of the matrix, which is by geos. There are smaller geographies that are in earlier stage of Internet development. So a Colombia, Chile, a Peru, where those are still more about top line growth and reaching scale than about starting to dial up the profitability objectives. Then you have Mexico that's somewhere in the middle. It's a very promising market. It's still a little bit earlier in terms of development in Brazil or Argentina. So there, I think we will continue to invest aggressively, but start to gradually try to drive that market to less losses than it's been delivering. And then you have Brazil and Argentina that because of the stage of evolution, the scale of those businesses, the development of e-commerce, those begin to have a P&L management that's more about continued focus on growth and maintaining our scale leadership, but paying more and more attention to also delivering operational leverage and incremental profit at a cautious and gradual pace but yes, focusing on bottom line.

Great. And if I may double-click on one of those initiatives, one of them is logistics. Can you just review a little bit for us what you're doing on the fulfillment side, specifically in Brazil, but also your other main geographies? And what's sort of maybe the right mix over time between what has traditionally been much more of a dropshipping model. And then over time, we'll blend it to a hybrid between dropshipping, cross-docking and fulfillment.

So I think this has been one of the areas, if I look back over the last 2, 3 years, where we really feel we've executed in the most encouraging and successful way, right, from where we are and where we are today. So as a marketplace that manages hundreds of thousands of SMBs and millions of total sellers, one of the disadvantages we had is that a lot of the deliveries and the fulfillment were left in the hand of our merchants. So we've tried over time to build a logistics network where we could start fulfilling for our merchants. Or in the case where the merchants didn't want to send the inventory for us, picking up and then using cross-docking to inject into our network. So we call that the managed network versus the dropship network. We're already at a point where, for our largest geos, Brazil, Argentina or Mexico, Argentina and Mexico, 40% of volume is already done on our managed network, Argentina is north of 50%. So that's very successful. And I think the aspiration is to continue to drive that to probably, I don't know, significantly higher than it is right now. Within that managed network, as you alluded to, there are 2 flavors. There's the fulfillment by MercadoLibre, very original name. And that's really, I think, from a user experience and a cost perspective, that's the preferred form of delivery. So we would like to drive as much inventory from our merchants in a co-located fashion into our own DCs, where we control the fulfillment experience entirely. Mexico, we've been incredibly successful there, 40%. So the entire managed network is fulfilled by us. Brazil is a step behind. So in Brazil, we're already somewhere in the low- to mid-teens being fulfilled by us and almost 30%, we still have to pick up at the merchants and then inject into our network. But the trajectory here has been very positive. I think we'd aspire to be able to push as much into fulfilled as possible over time. But it will take us time until we get there. But the results so far have been, I think, very, very positive.

Yes. And in Brazil, specifically, are you facing competition to try and drive merchants into your fulfillment or some degree of resistance? And when you think about weaning your merchants off the incentives that you've been providing to get them into your fulfillment, how do you think about what sort of impact that could be having? And what are your differentiating factors really to maintain them within your fulfillment?

Yes. So I think the answer is yes and yes, right? If a merchant sends inventory to us, then by definition, that's not inventory that he holds in his own store or that he can sell elsewhere. I think what we've learned more recently is that what's even more important for the merchant is, can you move that inventory for me? Because if you can, then that's fine. I'll just go for deeper inventory. The problem becomes, if it's stuck there and I can't sell it. So as long as we're rotating the inventory well for them, that should work out pretty well. The last quarter has actually been a very positive quarter. I mean you know this. If you look up until Q3, Brazilian fulfillment adoption had been kind of stuck at mid-single digits, and we were having some challenges getting merchants to send inventory for us. So the preference in Brazil, unlike Mexico, clearly was the cross-docking. The last quarter has been a lot better. So we've increased by almost nearly 10 percentage points of adoption for fulfillment. Hopefully we can sustain that. I don't think Brazil is at a point where we're aggressively trying to wean them off some of the benefits to get them to fulfill. We are diminishing those a little bit, but Brazil is still more about making sure what today is in the low- to mid-teens of fulfillment adoption can get to Mexico-like levels. Mexico, where it's already 40%, is where we now can start shutting down the subsidies. Because at the end of the day, the end game of fulfillment is that merchants should prefer it because it reduces costs for them of warehousing inventory. It should be operationally easier for them. And most importantly, it should allow them to sell greater volume and better on the platform. So that should be the reason why merchants opt for fulfillment and not subsidies or other benefits that we give.

Well, let's get to the elephant in the room then. Brazil GMV growth, I think there's always an incredible amount of focus from the investment community on that metric. And I think it's a good segue to sort of follow-on from your fulfillment, the progress, the impressive progress that you've actually made on the fulfillment side. Yet, I think it's probably fair to say that the improvement that you've made on the fulfillment side haven't necessarily translated into an incremental acceleration on the GMV growth front. Can you just sort of explain to us what's going on there? And what would it take to -- what choices are you making? And what would it take for GMV growth to maybe reaccelerate? I think you've said it publicly that you haven't been particularly happy with the level that you're at.

So I think we're not trying to tap dance our way around this or spin it in any way. I think our expectation, given that we are the market leader, this is still early stage e-commerce is we'd like to see Brazilian growth be higher than in the low 20s. It's above market, but it's not -- we aspire to grow more than that, right? I mean -- and I think we've identified the levers we want to focus on. You mentioned one of them. We think we've invested a lot in terms of logistics and user experience in general. And we are seeing some metrics that, hopefully, are precursor metrics of reacceleration, which we think are really important. Like, for example, Net Promoter Scores have been consistently going up. And the user experience, in general in the platform, is a lot better. And our belief is that sooner or later, that translates into more engaged users, repeat usage and that accelerates GMV. We are somewhat frustrated that, that hasn't happened yet. Because really, when you look at the metrics around user experience, they're all improving. But we've also identified, I think, few other things we need to focus on that could potentially be catalysts to unlock faster growth. So there's certainly a category mix play that I think we need to be faster at. There are emerging categories within commerce in Brazil that are moving online quickly that we need to quickly capture and bring on to our marketplace. I think we've talked a lot about the whole consumer packaged food categories that some of our competitors are moving into aggressively. We've talked about deepening apparel as a category for growth and there are a few others. So I think that's the second driver of growth we need to focus on. And again, these might be solutions that take a little bit longer, but they are sustainable, long-term competitive advantages. And then there's another element, I think, around pricing that we need to focus on again. I think the flip side of all of these investments we've made on user experience is that we've shared some of those costs with our merchants. And so some of that probably have gotten passed on to cost of products on the platform. We also compete against 1P retailers, primarily, that have greater control with price points when they sell online. So we're very focused on 2 things now. The first one is, how do we set up the right incentives for our merchants to start being more aggressive again on pricing. And the second one is we've launched, and we can get into more detail on this, and we need to scale up quickly our own 1P efforts. So through first-party sales, we can step into either areas where there is inventory breakage to expand into these categories. And perhaps, more importantly on the pricing issue, we can try to be very competitive on pricing, where we're seeing that we're losing competitive power. So that will be another area of focus. And then I think it's also important to highlight what we don't want to do. I think what we don't want to do is just try to spend our way into faster growth with marketing ROIs that don't make sense. I think, like I said earlier, the objective here is to be able to reaccelerate the Brazilian marketplace, while also treating it as a large scaled-out business that, at this point, should also begin to focus on making sure that's a steady and gradual improvement in its margin structure. So it's not just about throwing more marketing dollars behind this, but rather building these longer, more sustainable competitive advantages to kick start growth again.

Great. And into the third quarter and still into the fourth quarter, you stepped up the marketplace branding initiative. Can you just, for investors here in the room, explain what's behind this initiative? Because I think to some people maybe that associated you as a market leader, as a household name, and so you've been around for 2 decades, people may sort of be puzzled, like why do you need a branding investment for something that is already top of mind?

Yes. And I think this is good because I can also segue to the previous question, right? When I say focus on reigniting growth, but also finding the right balance between investment and profitability, we're still going to be very aggressive in how we invest. We're still going to continue to invest aggressively in marketing. But even if you look at Q3 to Q4 in Brazil, you do see that there is some improvements in margin driven by slightly less aggressive marketing improvement -- investments. So what happened with the bump up in brand spend is that -- 2 things. I think we are the market leader. We are a household name. But if you compare our spontaneous brand recognition or our brand awareness in Brazil and Mexico and Colombia and Chile to Argentina for example or Uruguay, where we're even stronger, we identified that there probably was some room for incremental brand spend. I think consumer Internet companies don't always spend very much in terms of brand. We're typically much more focused on programmatic and online marketing. And so we thought it made sense to spend a bit more. And then the second piece just had to do with the brand attributes. So over the past 3 or 4 years, like I said earlier, we've invested very aggressively, and we've done a lot in terms of improving the user experience. So we probably have the most widespread and aggressive free shipping program, return program. We've recently been launching a loyalty program. We are expanding into new categories. And sometimes we feel we hadn't done a good enough job of telling that to nonusers. Our users know that. When we look at engagement cohorts, they've consistently improved over time. But if you look at nonusers, there was still a lot of, "Oh, MercadoLibre is the old marketplace business." So part of the brand spend was to focus money over a few quarters to make sure that all of these new benefits that we've been overlaying on to the platform were communicated a little bit more aggressively.

Great. I want to switch gears to Pago for a moment before opening it to any questions from the audience. Clearly, you're investing a lot into the digital wallet. And it's been showing impressive pickup in the active user base or the active payers over the last couple of quarters. Can you just help us understand sort of what the road map is here over the next couple of years, where your focus lies in terms of investments?

So the wallet is, I think, a key piece of our overall FinTech strategy, right? The FinTech strategy is a little bit more ample. At the end of the day, like I -- there are large portions of the population that are either unbanked or underbanked throughout Latin America. And through technology, through cell phones, there's now a service model where you can service all of these people. The wallet is maybe the core feature or the core product within that strategy, right? So from the wallet, you will be able to pay, from the wallet we will be able to cross-sell other financial services to you. So it's an area of focus for us. In terms of where we're at right now, I think we're much more in that initial land-grab phase, where what we're trying to do is onboard as many merchants as we can to be able to accept wallet payments from our wallet. So there's a lot of effort on building the merchant side of that network. And then on the consumer side, we're trying to: a, distribute as efficiently as we can to our existing marketplace users, and I think that's one of the big competitive advantages we have is that we already started. This is similar to one of the Chinese players with this enormous ecosystem of people that are already paying on our marketplace. So the number for Q4 was more than 40 million people, if you take into account the marketplace that paid for something using Mercado Pago. That's enormous jump up point in terms of competitive advantage. But we're also trying to acquire wallet users away from our marketplace -- payers to get them on board. And so I think the road map right now is to build that capillarity both on the wallet user side and the merchant side, and to then start cross-selling the products that we've mentioned, right? Consumer and merchant credits, asset management that we've already launched, eventually get into more distribution of insurtech products. And that's probably where the monetization and the profit pools come in.

Any questions from the audience? I think we have revolving mics at the back. No questions, I'll just keep going. So still on Pago. When you think about -- you've started monetization just gradually very recently in Brazil this week, I think, and in Argentina already last quarter. But I think we're not at a stage, it's fair to say that we're not at a stage yet where margins are the focus, I think, growth is still the focus. Can you help us understand a little bit what the competitive landscape is like at the moment? And is there a threat from someone like WhatsApp Pay, for example, coming into the market?

So first of all, in terms of current competitive landscape, I think, because the opportunity is so large, and the TAM is so large, clearly financial services and banking throughout Latin America are being deeply disruptive, right? Either because you're able to reach consumers that had no financial services or very limited financial services, or even because you're able to attack those that did with a better user experience. And so the opportunity being that large, you're going to have new entrants. And there are a lot of, I think, publicly traded companies we compete against and a lot of very well-funded and that are executing very well, private companies. I do think that maybe unlike the commerce side of our business, and I've said this throughout most of our meetings today, this one is -- there are no real network externalities here. So there's probably room for a lot of these businesses to grow very well. We do think, and I'll use this as a segue to Facebook that, like I said before, we have a very strong competitive advantage and that we already have one side of the network quite well built out in all the buyers on our marketplace. And we also have a relationship with millions of merchants also on the market side of the business. So I think one of the Chinese peers that really built their payments product off of that, or even PayPal in the U.S. that initially, the eBay tie-in was critical in it being the first to scale. And so I'll use that to tie into, to Facebook. And I don't know what their design for payments is, that's a question for them. But I think we do recognize that Facebook is a player that has one side of the network also incredibly built out. So in that sense, there's someone that brings a platform to the payments party, which is always an extremely strong competitive advantage. But early days, only difficult to know what it is that PayPal is trying to do, what the regulatory, I think, appetite for Facebook getting into payments will be. I have more questions than, I think, well-thought-out answers to that one at this point.