Unallocated Corporate Costs Grew 8.6 Points Slower Than Revenue
MercadoLibre's Form 10-Q for the quarter ended June 30, 2012 reports net revenue of $88.84 million, up 28.1% from $69.38 million in the second quarter of 2011 - growth driven by a 21.7% increase in gross merchandise volume» (GMV) on a 35.6% rise in items sold, plus a 39.1% increase in total payment volume» (TPV) through MercadoPago. Measured in local currencies, revenue grew 47.1% - a 19-point gap between reported and constant-currency growth, as the Brazilian real and Argentine peso both depreciated against the dollar during the quarter.
Here is the genuinely new development: every quarterly filing since Q1 2011 through Q1 2012 documented unallocated shared/corporate costs growing faster than revenue - a gap that peaked at 113 points in Q3 2011 and had narrowed to just 3.1 points last quarter. This quarter the gap didn't just close, it reversed: the unallocated "operating expenses and indirect costs of net revenues" line grew from $10.42 million to $12.45 million, up 19.5% - eight and a half points slower than revenue's 28.1%. For the first time since this line was first tracked in the Q1 2011 post, the corporate-cost pool grew slower than the business it sits below.
Consolidated operating margin jumped 4.82 points, to 35.89% from 31.06% - a sharp break from last quarter's 1.61-point contraction. Segment performance mostly cooperated this time: Brazil's direct contribution» margin rose to 43.30% from 40.08% (+3.22pp), Mexico rose to 45.93% from 44.47% (+1.46pp), Venezuela rose to 69.97% from 60.65% (+9.32pp), and Other Countries rose to 48.40% from 43.95% (+4.44pp) - four of five segments improving. Only Argentina kept falling, to 53.59% from 58.41% (-4.82pp), a second straight quarterly decline after Q1's reversal, Argentina's first since Q3 2010 in a segment that had improved every single quarter of 2011. Consolidated direct contribution margin rose to 49.90% from 46.09%, up 3.81 points.
Net income attributable to MercadoLibre grew 71.2% to $25.38 million from $14.82 million, far outpacing revenue growth, helped by both tax rates falling together this quarter - the blended rate fell to 27.7% from 34.0% and the effective rate fell to 26.4% from 28.6%. Diluted EPS grew 67.6% to $0.57 from $0.34.
The Prescription
Management has now delivered the exact fix called for after four straight quarters of a widening corporate-cost gap: not merely tracking revenue growth, but growing slower than it. The next move should be locking that in as a stated target rather than a one-quarter accident - MercadoLibre's MD&A still doesn't name a specific cost-discipline goal or explain precisely what changed structurally (headcount mix, shared-services allocation, a high comparison base in Q2 2011). A company that just expanded operating margin 4.8 points to 35.9% owes shareholders a plainer account of why, especially given how volatile this line has been (88.5% growth in Q1 2011, 66.7% in Q2, 151.3% in Q3, 118.2% for FY2011, 39.4% in Q1 2012, now 19.5%) - a swing this large, quarter to quarter, reads as something management could explain in the MD&A itself rather than leaving to a reader's own segment-note arithmetic.
What it should stop doing: continuing to treat Argentina's margin erosion as a footnote to an otherwise good quarter. This is now Argentina's second straight decline (-3.00pp in Q1, -4.82pp in Q2) after a full year of consistent gains through 2011 - the opposite pattern from Brazil and the other three segments, which all reversed higher this quarter. Argentina is also the segment growing revenue second-fastest (+65.9% YoY, behind Venezuela's +71.6%, almost certainly inflation-inflated given the peso's depreciation this quarter), so a shrinking margin on one of the two fastest-growing top lines is exactly the kind of combination that deserves a specific explanation - wage inflation outpacing price increases, a competitive response, or something structural - rather than being absorbed into the consolidated good-news story the rest of the quarter tells.
Key Financial Metrics
Three months ended June 30, 2012 vs. three months ended June 30, 2011 - consolidated, reported in USD (MercadoLibre reports natively in dollars; no FX conversion is needed)
| Metric | Q2 2012 | Q2 2011 | YoY |
|---|---|---|---|
| Net revenues | $88.84M | $69.38M | +28.1% |
| Cost of net revenues | $(23.89)M | $(16.94)M | +41.1% |
| Gross profit (73.1% margin) | $64.95M | $52.44M (75.6% margin) | +23.9%, margin -2.5pp |
| Income from operations» (35.9% margin) | $31.88M | $21.55M (31.1% margin) | +47.9%, margin +4.82pp |
| Unallocated corporate costs | $12.45M | $10.42M | +19.5% - slower than revenue for the first time since it was first measured here (Q1 2011) |
| Adjusted EBITDA | not disclosed | not disclosed | twenty-first straight filing undisclosed |
| Blended tax rate | 27.7% | 34.0% | -6.3pp |
| Effective tax rate | 26.4% | 28.6% | -2.2pp |
| Net income» (attributable to MELI) | $25.38M | $14.82M | +71.2% |
| Diluted EPS | $0.57 | $0.34 | +67.6% |
| Operating cash flow (derived, quarter-standalone) | ~$39.50M | ~$18.56M | +112.8% |
| Free cash flow» (derived, OCF less capex/intangibles) | ~$33.52M | ~$8.20M | +308.6% |
| Cash, ST & LT investments (period end) | $220.18M | n/a | - |
| Loans payable (period end) | $0.24M | $0.26M | essentially flat - still Argentine car-lease obligations |
Gross margin compressed 2.5 points (73.1% vs. 75.6%), continuing the multi-year trend since free MercadoPago pricing began: collection fees rose $3.6 million as TPV penetration (now 33.7% of GMV in MercadoPago-enabled countries) keeps climbing, alongside a $1.4 million rise in customer-support compensation and a $0.7 million increase in hosting costs. Because MercadoLibre discloses cash flows only on a six-month cumulative basis, the quarter-standalone operating cash flow and free cash flow above are derived by subtracting the already-reported Q1 2012 figures from this filing's six-month cumulative cash flow statement - the same method used in prior mid-year quarters. The FCF jump is real but partly a base effect: capex fell to ~$5.99 million from ~$10.47 million a year earlier, when Q2 2011 included a one-time ~$6.6 million Caracas office purchase.
Unallocated corporate costs grew 8.6 points slower than revenue this quarter - the first time the gap has gone negative, after narrowing from 113 points (Q3 2011) to 3.1 points (Q1 2012). Operating margin rose 4.82 points to 35.89%. See Unallocated Corporate Costs Grew 8.6 Points Slower Than Revenue above.
Key Operational Metrics
Three months ended June 30, 2012 vs. three months ended June 30, 2011
| Metric | Q2 2012 | Q2 2011 | YoY |
|---|---|---|---|
| Gross merchandise volume» (GMV) | $1,299.2M | $1,067.8M | +21.7% |
| Total payment volume» (TPV) | $411.6M | $295.8M | +39.1% |
| Confirmed registered users (cumulative, period end) | 73.2M | 58.4M | +25.3% |
| New confirmed registered users (in period) | 3.7M | 2.8M | +32.1% |
| Items sold | 15.8M | 11.6M | +36.2% |
| Take rate (net revenues / GMV) | 6.84% | 6.50% | +0.34pp - first increase after five straight periods of decline (Q2 to Q4 2011, FY2011, Q1 2012) |
The take-rate decline first flagged in Q2 2011 and tracked through Q1 2012's fifth straight fall reversed this quarter - net revenue grew faster than GMV for the first time since that streak began, meaning the non-GMV-linked revenue lines (classifieds, ad sales, MercadoPago financing and off-platform payments) outgrew the marketplace itself rather than lagging it.
Five Country Segments - Four of Five Improved, Argentina Alone Kept Falling
MercadoLibre reports the same five geographic segments adopted in Q3 2010 - Brazil, Argentina, Mexico, Venezuela, and Other Countries.
| Segment | Q2 2012 Revenue | YoY Revenue | Direct contribution margin, Q2 2012 | Direct contribution margin, Q2 2011 | Margin change |
|---|---|---|---|---|---|
| Brazil | $44.21M | +10.7% | 43.30% | 40.08% | +3.22pp |
| Argentina | $20.56M | +65.9% | 53.59% | 58.41% | -4.82pp |
| Mexico | $6.05M | +12.6% | 45.93% | 44.47% | +1.46pp |
| Venezuela | $12.42M | +71.6% | 69.97% | 60.65% | +9.32pp |
| Other Countries | $5.61M | +26.2% | 48.40% | 43.95% | +4.44pp |
| Total | $88.84M | +28.1% | 49.90% | 46.09% | +3.81pp |
Brazil remains the segment that matters most to the consolidated result (49.8% of Q2 2012 revenue), and its margin swing this quarter (+3.22pp) partially offsets Q1's -3.24pp fall - a segment whose margin has genuinely never held still across six consecutive quarters tracked here. Venezuela's +9.32pp jump is the largest single-segment move this quarter, continuing a pattern that has benefited from the highly-inflationary, dollar-functional-currency accounting treatment adopted for that market since 2010; Venezuela revenue also grew fastest in dollar terms (+71.6%), though its 14.0% share of consolidated revenue limits how much it can move the total on its own. Argentina, by contrast, is now the clearest outlier in the opposite direction: its revenue grew second-fastest of the five segments (+65.9%, behind Venezuela's +71.6%, almost certainly inflated in dollar terms by the peso's depreciation against the dollar this quarter) while its margin fell for a second straight quarter - the reverse of every other segment's pattern.
The Stock Fell 22.5% This Quarter, Reopening the Valuation Gap for the First Time Since Q3 2011
MELI closed the quarter at $75.80 (June 29, 2012), down 22.5% from March 30, 2012's $97.79 close covered in the Q1 2012 post - the stock's first quarterly decline since Q3 2011's 32.3% fall, ending two straight quarters of gains (+48.0% in Q4 2011 and +22.9% in Q1 2012). Most of the move happened in a single month: the stock held near its highest month-end closes through April ($96.74) before dropping to $70.24 in May, then partially recovering to $75.80 by quarter-end. This filing discloses no company-specific event - litigation, a guidance change, a management departure - that would explain the timing; the drop reads as a broader market or sector move rather than anything tied to MercadoLibre's own numbers, which if anything improved this quarter. No stock split falls within the two-year price window used here, so none of these figures require split adjustment.
Target Valuation Range
Too early to call against peers; against its own history, cheaper on every multiple. EV/Sales fell from 12.8x to 9.2x, P/E from 52.4x to 36.0x and EV/FCF from 56.0x to 31.6x as the stock fell 22.5% while trailing free cash flow rose from $73.48M to $98.79M.
The $75.80 June 29, 2012 close pushed market capitalization down 22.5% from Q1 2012, in a single quarter.
| Market cap → enterprise value | Q2 2012 |
|---|---|
| Share price (period-end) | $75.80 |
| Shares outstanding | 44,148,720 |
| Market capitalization | $3,346.5M |
| Plus: loans payable | $0.24M |
| Less: cash, ST & LT investments | $220.18M |
| Enterprise value | $3,126.5M |
| Peer-multiple sanity check | Q1 2012 | Q2 2012 | Change |
|---|---|---|---|
| TTM Net revenue | $321.21M | $340.67M | - |
| Enterprise value | $4,115.7M | $3,126.5M | down 24.0% |
| EV/Sales | 12.8x | 9.2x | down sharply |
| P/E | 52.4x | 36.0x | down |
| TTM Free cash flow | $73.48M | $98.79M (29.0% margin, up from 22.9%) | - |
| EV/FCF | 56.0x | 31.6x | down - lower EV and higher FCF pulled the multiple down from two directions at once |
This is the first quarter since Q3 2011 in which the multiples have genuinely fallen, and unlike Q1 2012 (where the cost story improved while the stock still got more expensive), this quarter the two moved together in the reader's favor - free cash flow grew 308.6% and the stock fell 22.5%.
Beyond the Usual
A new, larger Brazilian federal tax claim surfaced the same quarter an older one shrank to a third of its size
In June 2012, Brazilian federal tax authorities asserted a new claim against the Company's Brazilian subsidiary covering fiscal years 2007 through 2010, for approximately R$23 million ($11.4 million at the June 30, 2012 exchange rate) - roughly four times the size of the pre-existing 2006 income-tax claim, which was itself reduced from R$5.2 million ($2.6 million) to R$1.5 million ($0.8 million) after an administrative recourse filed July 25, 2012. The Company presented administrative defenses against the new claim on July 27, 2012, and management and legal counsel consider the risk of loss remote on both claims, with no reserve recorded for either.
Net Brazilian federal tax exposure actually grew this quarter even though the older, smaller claim shrank by roughly $2 million - the new claim is more than five times larger than what it replaced in dollar terms. "Remote" risk assessments on tax claims this size are worth tracking for whether Brazilian tax authorities continue expanding the periods and amounts in scope, a pattern that would be different from a single claim simply working through appeal.
The litigation reserve and reasonably-possible exposure rose together for a second straight quarter
As of June 30, 2012, 492 legal actions were pending in Brazilian ordinary courts (up from Q1 2012's 444) and 2,533 cases were pending in Brazilian consumer courts, which don't require a lawyer to file (up from 2,077). The proceeding-related reserve rose to $2,163,347 from $2,115,635, and the aggregate reasonably-possible exposure rose to $3,125,661 from $2,713,854 - a 15.2% jump, continuing the pattern first flagged last quarter of both figures climbing together rather than diverging.
This is now two straight quarters where both the accrued reserve and the reasonably-possible exposure have risen in tandem, after several prior quarters where the exposure figure moved independently of (and sometimes opposite to) the case-count trend. Combined with the new $11.4 million federal tax claim above, Brazilian legal and regulatory exposure is genuinely trending in one direction this year, even though no single item here is individually large enough to change the investment case on its own.
The São Paulo customer-service claim is now fully closed, with no appeal filed
The state customer-service-level claim dismissed by the Lower Court Judge in March 2012, covered in the Q1 2012 post, is now finally resolved: the consumer-protection entity that had joined as co-plaintiff and objected to the dismissal did not file an appeal, so the case is closed. This closes out a matter open since Q3 2010.
Autopark's minority partner's share of consolidated net income reached $15,632 for the quarter
Since the September 2011 acquisition of AP Clasificados, the income statement has carried a separate "Net income attributable to Noncontrolling Interest" line - $15,632 for the quarter and $18,060 for the six months ended June 30, 2012, allocated to Hasteny Trading's remaining 40% stake in Autopark LLC. The underlying put/call structure (a $4.0 million floor price or 3.5 times trailing invoiced sales, whichever is greater) is unchanged from prior filings, and the mezzanine-equity balance-sheet placement stayed at $4.0 million. The line was nil in FY2011 and first showed $2,428 in Q1 2012, so the quarter's $15,632 is the larger step.
A new, cash-only 2012 retention plan replaced the mixed cash-and-stock structure of earlier years
On June 5, 2012, the Board approved a 2012 Long Term Retention Plan (LTRP) with a total expected compensation cost of approximately $7.3 million, payable entirely in cash over eight years (12.5% per year, rather than the four-year, 50%-cash/50%-share structure of the original 2008 plan). Like the 2009-2011 plans, half of each payment is fixed in nominal dollar terms and half floats with the ratio of MercadoLibre's own stock price at payment to its price in the grant year ($77.77 for 2012, the average closing price for the last 60 trading days of the year). Accrued compensation expense for the 2012 plan totaled $0.8 million for the six months ended June 30, 2012. The combined fair value of the 2009-2012 variable-payment LTRP liability stood at $14.2 million at quarter-end, of which $5.5 million was accrued in Salaries and social security payable on the balance sheet.
Coverage Table
| Theme | Q2 2012 | Q2 2011 | YoY | Why it matters |
|---|---|---|---|---|
| Net revenue | $88.84M | $69.38M | +28.1% | Slower than Q1's 36.2%, but still fast; constant-currency growth (47.1%) shows real demand held up |
| Unallocated corporate cost growth vs. revenue growth | +19.5% vs. +28.1% | +66.7% vs. +32.1% | -8.6pp gap | The structural problem running since Q1 2011 became a genuine tailwind |
| Consolidated direct contribution margin | 49.90% | 46.09% | +3.81pp | Four of five segments improved; only Argentina fell |
| Income from operations margin | 35.89% | 31.06% | +4.82pp | Margin expanded sharply |
| Take rate | 6.84% | 6.50% | +0.34pp | First increase after five straight periods of decline |
| Stock price (quarter-end) | $75.80 | $79.34 | -4.5% | First quarterly decline since Q3 2011; down 22.5% from Q1 2012's close |
MercadoLibre, Inc.'s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2012, filed with the U.S. Securities and Exchange Commission and signed August 3, 2012 by CEO Marcos Galperín and CFO Pedro Arnt. Historical MELI share price data covers month-end closes from June 2010 through June 2012; no stock split falls within the two-year price window used here, so no split adjustment applies to these figures. No presentation, press release, or transcript was located for this quarter, so this post does not include a management-commentary section.