Followers of Latin American online marketplace MercadoLibre, Inc. (NASDAQ:MELI) have been justifiably enthused over the rapid growth in its payments service, MercadoPago. MercadoPago is integrated within the MercadoLibre marketplace to facilitate buyer and seller transactions. But it also functions as an offline payments solution between merchants and purchasers. MercadoPago is currently available in many of the company's largest markets, including Brazil, Argentina, Mexico, and Columbia. In this article, we'll focus specifically on the division's potential as a payments platform independent of the transactions it facilitates on the company's namesake marketplace.
A model for a flourishing payments business
We can find an illustrative example of the potential of a non-marketplace payments business in PayPal Holdings Inc. (NASDAQ:PYPL). PayPal entered the public markets as a spin-off from eBay Inc. in July 2015 to focus on payments processing. The company has enjoyed double-digit revenue growth in its first few years as an independent entity, and it handles massive payment flows. In the first quarter of 2018, PayPal recorded total payments volume, or TPV (a measure of the total dollar amount of payments transacted over its platform), of $132 billion. This volume represented an increase of 32% over the prior year quarter.
MercadoPago's TPV in the first quarter was a relatively meager $4.2 billion, and of this figure, only about $1 billion is non-marketplace volume. However, MercadoPago's non-marketplace TPV, often referred to as "off-platform" TPV by management, has expanded at triple-digit rates in recent quarters. In Q1 2018, off-platform TPV jumped by 127% against the prior year.
Offering merchants payments functionality outside the company's retail buyer and seller exchange has significant potential. MercadoPago is investing in payments growth in its largest markets of Brazil and Argentina through the expansion of mobile point of sale, or "mPos" devices. While the company doesn't disclose unit figures, it's revealed that mPos device sales are expanding at a year-over-year rate of over 1,000% within these two countries. In the first quarter of 2018, transactions conducted on mPos readers accounted for 52% of MercadoPago's total off-platform volume.
As you can glean, mobile e-commerce is critical to payments success. PayPal has demonstrated as much: Roughly 37% of PayPal's TPV now occurs across mobile devices. Moreover, with an annual growth rate of over 50%, PayPal's mobile TPV is outpacing its overall TPV expansion. Trends are similar for MercadoPago. In Latin America, mobile connectivity often proceeds home connectivity. According to privately held media and data firm IDG, of the 690 million existing mobile connections in the region, over 350 million are smartphone devices. By the end of this decade, more than 1 billion users across Latin America are projected to be connected to a mobile network.
Explosive growth; gradual benefits
While MercadoPago's off-platform business mirrors PayPal's potential, and it can access vast opportunity in mobile-enabled payments, don't expect the division to deliver overnight value, despite its exponential growth rate.
There are several factors constraining its immediate economic returns. First, unlike PayPal, which has been able to focus solely on its payments business since separating from eBay, MercadoPago remains an integral part of MercadoLibre's ecosystem. This ecosystem encompasses not only the company's namesake marketplace, but also MercadoEnvios, the company's shipping program, MercadoLibre Classifieds Service, and MercadoShops, an online storefront provider.
Thus, the payments business must compete with other revenue streams for resources. However, a growing network typically benefits a payments platform -- the addition of new merchants and customers in the MercadoLibre marketplace expands the universe of potential MercadoPago users. MercadoPago recently achieved a penetration rate of 90% on MercadoLibre's marketplace. So, 9 out of 10 customers have used the MercadoPago app or web-based payment system, and that's a robust population to guide toward future non-marketplace transactions.
The second constraint involves the economics that undergird MercadoPago. Currently, the profits of the business as a payments platform are offset by its use as a funding mechanism. MercadoLibre "discounts" MercadoPago's customer receivables, that is, it sells funds due from marketplace customers at a discount to banks (which then receive customer payments). The company uses the proceeds to fund MercadoPago in its largest market of Brazil, as well as for general company operations. So, fees the division earns from transaction processing are currently diminished by receivables discounting.
In addition, MercadoPago has started to offer loans to merchants and consumers through MercadoCredito, a service launched initially in Argentina, Brazil, and Mexico. Lending to users is a logical extension of a payments platform, and both PayPal and competitor Square have ventured into the credit space. For the time-being, the company is self-funding its growing MercadoCredito loan portfolio.
During MercadoLibre's most recent earnings conference call, CFO and Executive Vice President Pedro Arnt cautioned analysts to recognize that between the discounting of receivables and the funding of MercadoCredito, the payments division is, for the time being, more of a "cash consumer" than a "cash generator" -- its rampant growth notwithstanding.
In sum, the off-platform payments business, MercadoLibre's fastest growing revenue source, is poised to become its most critical top- and bottom-line driver. Yet the transformation may take years. This isn't a concern for many long-term investors, however, who already sense an enormous opportunity in company shares over an expanded time horizon.