At first glance, there is a ton to like about shares of MercadoLibe (NASDAQ:MELI). Founded in 1999 in Argentina, MercadoLibre has expanded its e-commerce platform across 19 countries in Latin America and dominates e-commerce in the region. Even better, it operates in a region of over 600 million people, where internet penetration is still low but growing faster than in more developed regions.
That's allowed MercadoLibre to put up some impressive growth numbers. Last quarter the company grew its confirmed registered users by 24%, and grew revenue (on a currency-neutral basis) by 58%. There are often just a few e-commerce leaders in any specific country due to the network effects of attracting more buyers and sellers in a virtuous cycle, so MercadoLibre's first-mover status is a big advantage.
MercadoLibre has also succeeded in rolling out its own payments platform called Mercado Pago. The payments platform was developed to help customers pay for goods on MercadoLibre's marketplaces, but has now extended to offline services in a big way. In September, Mercado Pago processed more transactions offline than it did on MercadoLibre's marketplaces for the first time. MercadoLibre also developed a point-of-sale solution (mPOS) for merchants to complement Mercado Pago, with an aim to make Pago use a daily habit.
With so much going for it, why would I be hesitant to invest? Well, there are a few key risks investors should consider before investing in MercadoLibre shares.
Currency and political volatility
Remember how I mentioned a "currency-neutral" revenue growth rate of 58%? MercadoLibre operates in countries whose economies and political situations are much more volatile than the U.S. Despite 58% revenue growth in local currencies, the company's dollar-denominated revenue growth was only 17% last quarter -- quite a difference.
While a majority of MercadoLibre's costs are also in these local currencies, ultimately it's still an issue -- making the same margin on a lower dollar amount will ultimately make a business worth less to U.S. investors. In the last year, the Argentine peso depreciated by roughly 50% against the strengthening U.S. dollar. That could reverse and lead to big gains, but could also continue to go the other way.
The currency wildcard goes hand in hand with political instability. Late in 2017, the company had to exit its Venezuela operations after the country defaulted on its government bonds. MercadoLibre deconsolidated the Venezuelan segment, and wrote down $85.8 million in assets after the default.
While Venezuela seems like an outlier case in terms of its severity, political and financial instability have the potential to wreak havoc on MercadoLibre's results (through no fault of the company).
Amazon is a laggard, but taking aim
In addition to macro uncertainty, MercadoLibre investors also need to consider the looming specter of Amazon (NASDAQ:AMZN), which has had its sights set on Brazil since 2012, when it began to sell books in the country. Brazil has 200 million people, and is the world's eighth-largest economy, making it a big enough market for Amazon to target.
Brazil also happens to be far and away MercadoLibre's biggest market, making up 62% of the company's revenue last quarter.
Now, this isn't reason for panic, as MercadoLibre is far and away the leader in Brazil, with the largest network of buyers and sellers. Despite its efforts, Amazon hasn't made much headway as of yet, as Brazil's infrastructure problems and byzantine tax structure make it difficult for foreign competitors to get a leg up on the locals. According to the New York Times, Amazon made up just 1% of Brazil's e-commerce market last year, despite having been in the country for six years -- compared to MercadoLibre's 19% market share.
Still, that's not stopping Amazon from continuing to push into Brazil. Amazon has reportedly leased a massive warehouse outside of Sao Paulo, and hired a lot of workers in Brazil in 2018. While Amazon is far behind now, the relatively fragmented market in Brazil (with the leader only having 19% market share) means the threat likely hasn't passed.
And even though Amazon hasn't made headway, it's still having an effect on MercadoLibre: Last year, MercadoLibre began offering free shipping to pre-empt Amazon's push. That wound up being a huge hit to the company's profitability.
Eyes wide open
MercadoLibre shareholders shouldn't just look at the company's eye-popping growth numbers in local currency, but should realize they are investing in emerging markets. At the same time, the looming threat of Amazon, even in the background, needs to be monitored, as it may put a ceiling on MercadoLibre's ultimate profitability. While there is much upside opportunity, investors need to understand MercadoLibre's risks, too.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Billy Duberstein owns shares of Amazon. His clients may own shares of some of the companies mentioned. The Motley Fool owns shares of and recommends Amazon and MercadoLibre. The Motley Fool has a disclosure policy.