Plenty of companies like to compare themselves to Amazon (AMZN -1.23%), and sometimes the comparisons are apt. Take MercadoLibre (MELI -1.16%), for example.
The leading Latin American e-commerce company operates with a similar playbook to Amazon's, often with great success. Like Amazon, MercadoLibre operates both a first-party e-commerce business and a third-party marketplace, meaning the company sells its own products and allows other vendors to sell on its platform.
It also layers other complementary businesses on top of that, most notably Mercado Pago, its digital payments platform, which also reaches brick-and-mortar businesses through its point-of-sale machines. And like Amazon, it has its own logistics operation, Mercado Envios, as well as a lending arm, Mercado Credito, and even an asset management business, Mercado Fondo.
MercadoLibre has quietly launched a new Amazon-like business, advertising, and the early results are promising.
Image source: Getty Images.
Bring on the ads
In its third-quarter earnings report, management said that MercadoLibre's ads business reached 1.3% of gross merchandise volume (GMV), up from 0.9% in the quarter a year ago. Considering that GMV grew 31.5% to $8.6 billion in the quarter, that means that ad revenue nearly doubled in the quarter, reaching $112 million. That might sound insignificant, but it's more than 4% of MercadoLibre's third-quarter revenue.
Management also said that it's accelerating its investments in advertising, moving more engineers to that segment to improve the product with better automation and personalization. And it expects those investments to increase ad sales and profitability. Growth in the ads business also helped improve its e-commerce take rate and its overall profitability as operating margin reached 11% in the quarter.
On the earnings call, chief financial officer (CFO) Pedro Arnt said that it rolled out many of the new ad tools at the end of the month, implying that growth in the ads business should accelerate in the fourth quarter.
Arnt also explained the appeal of advertising, saying, "I think what we see in the third quarter is just the natural evolution of an advertising business that there's very strong demand for despite the macro backdrop given where we play along the conversion funnel." The conversion funnel is an e-commerce term that describes the different stages in a buyer’s journey toward a purchase.
Like Amazon does, Arnt sees MercadoLibre providing valuable real estate for the brands that advertise on its platform since customers generally come to MercadoLibre knowing what they want to buy.
In fact, Amazon's own CFO, Brian Olsavsky, made a similar statement about the strength of its advertising business on his company's third-quarter earnings call: "Advertisers are looking for effective advertising, and our advertising is at the point where consumers are ready to spend."
Both Amazon and MercadoLibre benefit from being at the bottom of the conversion funnel since advertisers want to be at the point of purchase.
Why ads are a big deal
Amazon's advertising business is only a decade old, but it's become a juggernaut for the e-commerce giant, on track to generate more than $30 billion in revenue this year. Though Amazon doesn't break out profits in its ads business, it almost certainly generates high margins based on the performance of digital ad peers like Google and Facebook, which generate operating margins of 30% or better from advertising.
With a 30% operating margin, Amazon's ad business would bring in about $10 billion in operating income this year. Its own advertising business has also proved to be more resilient than that of Alphabet's Google or Meta Platforms' Facebook in part due to its position at the bottom of the funnel. And MercadoLibre's ad business has performed well in a challenging environment, too, as Arnt's comments above indicate.
MercadoLibre is just starting to go down the same path as Amazon, and its recent investments in its ad products should only accelerate its growth. Amazon's advertising revenue is about 5% of its estimated $600 billion in annual GMV, so 5% of GMV seems like a reasonable goal for MercadoLibre's ad business as well. With its GMV now at an annual run rate of $34 billion, that would be equal to $1.7 billion in ad revenue, or roughly $500 million in operating income, assuming a 30% operating margin.
MercadoLibre's e-commerce business is still growing rapidly, and it would only need to grow 25% annually to triple over the next five years. If the company hit that 5% target in five years, assuming GMV triples, it would have $1.5 billion in operating income from advertising.
Considering MercadoLibre had just $685 million in operating income in the first three quarters of 2022, that shows advertising could have a huge impact on the bottom line.
With profitability already surging and the company posting strong growth in a difficult environment, the emergence of the ad business is one more reason to buy the stock while it's still on sale.
