Executives
Pedro Arnt – EVP and CFO
Analyst
Stephen Ju – Credit Suisse
MercadoLibre, Inc (MELI) Credit Suisse 2013 Technology Conference December 3, 2013 12:00 PM ET
Stephen Ju – Credit Suisse
All right, great. I think we are going to go ahead and get started. Stephen Ju from the Credit Suisse Equity Research team for internet. We are joined by Pedro Arnt, CFO of MercadoLibre. Thanks very much for coming Pedro.
Pedro Arnt
Thanks very much.
Stephen Ju – Credit Suisse
Great. So without much further ado, let's dive right into it. So you recently stepped up your R&D spend, some of this was in compensation, but it was also hiring of new engineers as well. This begs the question of product development. So what is the plan right now, which may have approved in the next 12 months.
Pedro Arnt
Yes. Great. So I think clearly it's still very early stages of e-commerce development throughout Latin America and we have a very aggressive product development pipeline and one that we are actually quite excited about and that does require a growing number of engineers to carry out.
So most of the R&D investments that you see flowing the P&L are compensation related cost for engineers and other software development costs whether it be licenses or agreements with global technology consultants and providers and that's most of the increase you've seen.
We did I think something like a 160 basis point of margin compression. So additional R&D spend as a percentage of marketing into Q3, we acquired a software development factory sometime towards the end of the second quarter, that allowed us to onboard 50 plus engineers from 1Q to the next.
So it's the kind of investment that we believe we need to be making over the next few years. This is a technology company and engineers are the life blood of the company.
When we switch over to the pipeline and what a lot of these engineers are working on, we've been fairly consistent with the product strategy and what it focuses on right. So we've said that we want to pursue a greater number of general merchandizing categories through improving the experience of buying and selling in those categories with more tailored feature sets.
So we've gone aggressively after the fashion and apparel category more recently and we hope to verticalize more and more categories going forward. That requires building out vertical market place experiences for these categories.
We've seen very, very good traction and progress on our mobile efforts. We think mobile is a paradigm shift for e-commerce in general, but may be even more so in emerging markets where large portions of the population will come online through their mobile devices. The more recent numbers we disclosed were already doing more than 10% of our GMV through mobile devices and this is in year two of our mobile development. So very, very steep adoption curve.
We began to get increasingly involved with shipping and logistics mainly through technology. So today we increasingly connect existing logistics providers and shipping carriers into our marketplace so as to offer a better and more consistent shipping experience for both buyers and sellers and also drive down cost of shipping, that's primarily through technology. So that also requires more R&D spend and more developers.
We continue to have very aggressive plans for our payments business both on platform and off platform, with the merchant service business, that's a growing team in terms of R&D spend in a number of developments and a huge opportunity for our business still going forward. And then we've also got more and more involved in improving the tools that we make available to our customer service reps so as to be able to service our buyers and sellers if and when they need to interact with us in a more efficient and faster way through the deployment of better and better technology.
So that's where most of the additional R&D spend is coming in, it's engineers and engineering compensation to carry out that very aggressive product development pipeline we have.
Stephen Ju – Credit Suisse
Got it. What is your philosophy in terms of getting involved in the logistics part of the equation? So is there a willingness as a first party basis to actually build warehouses and help your sellers to fulfil or is the model more like hey, here's the marketplaces platform, here is a job, delivery job that is up for bid, let's invite a bunch of carriers and to see if we can bids against that job.
Pedro Arnt
So what we are doing right now and that's really what we are focusing on and what we are delivering on is more of a enabling and existing ecosystem of logistics, warehousing and shipping carriers to deeply integrate their services into the marketplace and through that integration, make shipping on our platform cheaper, more consistent and more reliable.
So currently we are not running anything, nor is that division. It's all about leveraging the existing services that exist in most of the countries where we operate and really integrating those deeply into the marketplace so as to offer a better buying and selling experience on the shipping piece.
I think longer term, we've left that open and we've said whatever we need to do to make buying and selling on the marketplace more convenient, we will explore, that's sort of the longer term leaving that open. That's not something that's going to happen over the next four or five quarters because the focus continues to be driving adoption of the technology layer we've built out.
I think we said that we are still doing low single digits of overall unit shipped through these integrated logistic solution providers and that's a level of penetration that we need to quickly ramp up over the next few quarters.
Stephen Ju – Credit Suisse
Got it. So you've also stepped up your marketing spend as well this year. This was more grand oriented this year, but as you look at what your marketing mix might look like next year, how do things change?
Pedro Arnt
So that's accurate if you look at the third quarter results and it's somewhat reflective of the overall year. There were about we called out a 160 basis points of margin compression in the sales and marketing line as a consequence of our brand advertising. But if you look at the story around that on a multi-year basis, really what happened is that we had historically done brand advertising throughout most of our history and about two years ago, when we embarked on a very aggressive redesign of our technology platform and our product, we started, it made sense to slow down a little bit on the brand advertising customer acquisition figure.
So that portion of customer acquisition while we were improving convenience in the platform and we didn't do any brand advertising in 2011 and 2012, we once again started advertising on cable television and on other venues for brand advertising in 2013.
So because the comp is against zero, that's what generates the significant margin compression of about 160 basis points. I think going forward what we would expect is to continue to invest in brand advertising, but at levels more similar to what we saw in 2013. So that could grow less than revenues in which case it would actually be allowing us to scale, which is typically what we want to see out of sales and marketing and G&A in the business or it could be in line with revenue and so you don’t have any margin impact.
The big hit was because it was [comping] against a year where we had done zero brand advertising investment and more importantly from philosophical perspective, the lion's share of our customer acquisition efforts continue to be in online advertising. So if you look at the overall magnitude of our brand advertising spend, it's actually quite small, it's in the range of single digit million dollars on an annual basis. So nothing that's very significant. The really large advertisement is coming from online customer acquisition.
Stephen Ju – Credit Suisse
Got it. Now we have to address the 800 pound gorilla in the room and talk about that as well a little bit. So what action if any has the government taken on your auto as well as real estate verticals? Any pressure on the demand [where you cut sites] in terms of price controls?
Pedro Arnt
So let me just take a step sideways and claim that there shouldn’t be an 800 pound gorilla. There should be something significantly less relevant in that right. So to recap our Venezuela strategy, what we've always said is that we manage this business for the long run and we are very committed to being the preeminent e-commerce company throughout Latin America and Venezuela is a relevant market throughout the region.
And so the way we've tried to manage the existing complexity in running a business in Venezuela today is by making sure that our Venezuelan operations first of all is self funding and generates cash on its own. So we don’t invest any cash generated outside of Venezuela into Venezuela. And secondly, so that it doesn’t deter from the overall focus of managing the business, that most of the complexity is managed by the local teams.
And then the third piece is that we are able to transform the currency and the cash position that's being built in Venezuela into an asset that preserves value for the long term and that's why we've taken diving commercial real estate in Venezuela, which is probably the best way to preserve the value of the cash that's being generated in Venezuela, but under current conditions cannot be repatriated.
And so once we these three conditions in place, we feel very comfortable from a management standpoint that we can weather the situation in Venezuela and eventually when there is a change in regime, when more business friendly practices are once again put into place, we will emerge from this with an incredibly strong market share in Venezuela and we will be able to repatriate this cash generation, that's now being stored in other assets back to the U.S.
So that's the overall vision and one that hasn’t really changed much over the past few years as conditions in Venezuela have gotten more and more complicated.
As part of managing the Venezuelan situation, obviously we interact with the government. There was a recent round of conversations about three or four weeks ago where the government was looking at primarily our motors classifieds business and how that was an important player in communicating the prices of vehicles in Venezuela and so what the government -- what the agreement with the government eventually led to what that we no longer are allowing for the sale of certain new cars on the website, which was really not a very significant portion of the overall listings and where there have also been controls placed on cars that are being sold with a very low number of kilometres before they get resold through some particularities of the Venezuelan issue.
So I would say more on a positive side what it confirms to us is that you can still run the business and you can still have pretty rational conversations with the government and as long as you are willing to [seed on certain] points, you can continue to maintain the business running by and large in the same way that it was running prior to the conversations. So again, I think we continue committed to Venezuela and the way we've been managing it I think is the correct way to manage it.
Stephen Ju – Credit Suisse
Got it. So switching topic a little bit, so compared to other [locked] places platforms around the globe, MercadoLibre's take rate is still pretty low especially given that you are throwing in payments as a service as well. So what is your philosophy of raising take rates so especially as you get more wise spud adoption of the [pipeline].
Pedro Arnt
So that continues to be very consistent and we haven’t really changed the way we think through the take rate issue. We continue to believe that there is room for improving our take rates; A, because as you mentioned we have very low take rates compared to many other market places globally and B, also because we believe that there are ways to price on the marketplace that allow us to extract more value in an intelligent way, which isn’t simply raise prices across the Board.
So what I mean by that is because we are still trying to air on the side of simplicity given how early stage of e-commerce development it is and how users are still getting accustomed to selling online, we have flat pricing across all categories. Obviously different product goods have very different margin structures.
So by simply moving eventually to more category specific pricing is one way to improve the take rate. We can also tinker with caps that is still very relevant in terms of our overall pricing and then we can just raise prices. So we continue to believe that a mid to long term take rate level for us will be higher than what it is today, but we also continue to think that there is no rush to get there, that we are still in a very early stage of the market that seller acquisition is still a very important part of what we are trying to do to bring on as many merchants as we can to the marketplace.
And that running the business profitably at these low take rates also makes it more difficult for new entrants that we have to come in at very low price points. So we are comfortable with understanding that the mid to long term vision allows us to have a higher take rate, but that the shorter term vision it's probably still right for us to sustain these lower levels of take rate.
Stephen Ju – Credit Suisse
Okay. At this point I will open up the floor to questions from the audience if there are any, but while we are gathering any questions, I will log in another one here. So historically Mexico has under-punched versus all your other territories, there are some restrictions on a [top] side, but that seems to be loosening up. So what is your vision and what do you think has [an issue], what do you think has been sort of the impediment to growth in that region and what can you do to reaccelerate growth in the countries?
Pedro Arnt
Yes, so this is something that continues to be an interesting and intriguing opportunity for us is the overall size of Mexican e-commerce. So when you look at most measures percentage of GDP, percentage of retail, you would expect Mexico to probably be plus 20%, plus 30% of our Latin American player and our Mexican business continues to be sub 10% for us. So we think there is still significant value in growth to be unlocked out of Mexico.
This isn't a competitive issue. We actually -- we believe our market share in Mexico is amongst the highest market shares we have. So it's probably a combination of factors. You addressed the telecommunication space in Mexico that historically has been less competitive and less efficient. There are probably issues around just the Mexican consumer and his propensity to buy online that eventually changes and I also think and this is somewhat counterintuitive, but the numbers do back this up that the more competitive market, so for example Brazil, we actually see more growth and a healthier marketplace because there are more players that are bringing offline consumers online.
And if you think about market share gains over the next three to five years the most significant market share gains that need to occur for our business continue to grow are actually gaining share from offline commerce to online commerce much more than gaining share from other online competitors.
And so I think the fact that in Mexico there really -- that aren’t that many other players aggressively promoting e-commerce is also part of the explanation as to why that's growing so slowly. So we remain optimistic. We think obviously e-commerce is something that will occur on a global basis and Mexico will not be an exception. Harder to tell when that inflection point occurs there, but it will occur.
Stephen Ju – Credit Suisse
Okay. Let's talk about the competitive landscape in Brazil for a second, so if I were a company that's looking to launch operations in Brazil, [Ricardo] is probably going to be one of the first places where I will try to poach potential engineers or any employees whom I know something about the internet. So what are you noticing in terms of the changing competitive dynamics there? Any sort of change in stance that you are sensing from Amazon or any of the other competitors who are already on the ground?
Pedro Arnt
So I think there is two questions build into one there right. So when is just the overall competitive environment and then the other one is how does that affect our talent retention and let me split those out.
Brazil continues to be a very attractive e-commerce market and consequently obviously will attract more competitors. It's always been very competitive. We continue to see the most relevant and the largest competitors to be the Brazilian retailers and their online arms and I would say in addition to those are growing number of pure play online retailers that are rapidly gaining scale and doing a very good job of selling goods online and to a much lesser degree the efforts being made by the global players.
So Amazon continues to only run a digital offering out of Brazil. eBay has began to offer certain localized mobile apps within the fashion category and to promote its cross broader capabilities, some of the Asian players out of Japan have began to built out small scale marketplaces.
So really I think the competition continues to be the local players and there is something to be said about that. I think when like ourselves Brazil and the region is 100% of your focus, your ability to execute and to service your clients I think is really enhanced and if Brazil is just a piece of a larger global strategy.
So we really like our chances. We think we have the preeminent brand in Brazil. We have by far the largest traffic throughout Latin America and again with all the stuff we are doing, we really believe that [Ricardo] will be able to sustain its share gains and continue to grow quite nicely. So that's on the competitive landscape right. So not much has changed over the last few quarters.
In terms of employee retention I think it's very attractive to work at MercadoLibre because you are actually again going back to the previous point, you are working building the technology that's being run across the region and you are really in the center of where the decision making process is typically through working for one of these larger global corporations, it's probably a regional job. So we haven't had any significant issues retaining talent or seeing talent being poached by other organizations.
Question-and-Answer Session
Unidentified Analyst
(Inaudible)
Pedro Arnt
Yes, so it varies by markets, it's probably in the high teens in Brazil and that's the most competitive market and then in the other markets it will be somewhere in the mid 20s to low 30s depending on which market we are looking at. That's just the marketplace business right. Remember that 30% of our revenues are already coming from non-marketplace businesses that you can't really measure in terms of GMV, but for the marketplace business that's where the market shared numbers roughly come in at.
Unidentified Analyst
So building on your earlier point in regards to the more specific focus on there is vertical is whether it's fashion or something else, can you touch upon the various puts and takes in terms of what the ASPs as well as unit volume, how that will influence the GMV growth in Brazil?
Pedro Arnt
Right, so the trend that we've been seeing in average tickets or ASPs has been downward when you look at the Brazilian market and that's by design primarily right. So the biggest driver of that is as we focus on an increasing number of categories to compliment our historical strength in consumer electronics, the overall share [FTE] has come down. So it's increasingly beginning to index more like the overall e-commerce market and not over-indexed as it did in the past.
That's also been driving ASP down somewhat because a lot of these newer categories have lower average tickets in consumer electronics whether it be fashion and apparel, home and garden, the mom and baby demographics, office supplies and industrial supplies, most of those have lower ASPs in consumer electronics.
Unidentified Analyst
(Inaudible)
Pedro Arnt
So cross border trade is really I think what I would focus on there. If you look at our business today, cross border transactions are almost immaterial. They are low single digits and so when we look at the global e-commerce landscape, we really see tremendous interest from global retailers to be able to sell into Latin America, not from their own websites, but actually being able to push product through a local player as relevant as we are and until recently because we had not focused on that aspect of that business, the tools that we could offer many of these global retailers were actually quite limited.
That's something that we began to work on. I think you will hear us announce some pretty interesting things over the next three four quarters around cross border trade and I think it could be a sizeable opportunity for us if we are able to match the number one site throughout Latin America in terms of demand, which is ourselves with the growing number of global retailers that want to offer their supply into Latin America.
If you look at many of the other marketplaces on a global basis cross border trade is very relevant for us. For them, it hasn’t been for us and I think it will become more and more relevant and that's all upside.
Unidentified Analyst
So undoubtedly you've probably been collecting [best analysis] data about your consumer you've been founded, so not much of that is being used to [collect] recommendations in terms of what people might want to buy on the site. So where are you on that initiative and how much an opportunity could that be especially on conversion rates as you move forward.
Pedro Arnt
So it's definitely in an opportunity. Clearly we under leverage our user data and it's something that we will eventually get better at, but I think the honest answer is right now it's something that I would say is among our top six or seven priorities. So again, there are many areas of opportunities still for us. Data is certainly one of them and certain aspects of our business have used it better than others, something we will get better at, but it would be misleading to say that that's a focus of the next two or three quarters in terms of product development focus.
Unidentified Analyst
...Argentina currency situation and maybe the -- one of the positives if there are is that you've a lot of your expenses there, so can you talk about how much of your headcount is in Argentina? What are those people doing there and then update us on what the regulations are in Argentina? What black market exchanges versus what you have to report and walk though the issues with that for us please?
Pedro Arnt
Great. So lots of built-in questions. So Argentina I think is very different than Venezuela. Argentina is easier to explain and a lot more rational, right. Argentina has a floating peg currency. Argentina still has instruments to move money in and out of the country if you choose to do so.
The rate at which at Argentine peso has been devaluating versus the dollar has accelerated over the last three or four quarters and that's actually been beneficial to us because as you were mentioning, we have many of our development centers and most of our corporate headquarters in Argentina.
So we actually consumer more cash in Argentina than we generate. So we don’t have the same problem we have at Venezuela of tracked profits. We don’t need to worry about moving money out because we are not generating any money there and the fact that the peso has been devaluating at an increasing pace, means that our cost structure has been getting cheaper over the last few quarters when looked at in dollar terms.
So it hits topline somewhat because the revenue has been generated of Argentina when translated to dollars get hurt, but it's actually accretive to our earnings because we have more cost there than we do revenues.
Unidentified Analyst
(Inaudible)
Pedro Arnt
So roughly north of 45% of our cost base is denominated in Argentine pesos because it's located in Argentina.
Stephen Ju – Credit Suisse
And with that, we are out of time. Thanks very much.
Pedro Arnt
Great. Thank you for inviting us and thanks everyone for your interest.
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