GLOBAL INVESTING: Latin America's overvalued e-commerce colossus

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GLOBAL INVESTING: Latin Americas overvalued e-commerce colossus
Latin America has 620 million people, but only with 61 per cent Internet penetration.

Dubai - It can be very profitable to invest in a dominant franchise in emerging markets

By Matein Khalid

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Published: Sun 12 Mar 2017, 8:26 PM

Last updated: Mon 13 Mar 2017, 10:08 PM

China's Alibaba, South Africa's Naspers, India's Flipkart and Russia's Yandex all taught me that it can be very profitable to invest in the dominant franchise in emerging market e-commerce. After all, economics of scale and network effects on the Internet mean the embryonic Amazon.coms of a major emerging markets can exhibit viral, exponential growth in revenues and valuation as Internet penetration and population growth work their magic. Well, Latin America has 620 million people and an Internet penetration ratio of a mere 61 per cent, far below the 89 per cent rate in Gringolandia (aka the US). And who is the dominant e-commerce franchise in Latin America? An Argentine-based firm called Mercado Libre, whose shares happen to have risen 130 per cent in the past year and trade under the symbol MELI on the Nasdaq in New York.
Mercado Libre is 208 as I write and thus valued at an enterprise value/Ebitda ratio of 26, a stratospheric valuation that I cannot justify. Why?
One, operating margins will be pressured in 2017 due to the firm's decision to cut listing fees to boost transaction volumes, investing in its digital payment system Mercado Pago and investing in shipping infrastructure. This can only mean bad news for the shares.
Two, Venezuela is the firm's third-largest market after Brazil and Argentina. My ex-JPMorgan Chase alumni network in Panama City and Buenos Aires tells me that a Venezuelan sovereign default is imminent as the Maduro regime failed to jettison the catastrophic socialist policies of Chavismo and his moronic Bolivarian revolution. A Venezuela default will slam the shares since e-commerce is strangled when international trade and the free flow of capital is strangled by the inept, even brutal regime of Nicolas Maduro.
Three, the Federal Reserve will raise US dollar interest rates at least seven times in 2017 and 2018, thus pressure Latin America's local currencies. A rise in US interest rates means nosebleed valuations in hyper-growth momentum shares will compress. The end of Fed easy money also means a rise in volatility in the Treasury bond market. This means a 20 per cent hit or $40 a share fall in Mercado Libre is highly probable in the next four months. The case for owning high-delta put options on MELI is compelling.
Four, Brazil's emergence from its worst recession since the 1930s and Argentina's rejection of the Peronists with the election of Mauricio Macri have been amply reflected in the rise of Mercado Libre shares from 96 to 208 in the past 14 months. This made rational sense to me. After all, payment volumes on Mercado Pago also rose 50 per cent. The user base grew 20 per cent to 158.6 million users. Revenues were up 125 per cent in Latino local currencies.
Five, while eBay owns 16 per cent of Mercado Libre, it has shown no interest in buying the rest of the company, even as it launches takeover bids for a Swedish artificial intelligence firm, a data predictive analytics startup and a US ticket marketplace. If Amazon.com scales up in Latin America, every local online retailer and e-commerce marketplace is toast. Mercado Libre's earnings growth will decelerate in 2017. The storm clouds have begun to darken - and a spring sell off could see the shares tank to 160. Thankfully, my Argentine friend from the Chase New York training class will keep me plugged into the financial grapevine in the pampas in real time. So what exactly is an Argentine, as the old Porteño joke goes? An Italian who speaks Spanish but wishes he was English - as Jorges Luis Borges unquestionably did long before the Malvinas war!
I fell in love with Argentina long before I ever visited it. As a teenager, we stayed up well past midnight in Dubai to watch Mario Kempes and los hombres do their magic in the 1978 World Cup. Little did I know the pain, heartbreak and horror that fate had in store for this wonderful land - the dirty war, the brutal military dictatorships of generals Videla, Viola, Galtieri, the Falklands War, hyperinflation, the debt crisis, the currency collapse, banking crisis and sovereign default in 2001. Yet Argentina, like Pakistan, is a nightmare-turned-investment fairy tale. Argentina's Merval index fund returned 50 per cent in US dollars in 2016 even though the economy is still in recession. The state and provinces have borrowed $40 billion. Macri has implemented major currency and export tariff reforms. Yet inflation is still 40 per cent and Macri's four per cent trade deficit target is a dream - the Argentina money tango has finally begun!
The writer is a global equities strategist and fund manager.


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