[MELI – MercadoLibre] Digging the Moat (Or Is It A Grave?): Part 3

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[MELI – MercadoLibre] Digging the Moat (Or Is It A Grave?): Part 1

[MELI – MercadoLibre] Digging the Moat (Or Is It A Grave?): Part 2

In 2016, six years and several pro-competition pieces of regulation after the Central Bank of Brazil and antitrust authorities first pried the merchant acquiring market open to new competition, Cielo, the leading incumbent card processor in Brazil and Latin America¹², seemed to be doing fine.  With payment volumes growing by high-single digits and EBITDA margins at 45%, the consequences of regulation seemed manageable. 

But in the midst of growing internet access and wider smartphone adoption, Stone, PagSeguro, MercadoPago, and other payment processors emerged to target the 13mn SMBs and micro-merchants long ignored by incumbents³. These challengers offered cheap mPOS devices, easy on-boarding, excellent customer service, working capital relief, and interchange kickbacks to win over unbanked merchants who hadn’t before accepted credit cards.  Their volumes exploded.

In 2016, these challengers were still quite small compared to Cielo….

2016 TPV (BRL mn):

Cielo: 567bn

PagSeguro: 14bn

Stone: 28bn

…but they claimed a greater share of incremental volume in the ensuing years:

Change in TPV from 2016 to 2018 (BRL mn):

Cielo: 49bn

PagSeguro: 62bn

Stone: 55bn

In 2018, even with Brazilian credit and debit transactions growing by low/mid-teens, Cielo’s payment volumes and revenue flat-lined, and EBITDA margins fell below 40%.  Cielo’s stock lost more than 70% of its 2015 year-end value.  In 2019, the company’s payment volumes recovered but revenues declined by low-single digits while EBITDA margins plumbed new lows in the face of vicious price competition (the financials of Rede, the second largest acquirer in Latin America, are not publicly available so I can’t be sure what happened to it during this time, but I’m guessing it has met a similar fate).  In response, Cielo is trying to move down market and now undergoing a “digital transformation”, but things look pretty bleak. Today, fintech competition in Brazil is like a roided version of what’s taking place in the US and Europe, where relative newcomers like Square and Adyen have stolen share from incumbents like First Data and Global Payments. MercadoLibre, Stone, and PagSeguro have collectively raised ~$6bn in equity over the last 2 years to fund aggressive growth campaigns as they position themselves as not just processors but broad digital banking platforms for merchants. Even at 8x EBITDA, Cielo’s stock still feels too rich. 

In Brazil, credit cards only capture ~25% of the estimated ~$1.3tn running through a variety of addressable industries, and of that, the country’s 13mn Micro-merchants and SMEs – the sub-segment targeted by Stone, PagSeguro, and MercadoPago – account for ~$450bn⁴.  For the most part, Stone, with $29bn of TPV, targets SMEs while PS ($26bn) and MP ($25bn – but this is across all of Latam, not just Brazil) cater to micro-merchants⁵.  The latter two companies are both majority-owned by online properties – PagSeguro is controlled by internet content portal Universo Online (UOL) and Pago, of course, intermediates 90%+ of MELI’s marketplace volumes.  They both began by facilitating online transactions before availing themselves of Brazil’s pro-competition mandates to process offline payments and do a whole bunch of other stuff for merchants. They have both evolved their mobile wallets into digital banks that offer an ever broadening array of financial services (mobile data plan top-ups, bill pay, prepaid cards) for Brazil’s 68mn unbanked consumers.

Stone, perhaps taking a page from the playbook of US merchant acquirers, has built atop its payment processing foundation a broader platform of services for small merchants, offering POS/ERP/CRM software, digital banking accounts, and working capital loans. They’ve used a combination of these services to retain and grow merchant relationships, expanding take rates in the face of intense price competition (by contrast, take rates at Cielo and PagSeguro have persistently declined over the last 5 years). Also, fwiw, Stone seems to be the most merchant obsessed of the bunch…lots of pride about answering calls in less than 5 seconds on average, with 95% of calls rated “excellent”.

Pago’s total payment volumes (TPV) have gone nuts, especially its non-Libre (off marketplace or off platform) TPV (the subset of Pago TPV that isn’t Libre marketplace GMV):

Pago has become its own standalone growth story.  While over 90% of Libre’s marketplace GMV is processed through Pago, most of Pago’s TPV now comes outside of Libre:

Using PagSeguro’s TEV/TPV as a valuation proxy, you might peg MercadoPago’s value at $11bn, ~1/3 of MELI’s enterprise value.  Every passing quarter hints at the possibility that Pago might someday be more valuable than the marketplace it was meant to facilitate.  Pago has leveraged the two-sided wallet/merchant network developed online – facilitating Libre payments and gatewaying payments for non-Libre merchants – to spin up an alternative payment system that covers offline retail, where cash is still the dominant form of payment. 

Pago’s offline efforts began in earnest around 5 years ago with the rollout of mobile Point of Sale (mPOS) devices.  Payment volumes running through those devices continue to expand at a torrid pace, nearly tripling last quarter vs. a year ago, and now account for just under half of Pago’s total off-platform transactions.  More recently, with the shopper side seeded with a popular mobile wallet that a growing number of consumers used to transfer funds P2P, pay bills, top-up mobile data plans, and transfer money, MercadoLibre has been redoubling R&D and marketing investments in an effort to stoke a payments network based on proprietary QR codes, which allow customers to pay for goods with their wallet balances and bypass card schemes (though mobile wallet holders can also pay using a credit card saved in-app).  Nearly two years since management declared its mobile wallet to be in “early seed stage”, the growing number of offline use cases have reflexively given rise to surging adoption, with Pago’s mobile wallet consumer base growing by 35% to 6mn and volumes more than quadrupling over a year ago to run-rate at $4bn.