MercadoLibre Borrows in U.S. Dollars, But Calculates Cost of Capital Based on Foreign Bond Rates
MercadoLibre, a Latin American ecommerce platform, borrows in U.S. dollars but appears to calculate its cost of capital and discount rates based on inflated foreign country bond rates. The company generates 94.4% of its revenue from Brazil, Argentina, and Mexico. As of this writing, the yield on 10-year government bonds in those countries are: 8.3% (Brazil), 45.4% (Argentina), and 6.15% (Mexico).
If we average these bond yields proportionate to their country’s share of MercadoLibre’s revenue, we get 16.68%. It’s of little surprise then— at least initially— that MercadoLibre estimates its cost of capital at 17%:
“We use discount rates to each reporting unit in the range of 15.1% to 21.0%. The average discount rate used for 2020 was 17.2%
But MercadoLibre borrows in U.S. dollars. It recently refinanced its debt, issuing approximately $1 billion in five and ten year bonds. The coupon rate on the 5 year bonds is 2.375%, and the 10 year is $3.125%. As of this writing, the 5 year bonds trade above par and the 10 year bonds trade below par, yielding 3.35%
MercadoLibre Uses Discount Rate Significantly Higher Than Its Peers
Despite borrowing approximately 2% above the U.S. risk free rate, MercadoLibre disclosed in its 2020 10-K that it discounts operating leases by 9%. This rate— while lower than its stated blended cost of capital of 17%— is significantly higher than MercadoLibre’s ecommerce company peers, which report the following discount rates in their most recent filings:
Big Commerce: 5.47%
Using an inflated discount rate hide’s a firm’s true liabilities from investors.
MercadoLibre has $394 million in future operational lease obligations. The present value of those obligations, according to MercadoLibre, is $298.8 million. If we use the blended average discount rate for MercadoLibre’s peer group— 4.12%— we calculate a lease liability of $327.5 million. It means MercadoLibre is understating its lease liabilities by approximately $28.7 million, or 7.3% of its future operational lease obligations and 0.588% of total liabilities.
Accounting for Argentina’s Risk Premium
We concede Argentina, where MercadoLibre has nearly 7k of its 15.5k employees who do the bulk of its technology development, is a cost of capital risk. The country refused to exchange pesos for U.S. dollars, contributing to MercadoLibre’s $42.5 million foreign currency loss in 2020. Even if you agree this is an operational matter to which all multi-nationals are subject and may be hedged, Argentina’s debt problems present unique challenges, as does its 11.6% country risk premium.
If we add a country risk premium— proportionate to Argentina's share of MercadoLibre’s revenue— of 1.7%, we get a discount rate of 5.82%. We now calculate a lease liability of $305.3 million, which still understates MercadoLibre’s lease liabilities by approximately $6.5 million.
We believe this treatment is overly generous since MercadoLibre borrows in U.S. dollars and seemingly did not hegde its FX risk in Argentina as it did for other countries:
"During 2020, we entered into hedging transactions in Brazil and Mexico in order to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates.”
There was also plenty of time for MercadoLibre to adjust its operating lease discount rate following its U.S. bond issuance. The company’s 2020 10-K was filed March 1, 2021, nearly two months after the $1 billion debt offering