Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks arising from our business operations. These market risks arise mainly from the possibility that changes in interest rates and the U.S. dollar exchange rate with local currencies, particularly the Brazilian Real, Argentine Peso and Mexican Peso due to those segments’ respective share of our revenues and assets, may affect the value of our financial assets and liabilities. Latin American countries in which we operate have been negatively affected by the outbreak of COVID-19, which has generated macroeconomic instability and led to the depreciation of certain Latin American currencies.
We are also exposed to market risks arising from our long-term retention plans (“LTRPs”). These market risks arise from our obligations to pay employees cash in amounts that vary based on the market price of our stock.
Foreign currencies
We have significant operations internationally that are denominated in foreign currencies, primarily the Brazilian Real, Argentine Peso, Mexican Peso, Colombian Peso and Chilean Peso, subjecting us to foreign currency risk, which may adversely impact our financial results. We transact business in various foreign currencies and have significant international revenues and costs. In addition, we charge our international subsidiaries for their use of intellectual property and technology and for certain corporate services. Our cash flows, results of operations and certain of our intercompany balances that are exposed to foreign exchange rate fluctuations may differ materially from expectations and we may record significant gains or losses due to foreign currency fluctuations and related hedging activities.
We use foreign currency exchange forward contracts and currency swaps to protect our foreign currency exposure and our investment in a foreign subsidiary from adverse changes in foreign currency exchange rates. These hedging contracts reduce, but do not entirely eliminate, the impact of adverse foreign currency exchange rate movements. We designate these contracts as cash flow or net investment hedges for accounting purposes. The derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (“AOCI”). Cash flow hedges and net investment hedges are subsequently reclassified into the financial statement line item in which the hedged item is recorded in the same period the forecasted transaction affects earnings.
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As of December 31, 2022, we hold cash and cash equivalents in local currencies in our subsidiaries, and have receivables denominated in local currencies in all of our operations. Our subsidiaries generate revenues and incur most of their expenses in the respective local currencies of the countries in which they operate. As a result, our subsidiaries use their local currency as their functional currency except for our Argentine subsidiaries, whose functional currency is the U.S. dollar due to the inflationary environment. As of December 31, 2022, the total cash and cash equivalents, restricted cash and cash equivalents denominated in foreign currencies totaled $3,138 million, short-term investments denominated in foreign currencies totaled $1,491 million and accounts receivable, credit card receivables and other means of payments and loans receivable in foreign currencies totaled $4,812 million. As of December 31, 2022, we had $90 million long-term investments denominated in foreign currencies. To manage exchange rate risk, our treasury policy is to transfer most cash and cash equivalents in excess of working capital requirements into U.S. dollar-denominated accounts in the United States and to enter into certain foreign exchange derivatives, such as currency forwards contracts, in order to mitigate our exposure to foreign exchange risk. As of December 31, 2022, our U.S. dollar-denominated cash and cash equivalents, restricted cash and cash equivalents and short-term investments totaled $1,073 million and our U.S. dollar-denominated long-term investments totaled $232 million.
For the year ended December 31, 2022, we had a consolidated loss on foreign currency of $198 million mainly related to higher foreign exchange losses attributable to the acquisition of our own common stock in the Argentine market at a price that reflects the additional cost of accessing U.S dollars through U.S. dollar denominated securities due to restrictions imposed by the Argentine government for buying U.S. dollars at the official exchange rate (refer to Note 25 of our audited consolidated financial statements for further detail and see also “Item 1A. Risk Factors - Risk related to doing business in Latin America - Local currencies used in the conduct of our business are subject to depreciation, volatility and exchange controls”), and higher foreign exchange losses from our Brazilian subsidiaries. (See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal trends in results of operations—Other income (expenses), net” for more information).
See Note 2 to our audited consolidated financial statements for further detail on Argentina’s functional currency change.
Foreign Currency Sensitivity Analysis
The table below shows the impact on our net revenues, cost of net revenues, operating expenses, other income (expenses) and income tax, net income and equity for a positive and a negative 10% fluctuation on all the foreign currencies to which we are exposed to as of December 31, 2022 and for the year then ended:
Foreign Currency Sensitivity Analysis
(In millions) -10% Actual +10%
(1) (2)
Net revenues $ 11,707 $ 10,537 $ 9,579
Expenses (*)
(10,516) (9,503) (8,675)
Income from operations 1,191 1,034 904
Other income/(expenses) and income tax related to P&L items (381) (354) (331)
Foreign Currency impact related to the remeasurement of our Net Asset position (204) (198) (193)
Net Income 606 482 380
Total Shareholders’ Equity
$ 2,111 $ 1,827 $ 1,595
(1) Appreciation of the subsidiaries local currency against U.S. Dollar.
(2) Depreciation of the subsidiaries local currency against U.S. Dollar.
(*) Includes cost of net revenues and operating expenses.
The table above shows an increase in our net income when the U.S. dollar weakens against foreign currencies because of the positive impact of the increase in income from operations. On the other hand, the table above shows a decrease in our net income when the U.S. dollar strengthens against foreign currencies because of the negative impact of the decrease in income from operations.
Brazilian Segment
Considering a hypothetical devaluation of 10% of the Brazilian Real against the U.S. dollar on December 31, 2022, the reported net assets in our Brazilian subsidiaries would have decreased by approximately $178 million with the related impact in Other Comprehensive Income. Additionally, we would have recorded a foreign currency loss amounting to approximately $31 million in our Brazilian subsidiaries.
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Argentine Segment
In accordance with U.S. GAAP, we have classified our Argentine operations as highly inflationary since July 1, 2018, using the U.S. dollar as the functional currency for purposes of reporting our financial statements. Therefore, no translation effect has been accounted for in other comprehensive income related to our Argentine operations since July 1, 2018. Argentina’s annual inflation rate for the years ended December 31, 2022, 2021 and 2020 was 94.8%, 50.9% and 36.1%, respectively.
We use the Argentina’s official exchange rate to account for transactions in our Argentine segment, which as of December 31, 2022, 2021 and 2020 was 177.16, 102.72 and 84.15, respectively, against the U.S. dollar. Argentina’s annual depreciation of its local currency against the U.S. dollar for the years ended December 31, 2022, 2021 and 2020 was 72.5%, 22.1% and 40.5%, respectively.
Considering a hypothetical devaluation of 10% of the Argentine Peso against the U.S. dollar on December 31, 2022, the effect on non-functional currency net asset position in our Argentine subsidiaries would have been a foreign exchange loss amounting to approximately $16 million in our Argentine subsidiaries.
In the second half of 2019, the Argentine government instituted exchange controls restricting the ability of companies and individuals to exchange Argentine Pesos for foreign currencies and their ability to remit foreign currency out of Argentina. An entity’s authorization request to the CBA to access the official exchange market to make foreign currency payments may be denied depending on the circumstances. As a result of these exchange controls, markets in Argentina developed trading mechanisms in which an entity or individual buys U.S. dollar denominated securities in Argentina (i.e. shares, sovereign debt) using Argentine peso, and subsequently sells the securities for U.S. dollars, in Argentina, to access U.S. dollars locally, or outside Argentina, by transferring the securities abroad, prior to being sold (the latter commonly known as Blue Chip Swap Rate). The Blue Chip Swap Rate has diverged significantly from Argentina’s official exchange rate (commonly known as exchange spread). In recent years, the Blue Chip Swap Rate has been higher than Argentina’s official exchange rate. As of December 31, 2022, 2021 and 2020, the spread of the Blue Chip Swap Rate was 94.2%, 96.8% and 66.7%, respectively (see Notes 2 “Summary of significant accounting policies – Argentine currency status” and 25 “Share repurchase program” of our audited consolidated financial statements) .
Mexican Segment
Considering a hypothetical devaluation of 10% of the Mexican peso against the U.S. dollar on December 31, 2022, the reported net assets in our Mexican subsidiaries would have decreased by approximately $60 million with the related impact in Other Comprehensive Income. Additionally, we would have recorded a foreign currency loss amounting to approximately $20 million in our Mexican subsidiaries.
Interest
Our earnings and cash flows are also affected by changes in interest rates. These changes could have an impact on the interest rates that financial institutions charge us prior to the time we sell our credit card receivables and on the financial debt that we use to fund our Mercado Pago and Mercado Credito’s operations. As of December 31, 2022, Mercado Pago’s funds receivable from credit cards and other means of payments totaled $2,946 million. Interest rate fluctuations could also impact interest earned through our Mercado Credito solution. As of December 31, 2022, loans receivable net of the allowance for doubtful accounts under our Mercado Credito solution totaled $1,736 million. Interest rate fluctuations could also negatively affect certain of our fixed rate and floating rate investments comprised primarily of time deposits, money market funds and sovereign debt securities. Investments in both fixed rate and floating rate interest earning products carry a degree of interest rate risk. Fixed rate securities may have their fair value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall.
As of December 31, 2022, our short-term investments amounted to $2,339 million and our long-term investments amounted to $322 million. Our short-term investments, except for the $1,219 million related to the Central Bank of Brazil mandatory guarantee, can be readily converted at any time into cash or into securities with a shorter remaining time to maturity. We determine the appropriate classification of our investments at the time of purchase and re-evaluate such designations as of each balance sheet date.
Fluctuations of the interest rate could also have a negative impact on interest expense related to our Loans payable and other financial liabilities, as a portion of these instruments is subject to variable interest rates. As of December 31, 2022, our loans payable and other financial liabilities which accrue interest based on variable rates amounted to $2,615 million. See Notes 17 and 21 of our audited consolidated financial statements for further detail. We have entered into swap contracts to hedge the interest rate fluctuation of $842 million notional amount, $362 million of which have been designated as hedging instruments. See Note 24 of our audited consolidated financial statements for further detail on derivatives instruments.
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Equity Price Risk
Our board of directors, upon the recommendation of the compensation committee, approved the 2018 Long Term Retention Plan (the “2018 LTRP”).
In order to receive an award under the 2018 LTRP, each eligible employee must satisfy the performance conditions established by the board of directors for such employee. If these conditions are satisfied, the eligible employee will, subject to his or her continued employment as of each applicable payment date, receive the full amount of his or her 2018 LTRP award, payable as follows:
• the eligible employee will receive a fixed payment, equal to 8.333% of his or her 2018 LTRP bonus once a year for a period of six years starting no later than April 30, 2019 respectively (the “2018 Annual Fixed Payment”); and
• on each date we pay the respective Annual Fixed Payment to an eligible employee, he or she will also receive a payment (the “2018 Variable Payment”) equal to the product of (i) 8.333% of the applicable 2018 LTRP award and (ii) the quotient of (a) divided by (b), where (a), the numerator, equals the Applicable Year Stock Price (as defined below) and (b) the denominator, equals the 2017 Stock Price, defined as $270.84, which was the average closing price of our common stock on the NASDAQ Global Select Market during the final 60 trading days of 2017. The “Applicable Year Stock Price” shall equal the average closing price of our common stock on the NASDAQ Global Select Market during the final 60 trading days of the year preceding the applicable payment date.
Our board of directors, upon the recommendation of the compensation committee, approved the 2019, 2020, 2021 and 2022 Long Term Retention Program (the “2019, 2020, 2021 and 2022 LTRPs”), respectively, under which certain eligible employees have the opportunity to receive cash payments annually for a period of six years (with the first payment occurring no later than April 30, 2020 and 2021 for the 2019 and 2020 LTRPs, respectively, and no later than January 31, 2022 and 2023 for the 2021 and 2022 LTRPs, respectively). In order to receive the full target award under the 2019, 2020, 2021 and/or 2022 LTRPs, each eligible employee must remain employed as of each applicable payment date. The 2019, 2020, 2021 and 2022 LTRP awards are payable as follows:
• the eligible employee will receive 16.66% of half of his or her target 2019, 2020, 2021 and/or 2022 LTRP bonus once a year for a period of six years, with the first payment occurring no later than April 30, 2020 and 2021, and no later than January 31, 2022 and 2023, respectively (the “2019, 2020, 2021 or 2022 Annual Fixed Payment”, respectively); and
• on each date we pay the respective Annual Fixed Payment to an eligible employee, he or she will also receive a payment (the “2019, 2020, 2021 or 2022 Variable Payment”) equal to the product of (i) 16.66% of half of the target 2019, 2020, 2021 or 2022 LTRP award and (ii) the quotient of (a) divided by (b), where (a), the numerator, equals the Applicable Year Stock Price (as defined below) and (b), the denominator, equals the average closing price of our common stock on the NASDAQ Global Select Market during the final 60 trading days of 2018, 2019, 2020 and 2021 defined as $322.91, $553.45, $1,431.26 and $1,391.81 for the 2019, 2020, 2021 and 2022 LTRPs, respectively. The “Applicable Year Stock Price” shall equal the average closing price of our common stock on the NASDAQ Global Select Market during the final 60 trading days of the year preceding the applicable payment date.
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As of December 31, 2022, the total contractual obligation fair value of our outstanding LTRP Variable Award Payment obligation subject to equity price risk amounted to $157 million. As of December 31, 2022, the accrued liability related to the outstanding Variable Award Payment of the LTRP included in Salaries and social security payable and Non-current other liabilities in our consolidated balance sheet amounted to $58 million. The following table shows a sensitivity analysis of the risk associated with our total contractual obligation fair value related to the outstanding LTRP Variable Award Payment subject to equity price risk if our common stock price per share were to increase or decrease by up to 40%:
As of December 31, 2022
MercadoLibre, Inc
Equity Price 2018, 2019, 2020, 2021 and 2022 LTRP Variable contractual obligation
(In millions, except equity price)
Change in equity price in percentage
40 % 1,190.66 220
30 % 1,105.61 204
20 % 1,020.56 188
10 % 935.52 172
Static (*) 850.47 157
-10 % 765.42 141
-20 % 680.38 125
-30 % 595.33 110
-40 % 510.28 94
(*) Present value of average closing stock price for the last 60 trading days of the year preceding the applicable payment date.
In November 2021, we acquired Kangú Participações S.A. Former Kangú’s shareholders who after the acquisition became the Company’s employees will receive cash payments annually over a three-year period subject to certain performance and stay conditions. The payments will be indexed based on changes in equity price of our Common Stock. As of December 31, 2022, the total contractual obligation fair value of the mentioned payments amounted to $6.6 million.