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 macroeconomic instability and 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 Brazil’s, Argentina’s and Mexico’s respective share of our revenues, may affect the value of our financial assets and liabilities.
We are also exposed to market risks arising from our long-term retention programs (“LTRPs”). These market risks arise from our obligations to pay employees cash payments 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, net investment and fair value hedges for accounting purposes. The derivatives’ gain or loss for cash flow and net investment hedges is initially reported as a component of accumulated other comprehensive loss. 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. The derivatives’ gain or loss for fair value hedges is reported in our consolidated statements of income in the same line items as the change in the value of the hedged item due to the hedged risks.
As of December 31, 2023, 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, 2023, the total cash and cash equivalents, restricted cash and cash equivalent denominated in foreign currencies totaled $3,201 million, short-term investments denominated in foreign currencies totaled $2,466 million and accounts receivable, credit card receivables and other means of payments and loans receivable in foreign currencies totaled $6,482 million. As of December 31, 2023, we had $79 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, 2023, our U.S. dollar-denominated cash and cash equivalents, restricted cash and cash equivalents and short-term investments totaled $1,661 million and our U.S. dollar-denominated long-term investments totaled $83 million.
For the year ended December 31, 2023, we had a consolidated loss on foreign currency of $615 million mainly related to higher foreign exchange losses attributable to our own common stock acquisition in the Argentine market at a price that reflects the additional cost of accessing U.S. dollars through an indirect mechanism due to restrictions imposed by the Argentine government for buying U.S. dollars at the official exchange rate, and higher foreign exchange losses from our Argentinian subsidiaries due to the devaluation of the Argentine peso during December 2023 and the acquisition of U.S. dollars in the Argentine market at a price that reflects the additional cost of accessing U.S. dollars through an indirect mechanism due to restrictions imposed by the Argentine government for buying U.S. dollars at the official exchange rate.
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Foreign currency sensitivity analysis
The table below shows the impact on our net revenues, cost of net revenues, operating expenses, other income (expenses), income tax expense and equity in earnings of unconsolidated entity, 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, 2023:
(10)% (1)
Actual ' +10% (2)
(In millions)
Net revenues $ 16,081 $ 14,473 $ 13,157
Expenses (3)
(13,992) (12,650) (11,551)
Income from operations 2,089 1,823 1,606
Other income (expenses), income tax expense and equity in earning of unconsolidated entity related to P&L items (243) (221) (213)
Foreign Currency impact related to the remeasurement of our Net Asset position (640) (615) (595)
Net Income $ 1,206 $ 987 $ 798
Total Shareholders’ Equity $ 3,435 $ 3,071 $ 2,763
(1) Increase of the subsidiaries local currency against U.S. Dollar.
(2) Decrease of the subsidiaries local currency against U.S. Dollar.
(3) 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 decrease of 10% of the Brazilian Real against the U.S. dollar on December 31, 2023, the reported net assets in our Brazilian subsidiaries would have decreased by approximately $244 million with the related impact in Other Comprehensive Income. Additionally, we would have recorded a foreign currency loss amounting to approximately $49 million in our Brazilian subsidiaries.
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, 2023, 2022 and 2021 was 211.4%, 94.8% and 50.9%, respectively.
We use Argentina’s official exchange rate to account for transactions in our Argentine segment, which as of December 31, 2023, 2022 and 2021 was 808.45, 177.16 and 102.72, respectively, against the U.S. dollar. For the years ended December 31, 2023, 2022 and 2021, Argentina’s official exchange rate against the U.S. dollar increased 356.3%, 72.5% and 22.1%, respectively.
Considering a hypothetical decrease of 10% of the Argentine Peso against the U.S. dollar on December 31, 2023, the effect on non-functional currency net liability position in our Argentine subsidiaries would have been a foreign exchange gain amounting to approximately $4 million in our Argentine subsidiaries.
See Note 2 – Summary of significant accounting policies - Foreign currency translation - Argentine currency status and macroeconomic outlook of our audited consolidated financial statements for further detail on the currency status and the exchange regulations of our Argentine segment.
Mexican segment
Considering a hypothetical decrease of 10% of the Mexican peso against the U.S. dollar on December 31, 2023, the reported net assets in our Mexican subsidiaries would have decreased by approximately $103 million with the related impact in Other Comprehensive Income. Additionally, we would have recorded a foreign currency loss amounting to approximately $23 million in our Mexican subsidiaries.
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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 Mercado Pago receivables and on the financial debt that we use to fund Mercado Pago and Mercado Credito’s operations. As of December 31, 2023, Mercado Pago’s receivables totaled $3,632 million. Interest rate fluctuations could also impact interest earned through our Mercado Credito solution. As of December 31, 2023, loans receivable net of the allowance for doubtful accounts from our Mercado Credito solution totaled $2,694 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, 2023, our short-term investments amounted to $3,480 million and our long-term investments amounted to $162 million. Our short-term investments 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. See Note 3 – Fintech Regulations and Note 5 – Cash, cash equivalents, restricted cash and cash equivalents and investments of our audited consolidated financial statements for further detail on our restricted investments.
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, 2023, our loans payable and other financial liabilities which accrue interest based on variable rates amounted to $2,810 million, while our loans payable and other financial liabilities, which accrue interest based on fixed rates, amounted to $1,685 million. See Note 17 – Loans payable and other financial liabilities and Note 21 – Securitization transactions of our audited consolidated financial statements for further detail. Considering a hypothetical increase of 100 basis points in the interest rates, the reported Loans payable and other financial liabilities as of December 31, 2023 would have increased by approximately $16 million with the related impact in Interest expense and other financial losses. We have entered into swap contracts to hedge the interest rate fluctuation of $489 million notional amount, $244 million of which have been designated as hedging instruments. See Note 24 – Derivative instruments of our audited consolidated financial statements for further detail on derivatives instruments.
Equity price risk
Our board of directors, upon the recommendation of the compensation committee, approved the 2019, 2020, 2021, 2022 and 2023 Long Term Retention Programs (the “2019, 2020, 2021, 2022 and 2023 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, 2021, 2022, 2023 and 2024 for the 2019, 2020, 2021, 2022 and 2023 LTRPs, respectively). In order to receive the full target award under the 2019, 2020, 2021, 2022 and/or 2023 LTRPs, each eligible employee must remain employed as of each applicable payment date. The 2019, 2020, 2021, 2022 and 2023 LTRP awards are payable as follows:
■ the eligible employee will receive 16.66% of half of his or her target 2019, 2020, 2021, 2022 and/or 2023 LTRP bonus once a year for a period of six years, with the first payment occurring no later than April 30, 2020, 2021, 2022, 2023 and 2024, respectively (the “2019, 2020, 2021, 2022 or 2023 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, 2022 or 2023 Variable Payment”) equal to the product of (i) 16.66% of half of the target 2019, 2020, 2021, 2022 or 2023 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, 2021 and 2022 defined as $322.91, $553.45, $1,431.26, $1,391.81 and $888.69 for the 2019, 2020, 2021, 2022 and 2023 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.
As of December 31, 2023, the total contractual obligation fair value of our outstanding LTRP Variable Award Payment obligation subject to equity price risk amounted to $418 million. As of December 31, 2023, the accrued liability related to the outstanding Variable Award Payment of the LTRP included in Salaries and social security payable in our consolidated balance sheet amounted to $104 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%:
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Change in equity price in percentage As of December 31, 2023
MercadoLibre, Inc
Equity Price 2019, 2020, 2021, 2022 and 2023 LTRP Variable contractual obligation
(In millions, except equity price)
40% 2,210.74 585
30% 2,052.83 544
20% 1,894.92 502
10% 1,737.01 460
Static (1)
1,579.10 418
-10% 1,421.19 376
-20% 1,263.28 335
-30% 1,105.37 293
-40% 947.46 251
(1) 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 Kangu Participações S.A. Former Kangu’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, 2023, the total contractual obligation fair value of the mentioned payments amounted to $10 million.