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MercadoLibre Bringing Back Bubble Memories

Reasonable valuation has once again left the building.

MercadoLibre

(MELI) - Get Report

investors must be thrilled at the stock's recent gains.

I hate to be one to rain on their parade, but I find it just a little bit worrying.

MercadoLibre, which has become in Latin America what

eBay

(EBAY) - Get Report

is in the U.S. and

Taobao

is in China, saw its stock surge18% Wednesday -- and a further 11% Thursday to $37.06 -- after fourWall Street research desks issued reports that sounded a mating callfor bulls, targeting the stock between $35 and $45 a share.

Three of the bullish firms -- Merrill Lynch, JPMorgan and Pacific Crest -- were underwriters of MercadoLibre's IPO in July.

Underwriters are routinely among the first to issue analyst reports on a new stock for obvious reasons: They've had a good look at the company.

The fourth firm, American Technology Research, offered the $45 price target.

So I wouldn't say we're returning to the dot-com practice of research analysts touting stocks their firms have underwritten. That said, there are a couple of things about MercadoLibre's post-IPO performance that nervously remind me of the dot-com bubble.

First, there are the surreal valuations that analysts are putting onthe stock. MercadoLibre posted a profit of a penny per share last year.That gives the stock, at its current price, a historical

P/E ratio of3,706.

In the first half of this year, MercadoLibre has donemuch better, posting a profit of 3 cents a share. Now let's supposethe company doubles that figure in the rest of the year. Its P/E isstill 411 for 2007.

Merrill Lynch justified its $35 price target by valuing the stock at 46 times earnings for the year ending December 2009. In other words, MercadoLibre will fall to a valuation (one that most sensible investors are uncomfortable with) not this year, or even next year, but according to an earnings report that may not come out until March 2010.

I'm not knocking MercadoLibre, which is clearly poised for growth, and it's even possible these predictions may come true.

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In its IPO prospectus, MercadoLibre said that economies of scale would push up its operating profit, and that's exactly what happened in the second quarter. Operating margins were 25%, up from both 18% in the previous quarter and 12% in the second quarter of 2006 (See page 13 of

this investor presentation

).

But valuing a stock according to an expected profit two or three years down the road isn't

fundamental analysis, it's speculation. And it's the kind of speculative rationalization that we really haven't seen in the Internet sector since the waning days of the bubble.

What if eBay, which owns 18.5% of MercadoLibre,

decides to set up shop

in Latin America? That would cut MercadoLibre's revenue and drive up marketing costs, eroding profit margins. Remember, eBay recently began competing with Craigslist, a company in which it also owns a stake.

The other troubling thing about MercadoLibre's rally is how it popped after the IPO. Granted, the offering price may have been discounted to ensure a smooth launch in a turbulent market, but the market is valuing the stock at nearly twice what underwriters did.

We're seeing such pops more often in tech:

VMWare

(VMW) - Get Report

has nearly tripled from its $29-a-share offering price.

But the situation is a little more serious with MercadoLibre: One of the investors burned by the low offering price was underwriter JPMorgan, which

sold 5.35 million MercadoLibre shares

as part of the IPO, or $96 million. But those shares would now be worth $198 million, so Morgan left $102 million on the table (and possibly more, if its analyst is right to rate it overweight).

Nor was Morgan alone. Goldman Sachs (not an underwriter) made $33 million from the 1.86 million shares it sold, and those shares are now worth $69 million. Flatiron Funds sold $22 million worth of shares that are currently valued at more than double that. It could all make for some awkward chitchat at Wall Street cocktail parties.

The post-IPO surge puts the analysts at MercadoLibre's underwriters in a difficult spot. In effect, they're explaining why they believe the stock is worth twice what their own firm thought it was worth two months ago. And how, in Morgan's case, that miscalculation cost it so much money.

But my broader concern is this: Money being pulled from the collapsing mortgage market is desperate for somewhere to go. Some of it may be piling into well-run, growth-driven companies like MercadoLibre, inflating their market value and forcing analysts to scramble for reasons why the stock is surging.

What's wrong with that? It's exactly the kind of what-me-worry? thinking that paved the way for a bubble in tech IPOs nearly a decade ago. I'm not saying it has returned now, but it's time to start worrying -- at least a little bit -- about the possibility.