BIDDERS AT AUCTION OFTEN LOSE THEIR> nerve in the face of escalating prices. Investors contemplating a stake in eBay , which has rallied 52% this year -- and 15% just in the past two weeks -- might understand the phenomenon well. They, too, may be questioning whether the company and its shares are "worth it" at 21-and-change. They should stop worrying, and bid.
remains more than 50% below its peak level of five years ago. Moreover, at just 14 times this year's expected earnings of $1.51 a share, and around 13 times 2010 estimates of $1.62, the company trades at a 20% discount to the broad stock market, and looks like a bargain relative to similar e-commerce outfits such as Amazon.com (AMZN),
Ever since John Donahoe was elevated early last year to replace Meg Whitman as chief executive, management has been promising eBay would find a way to cut costs and streamline its online marketplace to heighten its appeal to large sellers of fixed-price goods. In recent months, these efforts began delivering positive results.
The volume of total items sold in the latest quarter increased by 2.7%, reversing a 1.6% decline in the prior quarter, in what Stephen Ju, an analyst at RBC Capital Markets, calls the "first real signs of a turnaround." Earnings and revenue in the quarter both were ahead of forecasts, improvements that likely mark the beginning of a lasting recovery.
Crucially, Donahoe's focus on better accommodating large sellers of merchandise, such as mainstream retailers, has driven the proportion of fixed-price merchandise, as opposed to auctioned goods, to 51% of sales in the company's marketplace segment, which rang up total revenue of nearly $5.6 billion in 2008. The growth rate of the auction business has been declining since the fourth quarter of 2008, highlighting the imperative to boost fixed-priced sales.
Majestic Research, which maintains a proprietary database to calculate e-commerce volumes, says total listings on eBay are up 17.3% year-to-year in the current quarter. Of the total, store-posted listings have soared 57.7%, while "core" listings from individuals have risen 11.2%.
Last week, eBay altered its listing rules to help top-rated large vendors win buyer traffic more easily, a move that drew predictable carping from small sellers but was otherwise roundly embraced.
Online retailing of fixed-price merchandise is no easy business, given powerful competitors from Amazon to the Websites of bricks-and-mortar merchants. But by growing its fixed-price business, eBay wisely is declaring itself agnostic about how people use its platform to buy and sell goods.
IN THE PAST DECADE, eBay has gone from overhyped and overvalued to underloved and underpriced. At the peak of the dot-com bubble in early 2000, when the San Jose, Calif.-based company barely was turning a profit, it had a market value of $30 billion. Today, its market value is $28 billion, supported by more than $2 billion a year of free cash flow.
The mania of the late 1990s that inflated all things technology-related shouldn't be expected or invited back for years, if ever. But even in these sober times, with the tech-heavy Nasdaq Composite still a shadow of its former self, Amazon fetches 50 times expected earnings. Even a terrestrial retailer like Target (TGT)
A whiff of the eBay of old -- an online auctioneer of quirky items and occasional gems -- still lingers. But the public, and particularly the investment community, doesn't fully appreciate the global, multifaceted and increasingly profitable company that has replaced it.
EBay may lack Amazon.com's reputation as the go-to site for media products, not to mention a product like Amazon's hot-selling electronic reader, the Kindle. Yet, it is evolving into a business much more like Amazon, only with far better margins.
Last year, eBay earned about $1.8 billion on $8.5 billion of revenue. Amazon netted $645 million on $19.2 billion of sales. Plus, in PayPal, an online-payments system, and Skype, an Internet-communications service, eBay has two unappreciated businesses whose growth is far outstripping that of many other technology-based services.
To be sure, eBay isn't the bargain it was at the market's lows in March, when it traded below 10 a share. A pullback below 20 wouldn't be surprising after the stock's recent run-up -- indeed, it might be welcomed by careful investors. Yet, eBay could trade up to the high-20s -- a level last seen in the summer of 2008 -- in the next year or so, as sales and earnings resume growing.
Ju, the RBC analyst, began recommending the stock following eBay's latest earnings report. He says there is an upside tilt to sales trends in the marketplace segment, and that the "multiple has room to expand as [eBay] begins to string together additional signs of platform improvements."
THE RALLY SINCE MARCH in eBay's shares reflects growing confidence that the company's sales trends are stabilizing after a rocky stretch, and that the improvements to the marketplace site instituted by Donahoe and his team are gaining traction. Donahoe, 49, joined eBay in 2005 to run the marketplace business, following a 20-year career as a consultant at Bain & Co., most recently as the firm's CEO. His emphasis on operational efficiencies, return on capital and cash-flow deployment reflects this background, and will leave eBay better-positioned as the global economy improves.
Bob Swan, the company's chief financial officer, describes eBay as a facilitator of "goods transfer." Snow emphasizes that the e-commerce industry is relatively young; online sales represent just 6% to 7% of total retail sales, and are growing at a 15% annual rate. Approximately $60 billion of online transactions were made through PayPal last year, up 27% from a year earlier; the service's total payment volume represented nearly 9% of global e-commerce, and 15% of U.S. transactions.
EBay's stated objective is to build annual revenue -- an estimated $8.5 billion this year -- to between $10 billion and $12 billion by 2011. The company aims to produce mid-single-digit percentage gains in earnings, and an aggregate $6 billion to $7 billion of free cash flow. If investors believed it could meet those goals, its shares likely would be higher. Yet, these targets are achievable, especially as the economy picks up.
Ebay, like many tech-related companies that liberally issue stock options, reports non-GAAP [generally accepted accounting principles] earnings results and forecasts. They exclude stock-based employee compensation and some goodwill amortization. Barron's has long argued this leads to systematic overstatement of tech profitability, but it does nothing to change the valuation discount of eBay versus other, similar companies.
LAST YEAR, EBAY'S MARKETPLACE unit contributed about 65% of total revenue, and 80% of operating income. PayPal accounted for 28% of revenue and 16% of income -- proportions that have been growing with the unit's sales and profits.
Skype, which still chips in less than 10% of revenue, is growing by more than 420% a year. It has 481 million registered users, and is the clear winner in Internet calling -- so much so that it's name has become a verb. EBay plans to spin off the unit through a stock offering early next year, in an acknowledgment that Skype isn't symbiotic with the rest of the company. A spinoff, however, could spotlight Skype's value, and simplify eBay's business mix. Donahoe has said Skype could be valued at $2 billion or more in the public market.
These days, eBay is getting an increasing percentage of its business from abroad. Non-U.S. revenue accounted for 54% of total second-quarter sales of $2.1 billion. In countries such as England, Germany and Korea (where eBay acquired its largest competitor, GMarket), auction activity is several times as popular as in the U.S.
In stark contrast to a decade ago, and even five years ago, when aggressive-growth investors swarmed into eBay's shares, the company's stock now is largely in the hands of a more value-oriented crowd. Big holders, who have upped their positions this year, include Southeastern Asset Management and Dodge & Cox.
Sell-side analysts remain skeptical of eBay's prospects. Only eight of the 32 analysts who cover the company recommend its shares, while three have Sell ratings. Even the putative bulls don't see much upside; none has a price target above 25. Contrarians, take note: Street sentiment in the face of a strongly performing stock and improving corporate performance often is a recipe for further investment gains.
In some respects, the analyst cadre remains overly focused on the company's core auction business, using "gross merchandise volume" as the key measure of eBay's results. The gross value of merchandise sold in the latest quarter at fixed prices, often from large retailers and manufacturers, surged 19% from a year earlier, adjusted for foreign-currency translation. That more than offset a 17% decline year-to-year in auction volume.
Yet this focus obscures the most unique and valuable franchise within eBay -- PayPal, the secure online-"wallet" payment processor. PayPal handled $16.7 billon worth of transactions in the second quarter, up 19% year over year after currency adjustments. Its loss rates are microscopic. The proportion of eBay transactions consummated via PayPal has risen from 56.5% to 64.4% in the past year. The larger opportunity is signing up more third-party merchants, both sole proprietors and large retail chains.
EBay management is committed to doubling PayPal's revenue in the next three years. Given that investors happily pay 23 times earnings for Visa International (V), whereas eBay, as a whole, trades for 14 times earnings, the likelihood that PayPal increasingly will contribute a higher percentage of company profits is another argument for eBay's valuation to rise over time.
Christa Quarles, an analyst at Thomas Weisel Partners, values the PayPal business at a multiple of 13 times cash flow, nearly twice what she suggests the core eBay-marketplace business is worth.
ONCE SKYPE IS CARVED OUT of eBay next year via an initial public offering, PayPal's sway in driving company profits should become clearer to the Street.
The Skype separation, a mere four years after its expensive and much-criticized acquisition by eBay, points to a valid concern among some investors: that eBay has a hit-and-miss record with acquisitions, which, after all, are a key use of all that lush free cash flow.
Shopping.com, acquired in 2005, wasn't exactly a boon to the bottom line. And when eBay bought Bill Me Later -- a PayPal competitor that extends credit to riskier consumers -- late last year, the deal was ill-timed, if strategically defensible.
Skype might never have meshed with the rest of eBay, but it has proved a category killer, with far more users for its telephony and video-conferencing services than its nearest competitors. Pretax profit margins in the Skype unit run above 20%, hinting that its stock could get a generous reception once an IPO is executed. There are some legal challenges to Skype's technology, however, so investors must remain alert to headline risk on the way to the spinoff.
There have been consistent suggestions over time that eBay itself could become a takeover target by a large online player covetous of its traffic and network efficiencies. These, presumably, could be leveraged into greater advertising revenue if integrated into a Google (GOOG)
It's plausible, but hardly probable, given eBay's relatively new top management, which by its own admission is only halfway through a long turnaround campaign. But the very things that make eBay so attractive as a hypothetical buyout target argue that investors should consider bidding for its shares as those promised results are delivered in the next couple of years.