EBay Stock Makes for Cheap Bet on Internet

Perhaps part of the problem is that eBay is more complicated than it first seems. A sizable chunk of business comes from other than hosting auctions. There's PayPal, the booming payment service; Skype, the Internet phone company that eBay famously overpaid for; and a host of smaller but fast-growing divisions like StubHub, Shopping.com and Rent.com, to name just a few, aimed at everyone from ticket buyers to apartment hunters. And don't forget partnerships with Yahoo (YHOO) and Google intended to generate some high-margin ad revenue that are kicking into gear.

Of course, the core marketplaces business still accounts for a good 70% of revenue, so it's not unreasonable for investors to maintain an intense interest in its fortunes, and that business, especially in the U.S. and Germany, just doesn't have the same growth as it once did. Chalk part of that up to the fact that it's hard to build on big numbers and part of it up to increasing competition. But that doesn't mean the business is broken, says Morningstar analyst Larry Witt, who rates shares at Buy. (Analysts' average call stands closer to Hold than Buy, according to Thomson Financial.)

"One thing that's scaring a lot of people is that actual listings on the web site have been slowing or down, but part of that was self-inflicted," he says. "They wanted to de-clutter the site and improve the experience for buyers. In the long run that's a good thing. Sometimes you have to take a step back to take two steps forward, and even though they did that, revenue didn't decline."

Indeed, lately it's been way up. For the third quarter, revenue rose 30% to $1.89 billion. It grew nearly 30% to $5.49 billion in the first nine months of the year. Earnings, excluding items like the $1.39 billion Skype write-off, eclipsed the Street's average estimate by eight cents a share. Even better, eBay raised its guidance relative to the Street.

And yet the stock dropped more than 6% the next trading day, hurt in part by concerns over margins and the pace of growth in the U.S. market. EBay, in a bid to boost volume, has slashed its listing fees by a third until Nov. 5.

Shares that started the year at $30 were trading north of $40 going into the earnings report. They've since given back about $4 a share. The stock's up a very respectable 20% or so year to date, and even better, still looks like a bargain.

"Compared to its peers it's clearly one of the more reasonably valued Internet companies out there," says Darren Chervitz, director of research at the Jacob Internet Fund (JAMFX), which has been adding to a small position in the stock. "The core business is definitely slowing, but overseas they're operating successfully. PayPal is a huge asset. Skype is trickier, but it's still a valuable asset. I'm looking for a reasonable valuation and eBay's still growing at 20% a year."

With a forward price/earnings multiple of 22 as of Thursday's close, eBay trades at a deep 32% discount to peers, according to Thomson Financial. Take a smaller sample of peers — just the Big Three of pure-play Internet guys — and the discount is even more compelling. Google's forward P/E stands at 33, Amazon.com's at 56 and Yahoo's at 58. That's right: eBay trades at a 56% discount to the mega-peer average.

Internet stocks aren't supposed to be this cheap unless they're in a really, really bad way. Bears worry that growth will continue to slow in the key U.S. and German markets, and can point to the company's failure to capitalize on its opportunity in China. And, yes, there's increasing competition.

But we're not convinced the U.S. business is preordained to decelerate. Furthermore, we like the way the company's deployed its piles of cash to expand and buy growth beyond its maturing core business and love the ongoing $2 billion share-repurchase program.

Finally, not to be pessimistic but eBay has some attractive defensive aspects. For one, it has a global revenue stream that should help it hold up in case of domestic weakness. And second, it has, at least in the past, offered some counter-cyclicality as tough times lead people to shop for bargains.

"If the U.S. economy slows down [eBay] won't be as sensitive to it, and they may even benefit," says Chervitz. "It could be a counter-cyclical. In the last cycle it certainly was."

EBay does indeed have its challenges, but it's still the No. 1 global e-commerce brand, operating in more than 35 markets. PayPal has more accounts that American Express (AXP). And, for the most part (cough, Skype) it's been smart about using its mountains of cash to buy and invest in growth.

Given all that, the valuation looks like the kind of deal we'd expect to find on, well, eBay. If the stock were listed on the web site, we'd have to click "Buy Now."