eBay Inc. (EBAY) has returned 46.57% in the last 52 weeks, trades at 26X PE, with an annualized average revenue growth rate of 24% in the last 3 years. It owns a premiere online marketplace and market leading payments systems in PayPal and Bill Me Later®. In most cases, it is a good thing to have at least one cash cow, and in eBay's case, even better to have two. If you are wondering why all this positivity scares me, it is because, in my opinion, what has taken them here will not necessarily take them there. It bothers me even more, because the stock is trading at a level that assumes that their growth rate, relevance, and competitive position will continue to drive similar levels of revenue growth, which I just can't see.
My overriding worry is that the company has not innovated enough within its business environment and against its competitors in core revenue generating areas. For a tech company, inadequate innovation can take a company from dominance to irrelevance in a very short time frame with very little opportunity to catch up once users move on.
If necessity is the mother of invention, there has been a lot of necessity in the payment systems sector. The necessity has been the need to adopt new technologies [NFC] to embrace the inevitable and rapid transition to mobile platforms which have presented new payment opportunities. Another catalyst was the antitrust lawsuit between the National Retail Federation VS. Visa (V) and MasterCard (MA). Though this settlement of $7B is still playing out, one of the outcomes has been an agreement between Wal-Mart, Target and other big retailers to create their own payment systems, and this cuts off a critical growth area for PayPal.
Payment services accounted an average of 38% of total revenue for the last 3 years for eBay Inc, which underscores its importance to the company. PayPal was the first viable online alternative for carded or paper money transfers. By becoming more secure and easy to use, it expanded internationally, including Australia and China, through partnerships and increasing services to current users. It has not evolved with newer technologies like NFC or provided an alternative to brick-and-mortar stores that they can rely on to escape transaction fees with cards that cut into their profits. To understand how fast this sector is changing, I will add a short list of some emerging concepts poised to impact eBay's payments revenue and growth potential: Square, Google Wallet, MasterPass digital payments from MasterCard Inc., Isis, and Visa payWave from Visa Inc. (V).
The marketplace platforms owned by eBay Inc. brings together buyers and sellers for fixed price or auction items. eBay Inc. has invested and modernized its marketplace access point experience to ensure that the platforms are equally functional through traditional or mobile devices. It has also used its payment systems to complement the shopping experience. To expect that eBay Inc.'s marketplace will continue to grow briskly is like arguing against the growth of online technologies, the importance of social media and the ability of sellers and buyers to find other ways to connect online. It is also like arguing that the "free shipping" phenomenon that is gripping Amazon (AMZN) and Google (GOOG) is a gimmick, even though they offer competitive prices and near instant gratification that an auction process delays.
The ability of established brands to reach consumers through other channels like Facebook and Twitter also enables them to close their eBay stores and drive traffic directly to their sites. I always thought it was a stupid idea for eBay to allow established brands to open eBay stores, since it diluted the adventure of finding unique items. But, their departure from eBay came with a business lesson for me. It demonstrated that as sellers got bigger and more established on eBay, they would be inclined to leave so they can maximize the revenue opportunities on their own platforms.
For companies that are expanding internationally and actively acquiring other companies, it is important to understand the makeup of their revenue. eBay Inc. has been active in both areas, and acquisitions in the last 3 years have contributed its revenue growth rate. Some of the more recent acquisitions include shopping.com, Zong, GSI Commerce and Hunch. Without adding International revenue U.S. sales growth, which is the core of the business, actually dropped from 30% growth from 2010-2011 to 24% from 2011-2012.
Total International revenue was $7.3B and GSI alone was 5% and 8% of total revenue in 2011 and 2012 respectively. In 2011 eBay Inc. also accounted for a onetime gain of $1.6B for the sale of Skype. These are good but indicative of a subtle struggle to grow revenue organically which will be exacerbated as payments systems and marketplace revenue slows down against competition.
The market has been too bullish on EBAY, pushing it above its 50 and 200 day averages of $45.29 and $38.51 respectively. With a DCF calculation assuming a growth rate of 18%, which I think is generous going forward, you get a fair price of about $39. eBay Inc. was an early entrant into the online marketplace industry and was able to build a leading market share position, but I think the stock is due for a pull back. The lack of significant entry barriers, low setup costs, and emerging technologies are changing the way buyers and sellers relate and pay for transactions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.