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eBay Inc. (EBAY) recently reported first-quarter earnings results on April 17. Fueled by growth in its two major business segments, the company's Q1 results were impressive and indicate that eBay has gotten off to a very solid start in fiscal 2013. The company earned $829 million, or $0.63 per share (GAAP: $677 million, $0.51 per share), on net revenue of $3.748 billion. Year-over-year, first quarter non-GAAP earnings grew 14.5% (from $0.55 in 2012 to $0.63 in 2013) and first-quarter revenue grew 14.37% (from $3.277 billion in 2012 to $3.748 billion in 2013).

As impressive as revenue/earnings per share growth was for eBay, the stock has dropped over 6% since earnings were reported last week for several reasons; the company failed to beat the EPS whisper number of $0.64 (the first time in a year eBay failed to do so), the company's reported Q1 revenue of $3.748 billion was slightly below the average analyst estimate of $3.765 billion and management's revenue/EPS guidance for the second quarter as well as for full-year 2013 was slightly below the average analyst estimate.

Despite the perceived negative earnings and guidance, the recent drop in eBay's share price presents investors with a nice opportunity to purchase a stock with a terrific long-term growth story at compelling valuation levels.

The Company

Originally founded in 1995 by Pierre Omidyar as a personal auction site, eBay Inc. has since grown into a global leader in e-commerce and payment solutions. While initially known only for its namesake auction site eBay.com, the San Jose, California-based company has branched out into multiple business segments over the years with a myriad of brand names including eBay, PayPal, StubHub and Half.com. Currently, eBay Inc. breaks its business into three main segments:

  • Payments -Includes PayPal, the company's transaction service that enables consumers and businesses to transfer money in-store, online and via mobile platforms in a fast and reliable manner, without ever having to exchange financial information. PayPal service is available in 190 markets and 25 currencies, with an estimated 128 million active accounts worldwide (as of Q1 2013). Also includes PayPal complementary services Zong, Bill Me Later and BillSAFE.
  • Marketplaces - Includes the eBay.com auction website, "the world's largest online marketplace," which boasts over 100 million active users globally and enabled over $67 billion in gross merchandise volume in 2012. Also includes StubHub, eBay Commerce Network, Half.com and brands4friends.
  • GSI Commerce - Includes a suite of e-commerce services provided to business clients engaged in retail merchandising. GSI provides marketing, online advertisement, web analytics and strategy development to optimize sales performance. Popular client brands currently include Aeropostale, American Eagle Outfitters, Calvin Klein and Ralph Lauren.

The Growth

I own eBay primarily for its 'Payments' business segment, which is where the company derives its more robust growth. However, most segments have been growing well as of late. Let's take a look at each business' growth performance and the portion of total revenue they comprise so we can have a better understanding of how each segment impacts eBay Inc.'s total growth rate.

The following table will break down the performance of each of eBay's main business segments by calendar year: 'Payments,' 'Marketplaces' and 'GSI Commerce.' For easier reference, I have included eBay Inc.'s total revenue generated on the far right for the stated time period.

Segment

Payments

Marketplaces

GSI Commerce

eBay Inc.

Revenue Generated (2011)

4.412B

6.642B

590M*

11.652B

YOY Change (%)

28%

16%

N/A

27.26%

Portion of eBay Inc. Net Revenue (%)

37.86%

57%

5.06%

N/A

Revenue Generated (2012)

5.574B

7.398B

1.083B

14.072B

YOY Change (%)

26%

11%

83.55%**

20.76%

Portion of eBay Inc. Net Revenue (%)

39.61%

52.43%

7.69%

N/A

(All numbers from eBay Inc.'s 10-Q, 10-K, found here)

*Number includes only full three quarters, as reported by eBay Inc.

**Growth rate derived from GSI revenue for only three full quarters, as reported by eBay Inc.

The above table best illustrates how the 'Payments' portion of eBay Inc. has been propelling the company's growth over the last few years. While the results from the prior two years are slightly skewed due to the introduction of GSI Commerce in Q2 of 2011, the overall trend is clear: the 'Payments' segment is leading eBay Inc.'s growth and is becoming a larger part of the overall company's business. As long as the growth driven from 'Payments' outpaces that of 'Marketplaces,' the former will continue to steadily become a larger and more important part of the company's total business.

To get the most recent look available at how each segment has been performing, I have included a three-year comparison of the company's 2011-2013 first-quarter performances:

Segment

Payments

Marketplaces

GSI Commerce

eBay Inc.

Revenue Generated (Q1 2011)

993M

1.553B

N/A

2.546B

YOY Change (%)

23%

12%

N/A

16%

Portion of eBay Inc. Net Revenue In Q1 2011

39%

60.99%

N/A

N/A

Revenue Generated (Q1 2012)

1.309B

1.728B

237M

3.277B

YOY Change (%)

32%

11%

N/A

29%

Portion of eBay Inc. Net Revenue (%)

39.94%

52.73%

7.23%

N/A

Revenue Generated (Q1 2013)

1.548B

1.957B

236M

3.748B

YOY Change (%)

18%

13%

-0.42%

14%

Portion of eBay Inc. Net Revenue (%)

41.3%

52.21%

6.29%

N/A

(All numbers from eBay Inc.'s 10-Q, 10-K, found here)

Since Q1 of 2013 was just reported, we now have a very recent picture of how well all businesses stack up against one another. Not surprisingly, the 'Payments' segment is still growing the fastest, although growth has slowed noticeably from the more robust 2011/2012 levels of over 30%. The segment has grown into a larger portion of eBay Inc.'s total business each successive first quarter for the last three years. At 41.3% of the company's total Q1 revenue in 2013, 'Payments' now makes up the largest percentage of revenue that it has for eBay Inc. in recent history. As long as the growth rates remain significantly above that of 'Marketplaces' this transition is beneficial to eBay Inc. as a whole on a revenue growth basis.

'GSI Commerce' has been growing the slowest out of all three segments but is at this time not a significant enough portion of revenue to be overly concerned with. As growth in the other segments continues to outpace GSI, the segment will become less significant to eBay Inc.'s growth rates as a whole. Q1 revenue for the segment in 2013 was actually down less than 1% from comparable 2012 levels.

Growth Catalysts

Since eBay's 'Payments' segment has been growing the fastest, driven by the rapid adoption of PayPal both domestically and globally, it can be considered the dominant driver of growth for the foreseeable future. Therefore, I will focus mainly on the 'Payments' portion of the company's business with regard to growth catalysts going forward.

When viewed on a year-over-year basis, the 'Payments' segment grew 18.25% in the first quarter of 2013 on revenue of $1.548 billion, up from $1.309 billion in 2012. Q1 of 2013 represents PayPal's fourth successive quarter of new user growth. PayPal ended the most recent quarter with approximately 128 million active accounts and added 5 million new users in the last three months alone, an increase of 4.06%. Even more impressive is that PayPal has grown its global active accounts year-over-year well over 10% for the last six quarters consecutively.

Breaking the PayPal unit into sub tiers allows us to see what is driving the new user growth. The three main drivers are mobile, in-store point of contact and international. In the most recent conference call, President and CEO John Donahoe stated, "one out of every four PayPal account holders made at least one purchase through mobile." This is encouraging and, when coupled with the fact that eBay claims to have added almost 3 million new users directly through mobile devices alone in Q1, indicates that management is utilizing the rapidly growing mobile market well and that there is still significant room for growth in this area.

The in-store PayPal solution is now available in almost 20,000 locations domestically. Additionally, the company's deal with Discover Financial Services (DFS) to issue payment cards, which will further expand PayPal users' payment options by effectively opening up Discover's 7 million retail locations, is set to go live in the second quarter.

PayPal has been gaining traction internationally as well. eBay, via joint venture with Softbank, released its 'PayPal Here' program in March across Japan, which follows on the heels of previous releases in Canada, Hong Kong and Australia. Additionally, eBay is preparing a chip-and-pin version of its 'PayPal Here' program for small businesses in the United Kingdom set to launch in the summer.

While not dealing with the 'Payments' business exclusively, it is extremely important to mention management's recently released three-year growth strategy, which was described in detail at the company's investor's conference [pdf] in late March. CEO Donahoe expects eBay to enable a staggering $300 billion in global commerce (includes commerce and payment volume across all three business segments) by 2015, a 71.42% increase in three years (eBay enabled $175 billion in global commerce in 2012). This jump in global commerce is expected to raise eBay's revenue by over 50% in the same time period, to approximately $21.5 billion in 2015 (eBay generated $14.1 billion in revenue in 2012). The following is a breakdown of what management expects in the following three years:

  • Total company revenue expected to reach $21.5-$23.5 billion in 2015
  • 'Marketplace' revenue expected to reach $10.5-$11.5 billion in 2015
  • 'Payments' revenue expected to reach $9.5-$10.5 billion in 2015
  • 'GSI Commerce' revenue expected to reach $1.5-$1.7 billion in 2015
  • Compound annual earnings per share growth (non-GAAP) of 15%-19% from 2012-2015.

These estimates are certainly encouraging. However, we can gain even more useful information by analyzing the expected growth trajectory of the 'Payments' segment. In 2012, the segment generated $5.574 billion in net revenue. If we take management's conservative revenue estimate for 'Payments' of $9.5 billion in 2015, this would mean an increase in revenue of $3.926 billion over the next three years, a gain of 70.43% (equal to 23.47% revenue growth per year on average). If the upper end of management's guidance were achieved, the segment would increase revenue by $4.926 billion, a gain of 88.37% (equal to 29.46% revenue growth per year on average).

Either scenario is very impressive for the rapidly growing segment and should serve as relative confirmation that it is most likely only a matter of time before the 'Payments' segment makes up the majority of eBay Inc.'s total revenue, not 'Marketplaces.'

Valuation

It is difficult to compare eBay to its closest marketplace competitor Amazon.com Inc. (AMZN) because, quite frankly, it is difficult to reasonably compare Amazon's valuation to anything. In order to best provide perspective on eBay's current and future valuation, I think it is best to compare the stock to payment rivals Visa Inc. (V) and MasterCard Inc. (MA). However, valuation by itself is relatively useless so for better comparison I have added the projected revenue and earnings per share growth of all three companies along with their trailing twelve-month and future twelve-month valuations.

Company

eBay

MasterCard

Visa

Revenue Growth (2013)

16%

11.7%

11.1%

Revenue Growth (2014)

16.7%

12.3%

11.4%

EPS Growth (2013)

16.1%

15.6%

18.4%

EPS Growth (2014)

17.5%

18.5%

15.8%

P/E (TTM)

25.43

23.79

45.61*

P/E (forward)

16.27

17.28

19.29

(Numbers from Yahoo! Finance, as of 4/21/13)

*P/E ratio reflects one-time settlement charge in 2012

All three companies are projected to grow at relatively comparable rates. However, with regard to revenue eBay is growing the fastest and by a significantly wide margin, above 4% that of both MA and V's projected revenue growth rates in 2013 and 2014. In terms of earnings per share, eBay is projected to grow approximately 16.8% over the next two years on average, which is slightly lower than both MA's projected two-year average EPS growth rate of 17.05% and V's estimated two-year average rate of 17.6%.

When it comes to valuation, eBay appears a bit expensive to MA on a trailing twelve-month basis but significantly less expansive than V, although Visa's trailing twelve-month P/E is more of an abnormality than anything else. However, on a forward-looking basis eBay appears cheap when compared to its payment rivals, with a future-twelve month P/E ratio of 16.27, lower than both MA and V. When viewed historically, eBay appears fairly priced going forward, as its forward P/E of 16.27 matches very close to its five-year average P/E of 16.08.

In summation, eBay's growth performance is very close to that of MasterCard and Visa, which is impressive considering the high quality of MA and V's sales and EPS growth as of late. However, eBay separates itself a bit when it comes to forward-looking valuation.

Risks

One of the risks for eBay Inc.'s PayPal service, and other digital wallet platforms like Google Wallet, is the delicate alliance that exists with the major credit card network operators. Recently, MasterCard management expressed frustration with PayPal and announced that it would begin charging fees over the summer on PayPal transactions that occurred via the MasterCard operating network. The 'Staged Digital Wallet Operator Annual Network Access Fee,' as eBay management called it, is not expected to significantly impact eBay's earnings (some analyst estimates are for an approximate $0.04 hit to EPS on MasterCard fees alone, based on PayPal usage last year). However, the impact to the company's overall EPS could be amplified if rival payment processor Visa also decides to raise fees on digital platforms like PayPal.

Additionally, while eBay is a major player in the payments space, the company is still very much an auction-retailer and with this comes the usual risks associated with major consumer trends. Any serious downturn in consumer/business spending will most likely have a negative impact on eBay Inc.'s 'Marketplaces' business segment, which still accounts for over 50% of the company's total revenue. As much as I like to think of eBay Inc. as a payments solution provider first and foremost, the reality is that the company still has to be viewed as an e-commerce auction-retailer despite what the growth numbers say to the contrary. This dynamic is definitely in the process of shifting but currently investors have to pay careful attention to eBay's 'Marketplaces' segment and the larger macro trends that can impact it.

Another note worth mentioning is that in the company's investor presentation [pdf] eBay reported its 'Marketplaces' segment margin at 42.1% in the first quarter, which was up from 38.7% in 2012's comparable quarter. This compares favorably to the 'Payments' segment margin which eBay reported at 24.1% in the first quarter, down from 26.4% from the same quarter of 2012. This is a bit concerning considering that the 'Payments' portion of eBay Inc. is the fastest growing business. The segment has lower overall margins than 'Marketplaces' and they have decreased in the first quarter on a year-over-year basis. The recently reported Q1 'Payments' margin of 24.1% is, however, up from the two prior quarters (Q3, Q4 of 2012, at 22.6% and 23% respectively). Although still strong, it would be ideal to have the company's fastest growing business also steadily growing its margins.

Conclusion

eBay Inc.'s future growth will most certainly come from what CEO John Donahoe described in the latest conference call as "a commerce revolution" that the company "is well-positioned to capitalize and lead in." However, when management refers to 'commerce' they are not speaking just of the company's namesake auction site, they are also referring to customers' newfound ability to conveniently make purchases from anywhere and everywhere and it is eBay's PayPal unit that is at the forefront of this remarkable change in consumer spending habits.

With regards to future growth, I tend to think of eBay as more of a competitor to Visa and MasterCard than to Amazon.com and other retail/auction sites. The company is certainly a major competitor to retailers like Amazon and a massive presence in the retail arena in general, the biggest by some metrics, but the more interesting and rapidly evolving growth story for the company as a whole is tied to its 'Payments' division and the widespread adoption of PayPal and related services. The commerce revolution is a viable growth trend that shows no signs of stopping anytime soon and eBay should remain a leader in the space for the foreseeable future. In fact, I own eBay alongside Visa and MasterCard in my portfolio for this very reason: eBay, with its new technology innovations that integrate seamlessly with its well established marketplace offerings, is a nice complementary investment to the credit card issuers/payment processors.

The fact that eBay Inc. reported solid growth numbers in the first quarter of 2013, which all seem to validate a continuation of the company's growth story, and still managed to drop 6% over the next two days, currently off 9.73% from all time highs, is a blessing in disguise for investors. The stock's negative reaction to management's guidance may be more a case of excessive and lofty analyst/investor expectations than any negative aspects of eBay's projected growth. While a victim of its own past success and outperformance, management at eBay is still projecting, perhaps conservatively, revenue growth of 14%-17% and non-GAAP EPS growth of 14%-16% in 2013, which is healthy by any standard.

The stock has sold off but the chart's long-term uptrend, the company's revenue and EPS growth and most importantly, the growth story are still very much intact. Investors now have a chance to purchase shares of eBay Inc. at a discount to the company's most likely main future competitors, Visa and MasterCard. I plan on taking advantage of this buying opportunity in the upcoming week by adding significantly to my long position.

Source: eBay: A Compelling Buy On Recent Weakness

Additional disclosure: I will be adding to my long position soon.