This article is a continuation of a series in which I try to find stocks that are trading at prices well below the intrinsic value of that share of the business they represent. So far, I have identified Dr. Pepper Snapple (DPS) and Teva Pharmaceutical (TEVA) as companies that seem to meet the criteria required to qualify as Intelligent Investments, to use the phrase and method authored by the father of value investing, Benjamin Graham.
In this article I will adapt this methodology according to the views of his most famous pupil, Warren Buffett, who has said that "it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." I have identified one such wonderful company and in this article will try to determine whether it's selling at a fair enough price to consider buying.
eBay (EBAY) is a leading global marketplace whose sites sell everything from textbooks on half.com to tickets through StubHub, not to mention pretty much anything else you can possibly think of from individual sellers around the world. eBay acts as a broker or auctioneer to link buyers with sellers, and in doing so avoids much of the downside of traditional retail such as dealing with excess inventory.
Whereas Amazon (AMZN) presumably has aspirations of selling everything to everyone, eBay has embraced a simpler strategy of only selling things they can actually make money on. As part of this strategy, they acquired a logistics company called GSI in 2011, which they have integrated into their Enterprise division to focus on e-commerce solutions such as managing the websites and inventory of brand name retailers ranging from Aeropostale to Zales.
Instead of subsidizing the cost of providing personalized delivery to individuals' doorsteps through the ever more distribution centers required by Amazon, eBay Enterprise uses their scale and partnerships with leading stores and freight providers to fulfill orders. This can include shipping items for in-store pickup or delivering direct to consumers by presorting everything by customer zip code to expedite things through their ShipQuik program.
eBay's traditional marketplaces could also be expected to be able to eventually piggyback on this distribution system to cost-effectively keep pace with Amazon's same-day shipping. It even has aspirations of being even faster, rolling out their eBay Now program in select cities. When coupled with their easy to use payment processing service, PayPal, this allows eBay to provide customers with a great shopping experience.
In fact, I believe PayPal is the crown jewel in eBay's collection of synergistic businesses. It is certainly providing the most growth, now accounting for over 40 percent of eBay's revenue. This is likely to accelerate as they integrate another company into the already leading mobile payment provider, recently buying Braintree for $800 million to gain access to their expertise in collecting payments across a variety of platforms.
While this eliminates one competitor, some might astutely point out that PayPal still has to contend with other competitors such as Twitter (TWTR) co-founder Jack Dorsey's Square, but I believe these fears are overblown because of both the ultimate size of the addressable market as well as PayPal's head start, established user base, and name recognition.
PayPal has its own entrepreneurial pedigree, having been co-founded by Tesla's (TSLA) resident Renaissance Man Elon Musk. It has also benefited from being in eBay's capable hands for over 10 years, more than twice as long as Square has even been in existence. This first mover advantage is critical in both technology and payment processing, where ubiquity of acceptance benefits from the network effect and becomes more valuable as more people continue to adopt it.
This article does a good job summarizing how far ahead PayPal is in the race to grab a share of the already lucrative and still fast growing mobile payments pie. Square already commanded an inferred market cap of over $3 billion last year on its way to a presumed IPO many multiples of that, with an annual revenue run rate likely approaching half a billion dollars this year based on the 2.75 percent fee they collect on the $15 billion in transactions they're expected to process this year, not even including payment from its deal with Starbucks (SBUX).
This sounds impressive until you consider that PayPal had revenues more than three times greater than this in just the past quarter alone. This amounts to an annual revenue run rate of over $8.5 billion assuming its 20 percent expected growth rate. If PayPal were to get the same price to sales multiple as Square got based on its likely now understated $3.25 billion valuation, this would be a valuation of about $55 billion, about 80 percent of eBay's $68 billion market cap.
Considering that the company also has over $10 billion in cash and short term investments on their balance sheet, not even including another almost $4 billion in longer term investments like corporate and government bonds, this means you're essentially getting all the rest of eBay's excellent businesses for free. This provides a built in margin of safety even if one of their business lines slows down.
PayPal certainly shows no signs of letting up, although the company recently warned of a possible slowdown in holiday sales in their traditional e-commerce business before backtracking slightly from those remarks. CEO John Donahoe actually used the unlikely excuse of cold season as an excuse for sounding too negative, but maintained that they "try to under-promise and over-deliver."
Even with the conservative outlook, eBay expects fourth quarter earnings to come in between 79 and 81 cents, the midpoint of which would give them full year earnings of $2.70, good enough to give them a P/E ratio under 20. Considering that analysts, who have a good consensus track record of being within a penny of actual earnings for each of the last 4 quarters, forecast them to earn $3.14 next year and expect them to keep up this 16% earnings growth for at least the next five years, leaving them with a PEG ratio of about 1.2, very reasonable for an established but still fast growing company.
These strong numbers seem to support the fact that eBay is doing an admirable job continuing to grow their businesses while maintaining profitability. This gives them the financial flexibility to continue to expand the reach of strong brands like PayPal, whether it be through acquisitions like we saw with Braintree, or internally developed innovations like PayPal Beacon, which expands the service into traditional retailers.
This strong presence, both in stores and online, whether it be through one of their own web portals or one that they manage for others with their Enterprise service, gives eBay serious clout in the future of retail. While they're up against serious competition from the likes of Amazon, which seems determined to suck the margin out of everything like some evolved vampire squid, I believe eBay is managing their diverse collection of businesses very smartly, which should continue to benefit shareholders for years to come.
If Amazon's predatory style sucks some of the life out of eBay's holiday numbers, investors should instead focus on the opportunity to pick up the rest of eBay's excellent businesses for a song. PayPal alone seems to have acquired the critical mass necessary to remain a disruptive force in the future of e-commerce, and the rest of eBay's businesses seem to have wisely focused on the more profitable niches necessary to put up a united front against Amazon's onslaught.
Investors would be similarly wise to buy a share of the businesses that actually make money, at a much fairer price than the 3+ "forward PEG" (expected 2014 earnings divided by 5 year estimated earnings growth rate) or other nonsense metrics invented to justify buying Amazon. While both might be wonderful businesses, only eBay is selling at a fair enough price, and Intelligent Investors never pay retail, preferring the margin of safety that comes with scoring a deal from a seller who doesn't know how much what they're selling is really worth.