Yahoo and eBay: Undervalued

Includes: EBAY, YHOO
by: Philip Davis

I hate to be cynical but, looking at Google, one could say this is the World's best example of "window dressing." After a huge early sell-off, the stock took off just after the March expiration. After a sell-off in May, the stock suddenly caught fire again after the June expiration -- finishing Q2 $30 over Q1. Now, as Q3 drives to a close, we see Google still a bit below the Q2 close. It may be projected to "dress up" to $450 but with earnings out on October 19th, pretty much anything can happen.

I think it is a week or two too early to make a big buy on eBay Inc. (NASDAQ:EBAY), but it's killing me to wait. The short-term chart looks weak, but they are very long-term oversold, and could explode any time. Looking at this month's action though, one could conclude they were being held up, not down, buy a buyer at the $28 level. Is eBay worth 40 times earnings? Apparently it depends on the time of year, as the stock often does well into the holidays, and then sheds half the run-up or more in the spring. The only Q3 that this stock went down was 2000, and everyone went down that quarter.

I'll tell you what's wrong with eBay -- runaway SG&A expenses. They've been tracking up on a 1:1 basis with sales for years and now take up close to $2B a year. I thought I was buying a database company -- why are we running retail looking numbers? The cost of revenue also does not get much bang for the buck, but has also started running up a bit. Compare that to a well-run retail operation like Target Corp. (NYSE:TGT) and you will see what I mean. On a 10% increase in revenues since 2004, Target's cost of revenue rose 1:1 but SG&A went up less than 4%, dropping an extra $1B to the bottom line.

I can't think of a single way to say this without coming across as sexist, but Meg needs to stop mothering her employees and start firing a few people! I applaud the price increase, heck I just picked the stock as a buy recently, but I am certain there are many CEOs who could knock a half a Billion off the nearly $3B in sales and operating expenses. Raising revenues is nice, but not when it's a trade-off to increasing efficiency.

It takes 11,600 eBay employees to make $5.2B in sales while 5,700 Googlinians rack up $8.2B in sales. Inc. (NASDAQ:AMZN) moves $9B in actual (not virtual) product with just 12,000 employees. That means that for each dollar in revenue an eBay employee oversees as clicks move through their computers, an Amazon employee generates $1.60, while they order the item, stock the item, package the item, ship and bill for the item...

eBay starts out with a bang, with a Gross Margin of 81% vs 59% for mighty Google Inc. (NASDAQ:GOOG), but when all is said and done, the Operating Margin comes in at just 26%, far behind Google's 34%. Someone, anyone, help these guys out! I'll do it myself if I have to! Again, I love this company; they earned their monopoly by being the best but boy could they be doing better...

Speaking of companies that should be doing better: Yahoo! Inc. (NASDAQ:YHOO) is down 13% for the year; well ahead of eBay Inc. (EBAY) but 15% behind Microsoft Corp. (NASDAQ:MSFT) (and the whole S&P), and 50% behind GOOG. Unlike eBay, I have no issues picking up the Jan $32.50s for $1.30 or perhaps the far safer buy of the Jan '08 $25s for $7.80 and selling the Jan $32.50s against it for $1.35 to wipe out half the premium (but I would wait for a test of $32 to sell calls). This is a nice play if Google holds $400, as we can hope for somewhat of a rubber-band effect to close the gap.

A lot of the monthly fluctuation we get between Yahoo and Google comes from the oft-quoted Hitwise statistics which, although interesting, are subject to statistical anomalies that are blown out of proportion by the press. Yahoo was off to the races early in the week, but was halted (as Google took off) by this statistic. Volume down from 22.73% to 22.58% is hardly significant (and still ahead of the prior two months), even if the measurement was absolute. Nor is Google's .3% rise a nail in anyone's coffin...

On a longer-range perspective, since Google's IPO in '04, Google is up 300% while Yahoo is at the exact same price. Despite the competition, YHOO has grown its revenues close to 100% while profits are more than doubled for the period. The financials don't look too sexy, because the Yahoo boys have been quietly making $1.5B in investments since last year. All the more reason to buy Yahoo on a Nasdaq rally.

Read all of Phil Davis's articles on Seeking Alpha.