William Smead is the founder of Seattle-based Smead Capital Management, where he oversees all activities of the firm. As Chief Investment Officer, he is responsible for all investment and portfolio decisions as well as reviewing the implementation of those decisions. William is the Lead Portfolio Manager on SCM's large cap portfolios as well as the firm's proprietary mutual fund.
We asked William to share his single highest conviction position and provide his investment thesis.
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What is your highest conviction stock position in your fund - long or short?
eBay (EBAY) is our top stock pick and the number one position in the Smead Value Fund (SMVLX).
First, eBay is a sum of the parts story. They own PayPal, Bill Me Later, StubHub, 28% of Craigslist, 30% of Skype, 5 of the 6 largest online classified advertising firms in the world, the greatest online auction business in the world and sit on 5-plus billion dollars in cash with no debt. If all these businesses trade on a stand-alone basis, the stock could be 50% greater than the current price. Here's my breakdown:
Marketplace: At a 18 P/E = $22.48 (Includes StubHub, 28% of Craigslist, 5 of the 6 largest online classified businesses)
PayPal: At a 30 P/E = $ 9.60 (includes Bill Me Later)
Skype and Cash: $ 4.48
How would you describe eBay's competitive environment? How is it positioned vis a vis its competitors?
eBay is a growth story. As the years go by and my children become middle-aged, buying and selling online will be as normal as drinking water out of the tap. Imagine all the transactions PayPal will take a small piece of and think about the earnings leverage and free cash flow. Google (GOOG) started a payment system a few years back and has all the resources you’d want, yet it has not made a dent in PayPal’s moat. PayPal recently opened its platform up to developers and the future business opportunities for eBay are boundless.
If Amazon’s (AMZN) recent success were the benchmark for all retailers and online businesses, everyone would look terrible in comparison. We believe that eBay is becoming a massive toll bridge in online classified advertising and online payments. They aren’t the merchandiser that Amazon is, but we didn’t use AMZN’s 60 P/E in our analysis either. The economy caused a severe consumer contraction and compared to most retailers, eBay held up great.
Can you talk about valuation and how it compares to the competitors?
eBay is a worldwide brand and a business with no inventory, and most investors don’t yet recognize the premium which should be placed on its P/E multiple. For comparison, Amazon is a great company and could generate $1.2 billion of cash flow in 2009. Amazon has a market cap of around $60 billion. eBay has a market cap of around $30 billion, yet should generate over $2.1 billion in cash flow this year. Why is eBay trading at less than 15 times earnings net of cash while Amazon trades for 56 times earnings net of cash?
What is the current sentiment on the stock? How does your view differ from the consensus?
Consensus is that the marketplace business is generally in decline, but we don’t agree. The last two quarters have seen significant improvement in listing conversion and gross margin volume. This can be tied to free shipping, progress on search, progress on selection, progress with top-rated sellers, safety improvements and other changes. The Marketplace business does pump out over a billion dollars of cash flow currently.
What catalysts do you see that could move the stock?
We prefer to be buy and hold investors and always assume that time is our catalyst. If you are going to own a stock for three to five years, it really doesn’t make much difference which part of the first three years produce the mark up in the price of the shares.
For other investors, it will probably be earnings surprises which will drive the stock or it might be the sale of various parts of the company over the years as in the case of Skype. We love to invest in powerful brands, and eBay owns a bunch of them. Short of nuclear proliferation or a worldwide flu pandemic, we see a very bright future for eBay.
What could go wrong with this stock pick?
Three events could ruin our thesis on eBay:
1. A viable rival to PayPal
2. An economic depression
Disclosure: long EBAY