Few companies I follow closely are executing as well as eBay (EBAY). The company has established one of the world's most successful online marketplaces while concurrently building an elite online payment platform in PayPal. Let's take a look at a few catalysts that could lie ahead for eBay in 2014.
Catalyst #1 - Additional Payment Consolidation
One of the largest risks to PayPal's business model over the past few years has been margin compression. eBay was the largest driver of PayPal's business (it still is), and it allowed PayPal to charge a high take-rate (percentage of transaction value) relative to competitors like Visa (V) and MasterCard (MA). As PayPal has reduced eBay to 30% of payment volumes, take-rates have fallen to 3.7%. Although there may be some more room to fall, the nature of payment systems leads me to believe the industry is ripe for consolidation.
eBay recently completed its purchase of Braintree for $800 million. Braintree counts many web 2.0 clients like Uber, Air BnB, and OpenTable as clients. Competitor Square, which charges 2.75% on transactions, plans on doing a round of financing at a $5 billion valuation. Even though eBay just spent $800 million on Braintree, eBay's robust balance sheet, which will probably have somewhere around $10 billion in cash and equivalents sitting on it, gives the company to make the acquisition if it so desires. eBay could also take on more debt if necessary.
A Square purchase gives PayPal access to a large network of small businesses in the bricks and mortar space-an area where PayPal is clearly lacking. Strategically, I cannot fathom a better buyer than PayPal, as it could then integrate its PayPal and Square customers onto one great platform.
With Visa and MasterCard still dominating the industry payment, I believe eBay can (and will) become a driving force towards online payments consolidation. Realistically, PayPal greatly lags the Visa and MasterCard duo, so to become a reasonable competitor, I think US regulators would allow, if not encourage PayPal to purchase its competitors. Scale and network growth would be dually beneficial, as PayPal would have more customers paying with a lower cost structure.
Catalyst #2 - eBay Dominance
The eBay Marketplace remains a dominant force on the net with $18.4 billion worth of goods sold on it during the third quarter, an increase of 13% versus the prior year. The network also added 4 million users during its last quarter, and its active user figure now stands at 123.6 million users. If eBay is able to grow its active users at a low-double digit pace next year, the network will have north of 135 million users.
More telling, even Amazon's own user forums suggest that eBay might be the superior platform for sellers. Earlier this year eBay simplified its cost structure and its active user growth could lure over even more top-notch sellers. I have spoken with a few power sellers myself, and most seem to prefer eBay. One of the factors, in my view, is the gambling, entrepreneurial nature of eBay. Buyers love the idea of getting a deal, and sellers love the idea of upside. Are prices any higher than fair market prices? Probably not. But eBay taps into the gambling, entrepreneurial spirit of capitalists in America and abroad.
Not even eBay is immune from global economic pressures. GDP growth in the US looked great in the third quarter. Oddly, this could pressure eBay's popularity. With employment on the rise, less people may look to eBay as a place for deals and a place to generate income.
Further, any acquisition could turn out to be a disaster. Though I haven't seen Square's financials, my natural inclination is that the company would have to be acquired at a hefty premium that pressures earnings. eBay also runs the risk that a new startup competitor comes out with another new system that takes market share and disrupts the industry. Unfortunately, this is simply the risk of investing in any industry dependent on technology, whether it is horse carriages (made obsolete by the automobile) or PCs.
Operationally, I do not see too many risks. PayPal and eBay are both riding strong secular tailwinds and have fantastic brand power behind them. Company-specific risk looks low, in my view.
2014 Price Target
Net income highly underappreciates eBay's earnings power, so on a multiple basis, it might be fair to conclude that eBay isn't all that interesting. Shares currently trade at 20x the 2013 earnings estimate of $2.70 per share and 18x 2014 earnings of $3.14 per share.
However, the company has already generated $2.3 billion in free cash flow compared to $2.6 billion in all of 2012. I think the company will generate in excess of $3.2 billion in 2013, with the potential for free cash flow in excess of $4 billion in 2014, giving eBay a forward free cash flow yield around 5.5-6%. For comparison, Visa trades at a free cash flow yield of 3.6%, and MasterCard trades at a free cash flow yield of 2.8%. These two payment providers also have considerable more legal and regulatory risk.
Assuming eBay can get to a free cash flow yield of 4%, the company would have a market value of roughly $100 billion. This leads me to a price target of $77.50, with upside catalysts from market share wins and PayPal acquisitions. This translates into 40% upside from the current price.
Additional disclosure: I may purchase shares of eBay.