eBay: We're Still Buying What They're Selling

Jul.22.10 | About: eBay Inc. (EBAY)

There are few stocks that are as polarizing as is eBay (NASDAQ:EBAY); message boards and forums are choked full of vitriol aimed at the online bazaar of things both old and new. When I first wrote about their stock in June of 2008, I was taken aback by the negative response and it seemed to outpace any other stock I had written on by a wide margin. It made me wonder if there is something fatally flawed about the company, or otherwise there could be an unloved stock that presents investors an opportunity. In the interest of disclosure, I am nothing more than a casual user of their sites and services and have no extreme affinity or hatred for the company (no position in the stock either). With that said, I hope to provide an analysis of eBay’s stock and the underlying fundamentals and not a commentary on their business.

EBay reported its second quarter results yesterday where they saw EPS of $.40 and revenue of $2.2 billion. As far as expectations the results were a mixed bag, as consensus estimates called for $.38 in profit per share on $2.2 billion in sales. As you can see, their performance was strong on the top-line matching expectations and profits advanced 26% which was slightly better than expected. The biggest highlight for the quarter was gains in itsEBAY Paypal online payment processing platform, whose revenue jumped 22% to $817 million and payment volume spiked 28% to $21.4 billion. Paypal is clearly a driver of growth for eBay and one of the most attractive pieces of the company as it grows into a larger percentage of revenue. Already counting for a little more than a third of sales, CEO John Donahoe believes Paypal will exceed their marketplace segment in short order.

Paypal’s exciting growth aside, the marketplace is still eBay’s bread and butter, and revenue growth of 11% to $1.4 billion is certainly not too shabby. The online auctioneer and marketplace claims 91.8 million active users on their platform as of the end of the quarter, up from 88.4 million a year ago. Donahoe alluded to the ongoing facelift for their marketplace that thus far has failed to live up to their hopes. They plan to continue to fine tune the site for the next 6 to 18 months. Surprisingly strong was the growth seen in Europe, particularly in the U.K., and the United States market was actually slower than expected. Furthermore, management said they expect to be negatively impacted by the strengthening dollar in the rest of the year, as foreign sales will likely translate into fewer dollars. The stronger dollar accounted for the modest guidance for the rest of the year: 2010 revenue of $8.8 billion to $8.9 billion and EPS of $1.60 to $1.65.

The results were good, but we have to admit they are compared to a pretty weak quarter a year ago. Furthermore, Wall Street analysts had been lowering estimates in anticipation of the impact of foreign exchange. Even still the stock is trading about 5.5% higher in morning trading on heavy volume, and we think that is appropriate. At Ockham, we have our most bullish Greatly Undervalued stance on eBay stock. For one thing, it is trading well below its historically normal valuation multiples. For example, over the past ten years (recent years weighed more heavily) we have established a price-to-cash earnings range of 32.8x to 60.1x, but at percent the stock trades at a multiple of under 14x expected 2010 cash earnings per share. Likewise, some might view a price-to-sales per share multiple of 3.2x as excessive, but historically speaking the market has been willing to pay between 5.7x and 11.1x.

Now, to be clear, we understand that eBay is on a slower growth trajectory than they had been when they were valued at the huge multiples of 60x times cash earnings and 11x times sales. Simply put, eBay will never again get back to that level. Furthermore, the Paypal division that has the most exciting growth is a lower margin business than their marketplace revenue; slumping margins is another thing investors won’t pay a premium for. However, we think it is worth considering that excluding this recession, the last time eBay traded for this price level was more than seven years ago. At that time, revenue and cash earnings were both one-quarter what it is today. We do think that eBay’s stock has continued growth potential through both of its main business segments and particularly in online payment processing which added a million new users a month in the last quarter. For a company with zero debt and nearly $4 per share in cash on hand, eBay has clearly fallen out of favor with the market but they aren’t going anywhere.

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