Defending eBay In A Big Way

| About: eBay Inc. (EBAY)


eBay has a vibrant economic castle and possesses one of the strongest business models on the market today.

Investors need to understand that news flow is quite different than valuation. Even firms with terrible press can be significantly undervalued and be great long-term investments.

eBay is trading at less than 15 times 2015 earnings on sales growth in the mid teens. The firm is cheap on almost every valuation multiple. Shares are worth ~$90.

eBay (NASDAQ:EBAY) has one of the strongest business models on the market today. The firm uniquely benefits from a network effect in its auction business and a secular trend toward consumer online consumption in its payments business, PayPal. Recent same-store sales performance has also been solid, albeit slowing, in recent periods. According to ChannelAdvisor, same-store sales growth at eBay came in at 11.5% in May, down from 14% in April. eBay retains a vibrant economic castle.

Before we start walking through the five relatively poor incremental data points from eBay, we need to make a couple of things clear. First, we hold eBay in the portfolio of our Best Ideas Newsletter, and we do not expect to make any changes to its weighting at this time. Second, every company has both good characteristics and bad characteristics, and every company strives to capitalize on positive trends as it navigates through inevitable challenges. Staying up with incremental pieces of news on your holdings is extremely valuable, but only insofar as the news informs the valuation process. An understanding of which pieces of news are material, and which pieces of news are 'noise' is one of the most important aspects of investing.

Let's walk through the recent eBay data points to assess materiality within the context that eBay's same-store sales are still growing at a nice double-digit clip.

1) Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) Panda 4.0. On May 20, Google rolled out a new iteration of Panda, an enhanced search algorithm. The goal is to improve the search experience, weeding out lower-quality "spammy" websites in the rankings and bolstering higher-quality websites that have strong brands and trusted, original content. Panda will impact as many as ~8% of all search queries performed in English. According to SearchMetrics, is expected to experience a reduction of as much as 33% of traffic on the basis of the rollout of the new algorithm. Wordstream estimates that eBay may lose ~80% of all of its first page organic rankings.

Valuentum's Take: The latest Panda update is the 25th iteration of such improvements to Google's search algorithm. This certainly won't be the last update, and we fully expect eBay to recover in coming periods from any search rankings that it has lost. Our opinion of InterActiveCorp's (IACI), which is expected to see traffic halved from Panda (much worse than eBay), is the same. We view the Panda 4.0 update as largely immaterial to long-term performance, though it may clip a few pennies off of earnings per share for this year and next as it forces some firms to buy more Google search ads.

2) The Cyberattack. On May 21, eBay disclosed a cyberattack that compromised a database containing encrypted passwords and other non-financial data. eBay concluded that after conducting extensive tests on its network that "there was no evidence of any unauthorized access to financial or credit card information." PayPal was not impacted in any way, shape or form, as the firm emphasized that PayPal data is stored separately on a different network and that there was no evidence of unauthorized access on that network.

Valuentum's Take: We think the market may be associating eBay's cyberattack with the recent credit/debit card data breach at Target (NYSE:TGT), the latter we view as more severe. eBay has simply asked users to change their passwords, and we're not reading into anything more than that. Though the news could cause some weakness in traffic flow this month or next, the security breach is immaterial to eBay's long-term trajectory. We would expect a full recovery.

3) Management Turnover. On June 9, PayPal President David Marcus announced that he will be leaving the company to join Facebook's (NASDAQ:FB) messaging products. The release indicated that Marcus is looking for a more entrepreneurial role: "leading smaller teams to build great product experiences." PayPal's leadership team will report to CEO John Danahoe until a replacement can be found.

Valuentum's Take: We're not reading too much into this piece of news either, as high-performing technology executives swapping companies is not unusual. For example, Sheryl Sandberg cut her teeth at Google before becoming chief operating office at Facebook. Marissa Mayer did the same before joining Yahoo (NASDAQ:YHOO) as chief executive. eBay has a deep bench to find a replacement, though we would not be surprised to see the firm look externally to reignite innovation. We also cannot rule out the possibility that Marcus's departure may possibly hint at the separation of PayPal, an event that we would consider to be a distinct positive.

4) News of Increased Payments Competition. On June 9, Amazon (NASDAQ:AMZN) indicated that it will start managing subscription payments for start-ups and other firms. Rivals such as Apple (NASDAQ:AAPL), Visa (NYSE:V), Facebook, and even Alibaba (ABABA) will also be looking to invade PayPal's turf in coming years. Any one of them, for example, could acquire mobile payments firm Square or other tech-heavy upstarts to accelerate a push into electronic payments technology.

Valuentum's Take: We think this news is more important than the others and speaks to a more competitive environment in the next 3 to 5 years for PayPal. Still, PayPal benefits from a substantial first-mover advantage and a large installed base. Switching costs are not small for existing PayPal merchants, and Amazon will have to offer a superior product at a much lower price to make inroads into this market. In any case, however, the competitive landscape needs to be watched very closely.

5) Carl Icahn's Proxy Fight and eBay's Tax Blunder. In mid-April, activist investor Carl Icahn, after an aggressive exchange with eBay management, abruptly ended the proxy contest, withdrawing his proposal to separate the company's PayPal business. eBay then in its first-quarter results, released late April, made a decision to repatriate earnings and foot a huge and unnecessary tax bill of $3 billion.

Valuentum's Take: Needless to say, we were disappointed with both events. We believe eBay should separate PayPal from its operations and preserve the economic relationship contractually. Existing eBay shareholders would benefit significantly from the separation, in our view, as the market would then assign more appropriate multiples to each firm individually. This may still happen in the years ahead, however.

The tax decision was a complete mess, in our view. To save from paying the tax bill, eBay could have issued new debt (like Apple) to fund repurchases and/or refill its cash coffers. The move is probably best-described as 'value-destructive from an opportunistic standpoint,' especially if an international opportunity comes along and eBay is unable to capitalize on it. We don't think Carl Icahn wanted eBay to repatriate earnings and foot a huge tax bill to buy back stock.

Wrapping It Up

The news flow hasn't been great for eBay as of late. Changes in Google's search algorithm, a cyberattack, management turnover, and growing competition have hit the wires in the past few weeks alone. These news items followed Icahn's withdrawn proxy contest and the tax debacle, both of which we weren't particularly happy about. eBay has been hit with a storm of negative news.

But in spite of all of this, eBay's same-store sales continue to advance at a nice double-digit clip, and we would expect the pace to continue to be resilient. With shares trading under $50 each at the time of this writing, our ~$90 fair value estimate implies substantial upside potential. Investors need to understand that news flow is quite different than valuation. Even firms with terrible press can be significantly undervalued and be great long-term investments. We're keeping our position in eBay in the Best Ideas portfolio at this time, though we fully admit that negative news flow could continue to pressure shares before they inevitably turn higher, in our view. eBay represents ~3% of the portfolio and has a cost basis just north of $30.

Shares of eBay are trading at less than 15 times 2015 earnings on sales growth in the mid-teens. They are cheap on almost every valuation multiple. The company's Valuentum Buying Index rating is a 6, but once technicals improve, it would register a 9 or higher (the equivalent of a "we'd consider buying" rating).

Disclosure: Several firms mentioned in this article are included in Valuentum's newsletter portfolios. The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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