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Summary

  • Despite the near-term challenges, the long-term growth potential remains. The company continues to grow itself both through acquisitions and organic growth.
  • As online and offline retail converge and as mobile becomes a key driver of disruption and innovation, EBAY is uniquely positioned to benefit.
  • Addressable market opportunity in emerging markets and mobile should continue to drive growth.

eBay Inc. (NASDAQ:EBAY) has been receiving a lot of bad press lately and the stock is down 6% YTD as a series of incidents/events, including departure of a key executive, a penalty imposed by Google, the recent security breach, and the technical breakdowns, had a negative impact on the stock. However, despite the near-term challenges, the long-term growth potential remains. The company continues to grow itself both through acquisitions and organic growth.

EBAY, which started as an auction based company, is little like what it was when it started back in the mid-1990s. EBAY's transformation in its business model over the years has been commendable. The company has transformed from an auction based retail model to a more comprehensive payments and market place model. The company has huge addressable market opportunity in mobile and in international markets (especially emerging markets), and these new markets should continue to drive strong revenue growth in the coming years.

The retailing company operates in three segments: Marketplaces, Payments, and GSI. eBay.com and StubHub are included in Marketplaces while Payments services include PayPal and Enterprise. Marketplaces and Payments generate approx. 70% of the company's overall earnings.

With Growth in B2C E-Commerce Sales, User Base Has a Significant Potential to Grow

The San Jose, California based company has the largest online payment network with more than 100 million active users. The company added approx. 20 million accounts to its database in 2013 alone and the active registered user accounts have increased approx. 86 million during the 2007-2013 period. According to eMarketer, the global business-to-consumer [B2C] e-commerce sales are anticipated to increase by approx. 20% to $1,500 billion during 2014, led by the growth in mobile usage in emerging markets, advancements in payment and shipping services, and geographical expansion.

The growth in B2C sales should continue to have positive impacts on EBAY's earnings. In fact, the company's first quarter reported results showed the impacts of these above mentioned factors and the tailwinds are expected to continue to impact the ratios for the rest of the year as well because of EBAY's continued investment in expansion of its product categories and PayPal's interface.

Marketplaces Expected To Stay Profitable Despite Competition

The online retail company is struggling to stay in place in its marketplace division because of tough competition. Although the company has made a number of changes to its business in order to remain relevant, none of them have enabled EBAY to gain market share as expected by the company. However, still the company is expected to grow its sales at least in line with the e-commerce growth.

The e-commerce market is highly efficient where consumers look for trust, value and selection. EBAY offers a wide variety of more than 550 million items such as clothing, used goods, car parts and collectibles to select from. While the company boasts a wide variety of goods, it doesn't offer any high tech must have items to offer the online buyers who largely belong to the digital generation. However, with respect to value, the company is offering the goods at pretty competitive prices.

When compared to mass market retailers such as Amazon (NASDAQ:AMZN), the company lags behind in providing quality service to its users as it has no control on shipping costs and delivery timing, which are two very important factors for online retailers. Despite this, EBAY has done a pretty good job with respect to gaining the trust of its users by improving sellers, rankings, and moving best vendors to the front.

Going forward, eBay is partnering with traditional retailers to increase its selection of the offered goods. This move is also expected to resolve the delivery issue faced by EBAY and enable it to get the product to consumers within 1-2 hours. The company is also working towards simplifying its product by adding collections (curated items picked by either users or experts) to its site. This would not only result in a more simplified product but would also make it more interesting and engaging for users, and would also add a social element to the shopping.

Although the company is innovating and expanding, the measures taken by the company are similar to what many of its peers are already offering. In order to really re-invigorate traffic and sales the company needs to do something additional in order to make it habit forming.

PayPal - The Star Performer

Despite the challenges from established financial companies, PayPal has grown into a worldwide market leader in the financial services sector. EBAY acquired PayPal in 2002 for approx. $1.5 billion, which amounted to approximately one quarter of all of eBay's reported transactions. At the moment, PayPal accounts for nearly half of the company's $65 billion market capitalization. The biggest advantage to PayPal's users is its ability to facilitate cross-border transactions due to its huge infrastructure. PayPal has license to operate in 193 countries and it has built relationships with 1500 financial institutions. PayPal has built an infrastructure, which is hard to replicate.

While PayPal has shown tremendous performance in the online space so far, it is expected to show a similar performance as the mobile payments become truly mainstream. Mobile is going to be one of the key growth areas for PayPal in the future not only in developed countries but also in the emerging markets of Latin America and Asia. Although the segment has been performing exceptionally well, it can grow further if the company shows a more aggressive behavior towards innovation i.e., its new product launches through more aggressive marketing and product plans in the future.

PayPal Spin-off?

Although the fight with renowned investor Carl Icahn appears to have cooled down, I do not believe that the uncertainty regarding PayPal's spin-off is resolved yet, as is evident from the CEO's comments during the first quarter call. At one point, he stated that a "full separation doesn't make sense at this point" and at another time he stated "the company is better together, for now." I think the company has just put to rest the issue as of now but it expects PayPal monetization sometime in the future.

I think the management made a good call by not spinning off PayPal at the moment, as it would have only resulted in an equity gain in the short term. From a competitive viewpoint, with the increasing trend towards online shopping, every major e-commerce retailer is launching its own online payment method. The Chinese company Alibaba has its online payment service by the name of Ali Pay. Similarly, Mercado Libre has Pago. According to me, the current market structure doesn't preclude eBay from working with other partners, so a spin-off wasn't going to help. Moreover, PayPal isn't able to generate as much free cash flows as it needs. The combined company gives PayPal greater access to capital to grow the business and therefore I do not think that PayPal is at any disadvantage by remaining part of eBay. In fact, it is actually in favor of PayPal to remain part of the combined company.

Compelling Valuation

As I mentioned in the beginning, EBAY shares are down 6% YTD as a series of incidents/events, including departure of a key executive, a penalty imposed by Google, the recent security breach, and the technical breakdowns, had a negative impact on the stock.

The company is trading at a significant discount compared to its peers and the industry. The company has an EV/EBITDA of 12.4 as compared to 41.6 of the direct competitor Amazon and 17.1 of Visa Inc. (NYSE:V). Moreover, the company has a price/book of 3.3 compared to the 15.8 of Amazon and price/cash flow of 12.7 compared to 31.0 of Amazon. Finally, EBAY is trading at forward price/earnings of 15.7 compared to 70.4 of Amazon.

Conclusion

Despite all the negative attention that EBAY has attracted this year, the company has a little downside risk going forward. EBAY's turnaround in its fundamental marketplace is expected to continue to gain traction and the PayPal division is anticipated to gain share both online and offline. The company made a sound decision of not spinning off its PayPal division as it would have resulted in only a short-term gain in the equity. Going forward, one thing that can hamper the company's upside potential is the increased competition faced by the company from its peers in both the consumer cyclical and financial services industries.

Although the company is growing itself both organically and through acquisitions, it is also to be noted here that these are weighing heavily on its cash flows. Still the company's management is making a number of encouraging moves in terms of execution and return of capital. While I do acknowledge the near-term challenges the company faces, I see long-term potential in EBAY.

Note: EBAY will report 2Q14 results after market close on Wednesday, July 16, 2014.

Disclosure: 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.

Source: Can You Look Beyond eBay's Near-Term Challenges?