eBay (EBAY) is a classic story of a solid company with solid ratios that is simply not trading at a price worth investing in.
The company is facing assaults from all sides in the form of well branded and capitalized competitors and the upside doesn’t leave any margin for error. Additionally, the company has a scary hit or miss reputation for acquisitions that seems to shroud any potential buyout rumors with a layer of dread. Some would argue that its capital allocation has improved since the Skype fiasco, but I believe the company could still pull the trigger on a non-core business acquisition that could create more tension headaches for stakeholders. Despite an admittedly strong fourth quarter from eBay, the benefits are simply not compelling enough for me to bid on this auction giant.
Q4 Earnings: Earnings from eBay today were strong. Net income for 2010 ended at $1.8 billion, down 25% from 2009 but fourth quarter revenues increased 5% year on year, or 10% excluding Skype. Operating and free cash flows for Q4 came in at $854.0 million and $656.5 million, respectively. PayPal continued to shine, ending the quarter with 94.4 million active registered user accounts and adding about one million per month through the end of the year. New payment volume was just under $27 billion in the fourth quarter, and over half of PayPal’s revenue in Q4 was generated outside of the United States. This is a true testament to the appeal of PayPal as a safe, global, e-commerce payment system. CEO John Donahoe said:
"We are driving strong global growth at PayPal and strengthening our core eBay business. And we are innovating quickly in areas such as mobile, which is helping to position us at the forefront of trends shaping the future of shopping and payments."
For 2011, eBay expects revenue in the range of $10.3 to $10.6 billion, which would represent growth of about 12%. However, expectations are tempered with a decrease in earnings per share from $1.73 to as low as $1.56 in 2011.
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Created using the Trefis Pro Investing Tool on Seeking Alpha.
Competitor Analysis: This is where the bears get the majority of their ammunition for the anti-eBay argument. Other companies, they say, are edging in on the auction market and providing new technological platforms for vendors and merchants to optimize their sales. As you can see from the graph above, eBay relies on the marketplace for the majority of its stock price justification. These new methods allow sellers to cross-list on Amazon (AMZN), eBay, personal sites and more; this could eventually remove the necessity for a third party sales platform like eBay. Buyers are already relying on search results to find the best deals on items on the internet, so the main advantage of eBay being a one stop shop for items is being eroded by a combination of e-commerce trends. eBay is trying to position itself as more of an e-commerce hub, and less of an auction site. However, they’ll have to move quickly to do this without losing more of their share to sites like Amazon that seem to have more of a social community to offer than eBay does.
As the CEO noted above, mobile sales have definitely been growing for eBay. As TechCrunch recently pointed out, mobile sales more than tripled from $600 million in 2009 to $2 billion in 2010. This is definitely a good sign, but just because buyers are moving from a computer to a cell phone doesn't mean a big boost.
Furthermore, people seem tired of the auction format. Last minute auction snipers, delayed gratification, third party difficulties and no guarantee of the lowest price possible have all contributed to a movement toward fixed price selling on the Internet. The advent of pricing information from intelligent search results also makes bargain hunters more equipped to find a better deal in fixed format and sellers better equipped to present the best deal on the net. The question is, where does an auction site go from here? If Internet trends drive the majority of e-commerce toward the fixed price format, then eBay loses its main competitive edge over sites like Amazon. Their only remaining advantage is ...
PayPal. Its bread and butter amidst all this uncertainty has been PayPal. The rise of PayPal has been a boon for eBay in general, and they have reaped the rewards of a wise investment in the firm. PayPal now has more registered users than Discover (DFS), and almost as many as American Express (AXP) according to Morningstar. This represents a massive set of market participants that now can use PayPal online, linked to a bank account, with security measures in place that make exchanges safe. However, as PayPal evolves into more of an e-commerce enabler and less of an eBay exclusive, there is a possibility that PayPal will actually allow other e-commerce sites better access to the established set of buyers and sellers that eBay has used to grow over the past few years. Another issue I have with PayPal is a potential for being subject to many of the regulations and fee caps that currently hamstring credit card companies. If PayPal wants a piece of the $4 trillion credit card pie, they may have to play by their rules. This would hurt its US. revenues.
Valuation: Given the recent earnings release from eBay, I have decided to give eBay a price floor of $22 and a ceiling of $29. This is due to the decrease in discretionary spending, rabid pursuit of rivals in e-commerce and general uncertainty surrounding PayPal’s place as a competitive edge. I feel there is very little upside to eBay right now, especially after a 3% after hours run up that has the stock trading over $30. I expect there to be very little in the way of a catalyst for eBay to have any sort of run up in stock price. The only thing that will benefit them is the increase in consumer spending as consumers become more comfortable buying things again.
Ratio analysis: Ratios are not a weakness for eBay. From a relative perspective, eBay is below historical PEs as earnings have finally caught up to the stock price. Their price/book and price/sales are also at five year lows. The firm has exhibited varying profit margins from 4.5% to 27.4% in 2009. Add to that an impressive FCF margin that has topped 26% for the last five years running, and eBay’s profitability is unquestionable. Their liquidity is solid, with current and cash ratios all above acceptable levels.
Conclusions: eBay is a profit machine that should be able to churn out sizable free cash flows for years to come. They have a pile of cash on hand, but unfortunately I’m not sure how they will utilize that cash in terms of acquisitions. Its purchase of over $400 million in common stock over the last quarter indicates to me that management feels the stock is undervalued. I wish I could agree, but given the depressed earnings and the questionable state of the online consumer in general, I don’t see the drivers for the supposed increase in stock price. Now that after hours trading has sent the stock above $30, I definitely don't see value from a fundamental perspective here.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
