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eBay (eBay) offers an online auction platform which handled over $68 billion of sales in 2011, a significant portion of the total e-commerce market. eBay also operates PayPal, a popular online payment system.

EBAY Chart
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eBay data by YCharts

eBay stock plummeted to around $10 per share in 2009 but has since recovered to about $40 per share, off from a high of nearly $60 per share in late 2004. Let's take a look at the financial performance over the past five years:

(In Million $) 2007 2008 2009 2010 2011
Revenue $7,672 $8,541 $8,727 $9,156 $11,651
Operating Cash Flow $2,641 $2,881 $2,908 $2,745 $3,273
Capital Expenditure $-454 $-566 $-568 $-724 $-964
Free Cash Flow $2,187 $2,316 $2,340 $2,021 $2,310

Revenue has grown substantially since 2007, increasing by over 50% in that time. Free cash flow has risen much more modestly.

Owner Earnings

Owner Earnings is a better measure for valuation purposes than free cash flow. Warren Buffett defines Owner Earnings as follows:

These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges ... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume ... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.

I'll calculate Owner earnings by taking the Net Income and adding back various non-cash items, such as depreciation, and then subtracting the 5-year average Capital Expenditures. I'll also add interest payments adjusted for taxes since interest is tax deductible.

(In Million $) 2007 2008 2009 2010 2011
Net income $348 $1,779 $2,389 $1,800 $3,229
Depreciation & amortization $601 $719 $810 $762 $939
Stock based compensation $0 $353 $394 $381 $457
Other non-cash items $1,986 $342 $-729 $350 $-1,050
Interest Payments $16 $0 $0 $3 $25
Avg Capital Expenditure $-654 $-654 $-654 $-654 $-654
Owner Earnings $2,290 $2,541 $2,212 $2,644 $2,943

Owner earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the Owner Earnings figures to determine eBay's Cash Return on Invested Capital, or CROIC. This is the cash return generated by the company on invested capital, and is simply the Owner Earnings divided by the total invested capital. This is a better measure than ROIC because ROIC relies on earnings, which is a poor measure of profitability.

(In Million $) 2007 2008 2009 2010 2011
Owner Earnings $2,290 $2,541 $2,212 $2,644 $2,943
Invested Capital $15,366 $15,592 $18,408 $22,003 $27,320
CROIC 14.91% 16.3% 12.02% 12.02% 10.77%

eBay's CROIC has be decreasing over the past five years but is still a strong 10.77%. This is a testament to eBay's ability to consistently generate ample cash. Here is the most recent balance sheet:

Cash and Cash Equivalents $5,871
Investments $2,861
Debt $2,085
Pension Obligations $0
Minority Interest $0
Net Cash (Debt) $6,647
Diluted Float 1,318
Cash/Share $5.04

eBay has a strong balance sheet, with significantly more cash and investments than debt. On a per share basis eBay has $5.04 in net cash, representing about 12.3% of the total market capitalization.

Valuation

I use a discounted cash flow analysis to estimate the fair value of a company. I will use a discount rate of both 12% and 15% and use these values to define a fair value range. I will assume that the owner earnings will grow by 9% next year, thereafter decaying over 20 years to a perpetual growth rate of 3%, as per the growth table below.

Year 1 2 3 4 5 6 7 8 9 10
% 9% 8.7% 8.4% 8.1% 7.8% 7.5% 7.2% 6.9% 6.6% 6.3%
Year 11 12 13 14 15 16 17 18 19 20
% 6% 5.7% 5.4% 5.1% 4.8% 4.5% 4.2% 3.9% 3.6% 3.3%

For reference, the average analyst estimate for earnings growth over the next 5 years is 13.09%. Using the above parameters I arrive at a fair value range of $32.37 - $43.05.

Conclusion

Currently trading at around $40 per share, eBay falls within my fair value range. With the total e-commerce market continuing to grow at a quick pace, and PayPal's push into in-store payments, eBay looks well positioned going into the future and currently offers a fair price for the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: eBay: A Good Company At A Good Price