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.
(Click to enlarge)
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.
