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Alex Zhao
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Investment professional working at Ibbotson Associates, a registered investment advisor and wholly owned subsidiary of Morningstar, Inc. Booth MBA expected in 2015. Passed all three CFA exams at first attempt. Will be eligible for the CFA charter upon completion of the required work experience.... More
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  • EBay Is Fairly Priced After Perfect Turnaround

    eBay (NASDAQ:EBAY) spent the past three years repositioning its business to stay ultra-focused on commerce and resume growth. The new eBay has the potential to grow top line and keep operating margin stable. However, increasing competitions pose greater risk for Marketplace and PayPal. My DCF model gives a fair value range of $37 to $48, which indicates that eBay is fairly priced. eBay does not currently offer a margin of safety at $42 a share.

    eBay announced a three-year turnaround plan in March 2009. Every goal listed in the plan is met expect Skype. As a result, market responded very positively. Stock price hit a new 5-year high of $42.25 today. According to Morningstar, its trailing P/E ratio also improves from 12 in 2009 to about 16 after it touched a high of 20 in 2011.

    eBay made a few strategic moves to revive its business. Click here to see my detailed analysis on how these moves worked out well in 2010 and 2011. This article will primarily focus on their long-term implications on future growth. Data presented in al the tables is sourced or calculated from annual reports and sheets of metrics and revenue posted on eBay's investor site.

    Communication Segment or Lack Thereof

    eBay sold 70% of Skype to private investors in 2009 and the rest 30% in 2011 to Microsoft. The sale, according to eBay, worked out a return of $1.40 bn on its original investment on Skype. It is wise for eBay to strip out non-core business.

    Marketplace's Fixed-price Focus

    eBay shifted toward increasing fixed-price sales to grow Gross Merchandise Value (GMV), which translated into robust revenue growth in 2010 and 2011. Fixed-price sales now accounts for 64% of the Gross Merchandise Value in Q1 2012, compared to 45% in 2009, according to eBay.

    Item (In millions, except percentages)

    2011

    2010

    2009

    2008

    Marketplace Revenue Growth

    16.10%

    7.70%

    -4.94%

    4.16%

    Transaction Revenue Growth

    13.15%

    7.58%

    -5.29%

    0.64%

    Service Revenue Growth

    31.52%

    8.36%

    -3.08%

    28.26%

    GMV (Excluding vehicle) growth

    12.70%

    10.72%

    0.72%

    3.06%

    GMV Growth

    11.02%

    8.06%

    -4.10%

    0.50%

    Fixed-price trading as % of total GMV

    63.00%

    60.00%

    53.00%

    45.00%

    Going forward, the fixed-price trend means eBay will have a growing number of fickle bargain-seekers and cost-minimizing, rational sellers, who have no problem jumping ship. At the same time, more auction sellers will move away from the site. This WSJ article in 2009 described on how changes to eBay's fee structure in recent years benefit fixed-price sellers of consumer electronics and burden auction sellers of antiques and collectibles. This change in the seller mix will increase volatility of eBay's GMV and revenue.

    Furthermore, eBay is not likely to beat Amazon (NASDAQ:AMZN) on revenue growth. Amazon makes seven times as much as eBay from online retail segment in 2011 (Media plus Electronics & OGM for Amazon, $46,491 mn versus Marketplace, $6,641 mn). According to Alex, eBay is already way behind Amazon in terms of traffics and total page views. Unlike Amazon, which rolls out Kindle Fire and Instant Video, eBay lacks such medium to draw more traffic to the site. It has not yet undercut price by offering free shipping akin to Amazon Prime either.

    In short, eBay is not likely to grow GMV and top line better than Amazon due to lack of differentiating strategies and buzz words. The business will become less resilient over time. Given that, my model supposes that marketplace's top line growth will be around the low teens in the next few years, remarkably lower than Amazon in an expansion scenario. The growth will gradually decrease to below 10% thereafter. Assuming eBay does not engage in activities that sacrifice margins for revenue growth like Amazon did, its gross margin will stay at the current level.

    PayPal Bets on 2Ms: Merchants and Mobile

    Merchant services fueled the growth on Total Payment Volume (TPV), as its share of total TPV grows from 56% in 2009 to 65% in 2011 according to eBay. It is common sense that a merchant account initiates more transactions than an average consumer. PayPal is doing the right thing by focusing on this group of users.

    Item (In millions, except percentages)

    2011

    2010

    2009

    Active Registered Accounts

    106.3

    94.4

    81

    Total Payment Volume

    118,758

    91,955

    71,607

    TPV Growth

    29.15%

    28.42%

    19.06%

    Payments Revenue

    4,412

    3,435

    2,796

    Payments Revenue Growth

    28.44%

    22.85%

     

    Take Rate

    3.72%

    3.74%

    3.90%

    Transaction Margin

    63.50%

    63.00%

    61.00%

    Merchant Services as % of net TPV

    65.00%

    62.00%

    56.00%

    Mobile payment is another area of focus. According to Slide 13 of the shareholder presentation prepared by eBay, PayPal's mobile TPV grew almost 40 times from $0.1bn in 2009 to $4 bn in 2011. Its mobile app has been downloaded over $70 mn times. In addition to organic growth, it is building a lead through its acquisition of Zong, a mobile payment service provider. Furthermore, this year it rolled out PayPal Here, a card reader that allows merchants to take credit card payments via smart phone. It also partners up with off-line retailers, such as Home Depot, and Point-of-Sale (POS) vendors, to support PayPal in brick-and-mortar stores. Although PayPal bashed on Near Field Communication (NYSEMKT:NFC), it has introduced a few NFC features, such as sending money via phone-to-phone tap and PayPal InStore in UK. eBay's strategy to focus on mobile payments is supported by research done by Gartner and Ferrester. Both researchers predict a boom in this market by 2016.

    PayPal will likely score 30-percent-plus revenue growth in the next year or two. However, pretty soon fierce competition in this open field will drag growth. The long list of rivals on page 40 of eBay's 2011 annual report unease me. These are some strong competitors: long-standing incumbents in payments industry, Visa (NYSE:V), MasterCard (NYSE:MA) and American Express (NYSE:AXP), fellow e-commerce gurus Aliaba and Amazon, Google Wallet and Google Checkout (NASDAQ:GOOG), and Square, which specializes in mobile payments and POS terminals, and other POS providers, such as VeriFone (NYSE:PAY) and Intuit GoPayment (NASDAQ:INTU). What is more, when it comes to the mobile market, one cannot ignore Apple (NASDAQ:AAPL). If Apple ever gets involved, either in direct competition via "Apple Wallets" or takes side with any of PayPal's rivals, things will become difficult for PayPal.

    Furthermore, I think PayPal needs to embrace NFC more while its engagement so far has been limited. The tap-and-go experience of Google Wallet is much more seamless than the checkout process of PayPal Here. PayPal argues that not so many NFC phones are out there and merchant adoptions are slow. I disagree. Everyone knows how fast smart phones are upgrading. I think merchants will carter to shoppers' preference once people get used to the tap-and-go.

    Given that, I predict that PayPal will grow at 35% in 2012 and the growth will decrease linearly to 25% by 2016. PayPal's take rate and transaction margin will be at the current level, given that merchants are a price-sensitive crowd and it is not easy for PayPal to raise price.

    Commerce Facilitator

    eBay added a third business segment to become a grand facilitator of e-commerce. It now offers online commerce and marketing solutions through GSI Commerce, which it acquired in 2011, and technical solutions through the X.commerce platform, which is joined by its acquisition of Magento this year. GSI Commerce now serves over 200 retailers. This is a smart diversification move, as eBay moves away from directly competing against retailers and goes behind the scene.

    I believe that the growth in this field will be reasonable and steady as the demand for retailers to go online is sizeable. Forrester estimates online retail spending to grow at a CAGR of 10% between now and 2016. Due to lack of comparable full-year operating data, growth in the low to mid teens would be my best guess. It could grow faster than that if there were synergy between this unity and other parts of eBay. However, this article pointed it out that "GSI is raking in less as an eBay unit than it did as an independent company" based on Q1 2012 numbers. This business segment has a much lower margin than Marketplace and PayPal according to the annual shareholder presentation. I expect it to maintain its margin in the long term.

    DCF Model Assumptions

    My model forecasts free cash flows for each of the next 5 years and calculates a terminal value in 2016. Segment revenue and margin data is taken from eBay's 2011 annual report and metrics. Other data on the income and balance sheets is sourced from Morningstar.com.

    Name

    Assumption

    Revenue Growth

     

    Marketplace

    13%, decrease linearly to 9% by 2016.

    Payments

    35%, decrease linearly to 25% by 2016.

    GSI and X.Commerce

    2012 revenue is set as $1.2 bn, same as management prediction. Revenue grows at 12% after.

    Gross Margin

     

    Marketplace

    81.6%, three-year average

    Payments

    56.9%, three-year average

    GSI and X.Commerce

    35.5%, same as 2011

    Total operating expenses

    50% of revenue, about three-year average

    Interest Expense

    $50 mn

    Tax Rate

    17%

    Depreciation & amortization

    8.39% of revenue, three-year average

    Stock based compensation

    $411 mn, three-year average

    Provision for transaction and loan losses

    4.37% of revenue, three-year average

    Other non-cash items

    -$312.41 mn, three-year average of non-cash items on Page F-6 of 2011 10-K, excluding "Depreciation & amortization", "Stock based compensation", "Provision for transaction and loan loss", "Gain on sale of Skype", "Joltid legal settlement", "Loss on divestiture of a business" and "Gain on acquisitions"..

    Discount Rate and Terminal Value

    I use WACC as the discount rate. The weights of equity and debts are calculated using the shareholders' equity and long-term debt on the balance sheet of the latest quarter: I set cost of debt to be 3.28%, twice as much as the ratio of the interest expense over long-term debt, 1.64%, in 2011. The cost is equity is set to be 10%. Refer to this article on my blog for more details on how I decide the cost of equity. This gives a WACC of 9.45%.

    Terminal value is calculated by picking a terminal year P/E and backing out the terminal value from projected earnings in 2016. Below is how the fair value changes according to different terminal P/E ratios. Alternatively, if I calculate the terminal value using 3% as the perpetual growth rate, I get a terminal P/E of 20.66 and a fair value of $45.28. eBay is trading at $42.5 per share. The mere $3 discount does not offer enough margin of safety.

    Terminal P/E

    Price

    16

    37.12

    18

    40.62

    20

    44.12

    20.66, long-term cash flow grows at 3%

    45.28

    22

    47.63

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

    Jun 18 3:03 PM | Link | Comment!
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