eBay: Fundamentals Remain Strong, How About Valuations?

| About: eBay Inc. (EBAY)

Shares of eBay (NASDAQ:EBAY) have appreciated significantly by 75.7% over the past 12 months. At $55.66, the stock is trading near its 52-week high of $56.66 attained just recently. Should investors ride on the uptrend momentum? In this article, I will elaborate on my stock valuation analysis which may assist you in formulating the appropriate investment decision.

Relative Valuation

Sell-side analysts on average predict the firm's revenue, EBITDA and EPS to grow at solid CAGRs of 15.6%, 16.0% and 16.0%, respectively, over the current and next few years (see comparable analysis chart below). The consensus estimates outperform the averages of 14.3%, 14.7%, and 15.4%, respectively, for a group consisting of eBay's primary peers. However, the firm's EBITDA margin is forecasted to expand by only 0.3% over the same period, compared to the group average of 0.8%. On the profit side, eBay has demonstrated a superior margin performance as all of the company's margin metrics are considerably above the par. The firm's capital return measures, however, are below the peer averages. eBay carries a relatively higher level of debt as reflected by the firm's above-average debt to EBITDA and debt to capitalization ratios. In terms of liquidity, the company's free cash flow margin is below the par. Both its current and quick ratios are just slightly below the peer averages, reflecting a somewhat healthy balance sheet performance.

To summarize the financial comparisons, eBay's above-average growth potential and superior profitability should be the primary support to the stock valuation. However, given the company's mediocre performance in capital return and liquidity, I believe the stock's fair value should not be significantly above the peer-average level. eBay is currently trading at 12.6x forward EBITDA and 20.5x forward EPS, compared to the peer-average multiples of 9.8x and 24.8x, respectively, indicating a fairly in-line valuation level. A further look at the stock's PEG ratio, which is at 1.4x compared to the markedly higher peer average at 2.7x, however, would suggest eBay's valuation remains somewhat attractive after the significant price appreciation.

From a historical standpoint, eBay's valuation appears to be somewhat rich. The stock's trailing EV/EBITDA multiple of 16.5x is now trading at 50.2% premium above its 5-year historical average of 11.0x (see chart below) despite the fact that 1) eBay's capital return metrics including ROE, ROA, and ROIC have all experienced a downtrend over the past 5 years; 2) the firm's various profitability margins have remained flat over the period; and 3) the market's estimated revenue and EBITDA growth rates for the next few years are slightly below the level in 5 years ago (see charts below).

DCF Valuation

I also performed a DCF valuation which incorporates the market's consensus revenue and EBITDA estimates from fiscal 2013 to fiscal 2017 (see DCF chart below). The purpose of this analysis is not aimed to derive the fair value but to gauge the various assumptions embedded in the current share price and perform a ballpark reasonability check.

The terminal revenue growth rate is set at 3.0%, which is slightly higher than the estimated US long-term inflation rate. The terminal EBITDA margin is assumed to be consistent with the market's estimated margin for fiscal 2017. Other free cash flow related items including tax expense, depreciation and amortization, capital expenditure, and non-cash working capital investment are projected based on their historical figures relative to the total revenue as those ratios have been trending steadily over time. A company-specific risk premium of 2.8% is applied in the cost of equity calculation to account for the financial forecast risk. As such, based on a WACC of 10.0%, a terminal growth rate of 3.0%, and an implied terminal EV/EBITDA multiple of 7.9x, the DCF model yields a stock value of $55.93, which is quite close to the current share price at $56.66. Since the key assumptions (i.e. WACC, terminal growth rate, terminal EBITDA margin) used in the model are fairly reasonable, the analysis suggests eBay is now appropriately valued. Based on the sensitivity tables and a fixed terminal growth rate at 3.0%, a slightly higher WACC at 11.6% would drag down the stock value to $46.06 or a lower terminal EBITDA margin of 32.2% would imply a stock value of $51.41. Both scenarios would suggest an average downside of approximately 14.0% from the current share price. Given that those less favorable assumptions are not really unrealistic, the margin of safety on eBay's valuation appears to be mediocre.

On the qualitative side, eBay's fundamentals remain solid. Except for Q3 2012, the company has consecutively beaten revenue and EPS estimates over the past 8 quarters (per Thomson One). After the recent Q4 2012 earnings release, brokers including Wedbush, Stifel Nicolaus, and Needham have all reiterated their buy ratings on the stock and raised their price targets to above the $60 level. In a recent research note, Morningstar's research analyst, R.J. Hottovy, elaborated on his long-term view on the company (sourced from Thomson One, Equity Research), which I tend to agree:

"Needing only modest investment to drive strong returns, eBay has one of e-commerce's most powerful business models. EBay's wide economic moat is based on the network effect inherent in PayPal (117 million active users) and its online Marketplaces (108 million active users). We don't foresee changes in eBay's capital efficiency or strong margins anytime soon, suggesting that revenue growth will be the primary valuation driver. PayPal should sustain strong momentum as it captures a larger share of the online and offline payment market. We're also optimistic that fixed-price offerings, upgraded search capabilities, local merchandising, and mobile commerce functionality will reinvigorate eBay's Marketplaces and drive global transactions higher. The integration of GSI should also be additive, as GSI's clientele, eBay's network, and PayPal's capabilities should yield meaningful synergies."

Bottom line, I expect eBay's healthy business fundamentals and strong market position would continue to drive solid growth down the road. However, given that the stock's valuation has picked up significantly, I recommend establishing a long position by selling out-of-money put options to either collect upfront premium or take an opportunity to acquire the shares at a lower valuation level.

The comparable analysis and DCF charts are created by the author, all other charts are sourced from Capital IQ, and all historical and consensus estimated financial data in the article and the charts is sourced from Capital IQ unless otherwise noted.

Disclosure: I am long EBAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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