eBay Q2 2009 Earnings Call Transcript

| About: eBay Inc. (EBAY)
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eBay Inc. (NASDAQ:EBAY) Q2 2009 Earnings Call July 22, 2009 5:00 PM ET


Mark Rowen - Vice President, Investor Relations

John J. Donahoe - President, Chief Executive Officer, Director

Robert H. Swan - Chief Financial Officer, Senior Vice President - Finance


Christa Quarles - Thomas Weisel Partners

Jeffrey Lindsay - Sanford C. Bernstein

Benjamin Schachter - Broadpoint Amtech

Imran Khan - J.P. Morgan

Scott Devitt - Stifel Nicolaus

Mark Mahaney - Citi

James Mitchell - Goldman Sachs

Douglas Anmuth - Barclays Capital

Justin Post - Merrill Lynch

Steve Weinstein - Pacific Crest Securities


Good day, everyone, and welcome to eBay's second quarter 2009 earnings results conference call. Today’s call is being recorded and at this time, I would like to turn the call over to Mark Rowen, Vice President of Investor Relations. Please go ahead, sir.

Mark Rowen

Thank you, Operator. Good afternoon. Thank you for joining us and welcome to eBay's earnings release conference call for the second quarter of 2009. Joining me on today’s call are John Donahoe, our President and Chief Executive Officer; and Bob Swan, our Chief Financial Officer.

We are providing a slide presentation to accompany Bob’s commentary during the call.

This conference call is also being broadcast on the Internet and both the presentation and call are available through the investor relations section of the eBay website at investor.ebay.com.

Before we begin, I’d like to remind you that during the course of this conference call we will discuss some non-GAAP measures in talking about our company’s performance. You can find the reconciliation of those measures to the nearest comparable GAAP measures in the slide presentation accompanying this conference call.

In addition, management may make forward-looking statements relating to our future performance that are based on our current expectations, forecasts, and assumptions and involve risks and uncertainties. These statements include, but are not limited to, statements regarding expected financial results for the third quarter of 2009 and anticipated future stability and growth in the marketplace’s business unit.

Our actual results may differ materially from those discussed in this call for a variety of reasons, including but not limited to the impact of recent global economic events and the global economic downturn, foreign exchange rate fluctuations, changes in political, business, and economic conditions, the impact and integration of recent and future acquisitions, our increasing need to grow revenues from existing users in established markets; an increasingly competitive environment for our businesses; the complexity of managing an increasingly large enterprise with a broad range of businesses; our need to manage regulatory tax, IP and litigation risks, including risks specific to PayPal, Bill Me Later, and the financial industry and risks specific to Skype's technology and to the VOIP industry; and our need to upgrade our technology and customer service infrastructure at reasonable costs while adding new features and maintaining site stability.

You can find more information about factors that could affect our operating results in our most recent annual report on Form 10-K and our subsequent quarterly reports on Form 10-Q, available at investor.ebay.com. You should not unduly rely on any forward-looking statements and we assume no obligation to update them.

All information in the presentation is as of July 22, 2009 and we do not intend nor undertake no duty to update this presentation.

And now, I’ll turn the call over to John.

John J. Donahoe

Thank you, Mark and good afternoon, everybody, and welcome to our Q2 earnings call. Our second quarter results were solid. Revenue was almost $2.1 billion with organic growth up slightly over the prior year. Non-GAAP EPS was $0.37.

We’ve executed well and we’ve executed aggressively in the second quarter. We are focused on improving experiences for our buyers and sellers and strengthening our company. PayPal continues to gain share, driving penetration on eBay and rapidly adding new merchants across e-commerce. And our core marketplaces business is stabilizing with the economy as we execute against our turnaround priorities.

PayPal, eBay's fixed price format, classifieds, and stub hub all continue to outpace e-commerce growth rates. We are moving in the right direction -- a strong company getting stronger.

We are managing our business with discipline, focus, and accountability to meet today’s challenging environment.

However, for a strong company such as ours, these are not times to be timid. In this current economic cycle, decisions we make today will determine leadership tomorrow and we intend to lead.

We are leveraging our cash flow and our focus on operational excellence to make smart investments in our core e-commerce and online payments businesses. And we are taking the necessary actions and bold steps required to win.

Now we still have a lot of work to do to achieve our three-year growth targets but I am pleased with our pace, our progress, and our performance.

Before I comment on our Q2 results, let me remind you of the three-year growth goals that we outlined earlier this year. We intend to approximately double PayPal by 2011 and we believe PayPal is well-positioned to become the leader in global online payments.

Tomorrow PayPal will announce plans to become the first and only global payments platform open to third-party developers. This is a significant step, one which we expect will drive further acceptance of PayPal and will fuel payments innovation beyond e-commerce.

In our e-commerce business, we are steadily improving trust, value and selection, and transforming the user experience on eBay. We are also growing other formats, such as classifieds and stub hub and we are strengthening our e-commerce portfolio with acquisitions such as G-market in Korea, which we completed in Q2.

We are focused on where we can win and we are aggressively working toward our goal of positioning our total marketplace’s business to grow with e-commerce in 2010 and faster in e-commerce in 2011.

In addition, by driving operational excellence across our company, we intend to free up and reinvest $2 billion over the next three years. We are unlocking technology to drive innovation and enhance the user experience and we continue to build a strong management team, ensuring that we have our best talent focused on where they will make the greatest difference and recruiting new talent where we need to.

Now let’s look at the results from each of our VUs. PayPal had another excellent quarter -- revenue, payment volume, and active users were up across the board. PayPal continues to drive synergies with eBay, increasing its penetration on eBay by almost 8 points year over year.

In May, PayPal launched on eBay's [Market Plots], the leading online classified sites in The Netherlands. This program grew from three categories at launch to over 900 within just three weeks due to the overwhelmingly positive response from sellers.

PayPal's merchant service business continues to gain share, delivering merchants higher checkout conversion than other payments products. On an FX neutral basis, our merchant services total global payments volume grew 32% during Q2, with strong growth in all regions around the world.

In the U.S., the integrated sales team for PayPal and Bill Me Later has signed 70 large merchants over the past six months, representing an estimated $17 billion in addressable online sales. These merchants include Foot Locker, Pacific Sunwear, Sears, K-Mart, Pro Flowers, and J&R Electronics. In fact, 54 of the top 100 online retailers in the U.S. now offer PayPal or Bill Me Later, and 22 of them offer both.

Outside the U.S., PayPal's merchant services momentum is also accelerating. Over one-quarter of the top 50 online retailers in Western Europe now accept PayPal, including Boots in the U.K., [Finac] in France, and T-Online in Germany. And in Asia, more than half of the top 50 online retailers in Australia, China, and Hong Kong now offer PayPal.

On an FX neutral basis, total merchant services payment volume in Europe was up 57% in Q2 over the prior year and up 47% in Asia. So PayPal continues to grow share in the payments market.

Our integration of Bill Me Later is going well. The combined PayPal and BML sales team is doing a great job, as evidenced by the new merchant sign-ups I mentioned a minute ago. And in time for this holiday season, we expect Bill Me Later to be available as a payment choice within the PayPal wallet, both on eBay and everywhere PayPal is offered in the U.S.

The Bill Me Later team also continues to carefully manage risks in the current environment and they are making the right trade-offs. Bob will provide more details on BML's performance in the quarter.

Now let me move to our core eBay marketplaces business. We saw GMV growth accelerate in Q2 for the first time in seven quarters. This was primarily driven by an acceleration of sold items.

Our format migration continued in the second quarter as more buyers chose fixed price items over auctions. Our fixed price business increased 19% while auctions continued to decline, although less so than in Q1. Fixed price accounted for 51% of total GMV in Q2 and we continue to focus on giving buyers the value and selection they want in the format they choose from sellers they trust.

And trusted sellers are winning on eBay. Our highest rated sellers continue to grow their businesses in a very difficult environment.

For Q2, the highest rated sellers in the U.S. -- that is, sellers whom buyers have rated 4.8 or above -- increased their year-over-year same-store sales by almost 14%. And total volume from sellers with DSRs 4.8 or above increased to almost 39% of total GMV in Q2, up five points over Q1.

Simply put, this means more buyers are enjoying a safer, more trusted experience when they shop eBay.

We are also making good progress in improved customer service for both buyers and sellers. We are getting better at eliminating problems that generate customer contacts before a listing goes live. And in Q2, we piloted our Buyer Resolution program for top buyers in the U.S. and U.K. We will keep extending this program until we cover most all of our buyers. This is a major push toward creating a more consistent and trusted experience on eBay.

Buyer loyalty is another focus and we’ve seen good results from our eBay Bucks pilot program in the U.S., in which a limited number of buyers were invited to participate. More than half the buyers in that pilot program redeemed their eBay Bucks within six days of receiving them. And this pilot program is generating strong word of mouth -- in fact, the number one eBay Bucks question we get is why wasn’t I invited?

So we’ll continue to test eBay Bucks in the U.S. and earlier this month, we launched a similar loyalty program in the U.K. called eBay Plus.

We are also taking actions to make eBay even more attractive for consumer and smaller sellers. For example, in Q2 we introduced free insertion fees for up to five auction listings a month in the U.S. and we eliminated insertion fees for 99 pence auctions for consumer sellers in the U.K. And next week, we’ll be announcing our second half changes to our community, changes designed to drive trust, value, and selection -- changes that will provide further benefits to sellers and buyers this holiday.

So all in all, we’re pleased with this performance and the continued stabilization in our core eBay business. We are making progress.

But we know we still have a long way to go as we work to improve trust, value, and selection and we will stay focused on this execution path.

Last but not least, Skype -- now I’m limited in what I can say about Skype in light of our previously announced plans to separate the business. But I think the facts speak for themselves -- on an FX neutral basis, Skype's revenue was up 43% in Q2 and segment margins continued in the mid-20s. These financials are being driven by strong user metrics.

Registered users were up 42% to 481 million, and Skype-to-Skype minutes increased 72% in Q2, accelerating over the past two quarters, while Skype out minutes were up 57% to 3 billion. Once again, Skype had another strong quarter.

So in summary, we feel very good about where we are at mid-year and the progress we are making. We are doing what we said we would do -- transforming our core eBay business, building a strong portfolio of adjacency e-commerce businesses, and driving strong momentum and market share in PayPal. We are consistently delivering on our financial commitments while doing what’s necessary to position our businesses for long-term growth and leadership.

And now, before taking questions, let me turn it over to Bob for more specifics on our performance

Robert H. Swan

Thanks, John. During my discussion, I’ll reference our earnings slide presentation that accompanies the webcast. All growth rates mentioned in my prepared remarks represent year-over-year comparisons unless I clarify otherwise.

Overall, we delivered a strong second quarter against the backdrop of a difficult operating environment. We exceeded the high-end of guidance on both the top and bottom lines, due to better than expected growth in GMV and the impact of currency.

We continue to execute against our priorities at PayPal, eBay, and Skype. We closed our acquisition of G-market during the quarter and we continue to work towards our previously announced plan to separate Skype.

All in all, it was a busy and a good quarter for eBay.

Our combined businesses generated net revenues of $2.1 billion in the second quarter, a 4% decrease. A stronger U.S. dollar lowered our growth, our revenue growth by 8 points and acquisitions benefited us by 3 points, leading to organic revenue growth at 1%.

Non-GAAP EPS was $0.37 in Q2, a 14% decrease. Non-GAAP operating margins was 28.7% in the quarter, down 320 bps from last year. We made good progress on cost controls and operational efficiencies but these were more than offset by currency translation impacts, business mix, and dilution from BML.

Excluding the impact of a stronger dollar, our non-GAAP EPS increased by 1%.

We generated $602 million of free cash flow in the quarter, or 29% of revenue. CapEx as a percentage of revenues was 6%, and over the last 12 months, we have generated $2.2 billion of free cash flow.

And we’ve used our strong balance sheet and cash flows to strengthen our portfolio and build on core competencies through a series of acquisitions. Over the past nine months, we’ve allocated $2.5 billion to complete the acquisitions of Bill Me Later, EBA, [inaudible], and most recently G-market. These acquisitions are a natural extension of our two core businesses and the integration of each of these is on track with our internal plans.

Return on invested capital was 23.6% on a trailing 12-month basis. The decline from prior quarters is primarily attributable to our recent acquisitions. While these acquisitions caused some near-term downward pressure on ROIC, we believe they will generate attractive long-term returns for our shareholders.

Now let’s take a closer look at our segment results. Starting with our payments business, PayPal posted another strong quarter and now represents 32% of company-wide revenues, up from 27% last year. Total revenue came in at $669 million, an 11% increase.

Total payment volume was $16.7 billion, an increase of 12%. TPV growth in the U.S. remained stable at 9%, while international TPV accelerated five points to 16% growth, driven by strength in addressable GMV.

In key operating metrics, consumers continue to migrate towards PayPal's key value propositions of convenience and security, as global active accounts increase 20% to $75.4 million.

PayPal continued to increase its penetration of addressable GMV on eBay, which we believe was helped by increased buyer protections. The penetration rate was up almost 8 points from a year ago to 64.4% globally.

PayPal merchant services business posted another strong quarter. Merchant services recorded $9.1 billion of global TPV in the quarter, accounting for 55% of total TPV and representing 26% growth over last year, or 32% on an FX neutral basis. We remain on track to deliver against the ambitious goals that Scott laid out at analyst day for our merchant services business.

PayPal's global take rate was 3.77% in Q2, down 12 bps from a year ago, primarily due to a shift in volume to larger merchants and lower cross-border TPV. Transaction expense was down 8 bps, predominantly due to efficiency gains in transaction costs, a geographic mix shift towards international, which carries lower [card] expense, and a consumer trend away from credit. Transaction margins remain stable at 62% in the quarter.

Let me touch on a few key operating metrics from Bill Me Later. Bill Me Later's gross receivable balance at quarter end was $553 million. We continue to be cautious in our credit approval process in order to manage the quality of new receivables we under-write, which we believe is the right trade-off in the current environment.

Our desire to manage risk in our loan portfolio, coupled with a consumer shift away from credit usage, has caused BML to grow at a slower pace than in last quarter. Net charge-offs as a percentage of receivables increased to 11.1% in the quarter, up 213 bps from Q1. The charge-off rate was impacted by increased write-offs, along with a modest reduction in average receivables. Risk-adjusted margin declined at 10.3%, but remains higher than industry average.

Let’s now move to our marketplaces business -- overall, this business achieved net revenues of $1.3 billion, a 14% decrease from a year ago but an acceleration of four points from Q1.

Transaction revenue also decreased 14% while marketing services declined by 10%.

Our international business accounted for 57% of marketplace’s revenue this quarter and revenue on an FX neutral basis was down 5%.

We continue to bring buyers and sellers together in a variety of formats. Our fixed price format continues to grow significantly faster than the overall e-commerce market.

On an FX-neutral basis, fixed price GMV excluding vehicles grew 19%, a 7 point acceleration from Q1 of which G-market contributed 4 points. Auctions GMV excluding vehicles remains under pressure, declining 17% in the quarter but did show a 3 point improvement compared to Q1.

Vehicles GMV declined 25% during the quarter on an FX neutral basis, as this big ticket category continues to be dramatically impacted by the economy.

Let’s turn to marketplaces marketing services, which we view as alternative formats for bringing buyers and sellers together. Our classifieds business continued its strong growth trajectory in Q2 with 19% revenue growth, or 33% on an FX neutral basis. Total global advertising revenue decelerated by 12% due to a continued impact from a weak advertising market lapping our year-ago advertising ramp-up in Europe and refinement in our ad placement strategy.

Consistent with the last few quarters, shopping.com declined due to rules changes made by the major search engines in the third quarter of last year.

Just a couple of quick highlights on operational metrics -- active user growth came in at 2% on a trailing 12-month basis; sold items grew 5.6%, excluding G-market the growth was 2.7%, a 4 point acceleration from last quarter, primarily driven by strength in the U.K., China cross-border trade, Germany, and Korea.

GMV excluding vehicles accelerated by 3 points in the U.S. and by 7 points internationally on an FX neutral basis.

Cross-border trade accounted for 17% of core GMV, flat with the first quarter. In marketplaces, segment margin was 42.5% in Q2, down 130 bps but good cost controls were more than offset by currency impact.

During the quarter, our take rates excluding vehicles, stub hub, and currency was more than a half point lower than a year ago, as we invested in our customers with lower prices, more incentives for our trusted sellers, and investments in our customer experience.

Now let’s turn to our communications business -- Skype posted revenues of $170 million in the second quarter, an increase of 25%. On an FX neutral basis, growth was 43%. Total registered users grew to $481 million, representing an increase of 42%.

Skype-to-Skype minutes increased to more than $25 billion during the quarter, representing 72% growth and Skype out minutes increased 57% to $3 billion.

Skype segment margins continued to expand to 23.6%, up 480 bps.

Now let me touch briefly on ink level operating expense and cash position before I discuss guidance. In Q2, sales and marketing as a percentage of revenue decreased by 80 basis points, largely due to a more efficient online spend and some reallocation to product and contra spend. Product development came in 90 basis points higher than last year, driven by a continued investment in the user experience and our technology platform.

G&A costs increased 30 basis points from last year, predominantly due to deal related costs, FX, and business mix, which were mostly offset by efficiencies in cost controls.

Our provision for transaction loan losses was up 50 bps, caused by the inclusion of BML credit losses.

At analyst day, we talked about operating smarter and more efficiently in order to free up capacity to invest in technology, our user experience, and the expansion of buyer production programs for our customers. As John mentioned, we laid out our plans to reduce our cost structure by $2 billion over the next three years to reinvest back into better serving our customers.

Since the fourth quarter of 2008, we’ve continued to focus on specific initiatives in the areas of customer experience, marketing, technology, and transaction expenses to drive operational excellence throughout our organization.

We expect these efforts to generate approximately $500 million through 2009, to be reinvested in our customers and our product.

As I mentioned earlier, we generated strong free cash flow during the quarter. Cash and cash equivalents was $2.6 billion at quarter end, of which $2.2 billion was held internationally, despite utilizing more than $1 billion for the G-market acquisition.

Now let me turn to guidance -- we anticipate Q3 revenue of $2.05 billion to $2.15 billion and Q2 non-GAAP EPS of $0.34 to $0.36. The midpoint of our guidance is similar to our Q2 performance on revenue and $0.02 lower on non-GAAP EPS.

We expect modest momentum and easier comps from GMV and TPV, benefits from the G-market acquisition and a modest lift from currency. These factors will be offset by a decline in take rates, softness in our advertising business, and traditional seasonal decline due to our larger international presence.

In addition, we anticipate continued weakness in our vehicles business that will impact our Q3 results.

In summary, we delivered strong second quarter results above the upper end of expectations on both top and bottom line. We generated more than $600 million in free cash flow. The marketplaces business has stabilized and exhibited a slight acceleration in key metric, and PayPal continues its strong growth trajectory.

Going into the second half, we see modest momentum and at the same time, we’ll invest in customers to improve our competitive position.

And with that, Operator, we’d be happy to answer questions.

Question-and-Answer Session


(Operator Instructions) First up in the roster is Christa Quarles with Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

I was wondering if you could -- you didn’t mention the wholesale part of your business as much this quarter. I was wondering if you could just talk a little bit about the progress that you are making there as it relates to buy.com, et cetera and what percentage that is of the total mix? And then if you could also just dig in a little bit also to the margin characteristics of the business as it tends to be lower type margin business. Thanks.

John J. Donahoe

Sure, Christa, let me take that. We talked at our analyst day about the secondary market and that includes both our historical areas of focus of used and hard-to-find but as we said, an increasing amount of our business is on the -- is new items, branded in many cases, but are sort of out of season, or one life cycle old. And a lot of the “wholesalers”, which include retailers, include wholesalers and in some case manufacturers, so in the first half this year, we signed merchants -- you mentioned buy.com, Tiger Direct, Smart Bargains, Argos in the U.K. and the area we are really focusing early on is in our deals of the day because often these merchants want to move a deep SKU, which is they want to move a lot of items quickly. And so we have examples where 6,000 and 7,000 items will sell out in a matter of a couple of hours.

So we are very pleased with the progress on this. These merchants really like the ability to move high volumes of SKU and the margins are good. There’s no material difference in the margins there because they pay a take rate, they have a lower cost to serve and we do a lot of volume.

So I think this is the way of really accentuating an opportunity in the market as more and more new in-season inventory is coming into the secondary market.


Our next question comes from Jeffrey Lindsay at Sanford Bernstein.

Jeffrey Lindsay - Sanford C. Bernstein

Thanks for taking my question. Can I ask two things -- first of all, could you just update us on what moves you are making to upgrade the platform and where we are in that process -- the beginning, the middle or are we well along?

And then secondarily, could I ask Bill Me Later's net charge-off rate is 11.1%, which would be significantly higher than the U.S. credit card average. Could you just update us as to why this is and what actions you would take to manage that, so that you wouldn’t be sort of criticized for, if you will, vendor financing or using BML to appeal to people who’ve got bad credit? Thank you.

John J. Donahoe

Jeffrey, why don’t I take the first one and Bob takes the second -- on your question of upgrading the platform, I’m not sure if you are talking about our search platforms or our third-party platforms that are open to third-party developers but let me just briefly comment on each, because I think there’s nice progress on both.

Our search platform continues to make strong progress. In early July, we completed the infrastructure that will allow cataloging eBay items for search to be scalable a lot easier, and you heard Mark Carr just talk about that at our analyst day. And so we are seeing an increased number of items being cataloged and I think we are well-positioned to make continued advancements in search on the eBay marketplace.

Now in both eBay and in PayPal, we are making progress on opening our platforms up to third-party developers so that others can innovate on top of those platforms and let me just draw your attention to tomorrow, we’ll be announcing that the beta phase for the PayPal platform, which is I think just tremendously exciting because it will be the first global payments platform that is open to third-party developers and you are going to see the beginnings of application innovation done by third-party developers that I think will be analogous to the iPhone. You are going to see PayPal being pulled into more and more situations and more and more applications where payment is necessary and I think it’s going to absolutely accelerate the pace and direction of innovation of PayPal, so we are very excited about that.

Robert H. Swan

On your question about BML, a couple of things -- on just the losses in general, the trend, they are going up, similar to what you’ve seen across other consumer loan portfolios and they are -- our losses are a bit higher and really the reason is two-fold, and it relates less to the losses and more to the denominator. First, BML's loan portfolio has tendency to turn more rapidly than other traditional loan portfolios so our average balance at any one point in time is likely going to be lower for that reason.

And for the second reason, we don’t really take transferred loan portfolios into BML's portfolio, so the denominator doesn’t necessarily get [sway] to that end of periods, so for those two reasons our denominator is usually lower than the competitive offerings.

The metric that we try to watch most in terms of how we look at credit decision and risk, growth and profitability is the risk-adjusted margin and that margin for BML, which I think is a more holistic measure, is one that continues to outperform the industry, although it has been coming down a little bit as we expected during these more turbulent times for consumers.

Jeffrey Lindsay - Sanford C. Bernstein

Thank you.


Our next question comes from Benjamin Schachter at Broadpoint Amtech.

Benjamin Schachter - Broadpoint Amtech

I wonder if you could shed anymore light on the trendline and the PayPal margin, when we can expect that to potentially turn positive and if there was any change to the long-term target for PayPal margins. Thanks.

Robert H. Swan

Ben, so just overall, PayPal's margins declined by almost 3.5 points in the quarter and it was solely due to the acquisition of Bill Me Later. So we expect that over time, that Bill Me Later will help us expand PayPal's operating margins.

If I separate out Bill Me Later for a second, what PayPal margins were flat year over year and I would characterize as great productivity from operating leverage and from improvements in transaction expense, more than offset almost 200 bps impact from currency translation.

So the underlying fundamentals of the PayPal business have resulted in expanding operating margins but they’ve been weighed down by just the stronger dollar year over year and by what we would characterize as short-term impact of BML dilution that will be accretive to margins over the long haul.

John J. Donahoe

And what we set out at analyst day, those margin expectations still hold.

Benjamin Schachter - Broadpoint Amtech

Okay, thanks.


Our next question comes from Imran Khan at J.P. Morgan.

Imran Khan - J.P. Morgan

Thank you for taking my questions -- questions on PayPal. You know, I think right now you have roughly 64.4% penetration on eBay for PayPal. How should we think about PayPal’s penetration on eBay?

And secondly, similar to that line, PayPal's on-eBay growth rate was 4% on local currency -- how should we think about PayPal on eBay growth rate over the next couple of quarters? Thank you.

John J. Donahoe

Imran, on PayPal, the penetration on eBay, as I mentioned we are -- we put real renewed focus on this because we think it offers a safer experience for buyers and a better experience for sellers. And the 64%, as I mentioned earlier, is up 8 points year over year.

What Scott laid out at our analyst day is we think we can get to somewhere between 73% to 79% over the next couple of years and that’s driven largely by penetrating countries like Europe, or like, I’m sorry, like Germany where we have a lot of progress. We’re making nice progress in France and Italy, so -- and we’ll top out our progress I think in the U.S. and U.K. and Australia, the English speaking countries. So the nice thing about PayPal is it’s got real global momentum and it’s -- we think there’s still, as I said, 10, 15 points locked.

And then your second question, Imran, remind me again?

Imran Khan - J.P. Morgan

Just about the growth rate of on eBay -- you know, it seems like the last couple, three quarters the growth rate was mid- to low-single-digits on eBay and so how should we think about the growth rate on eBay for PayPal?

It’s relatively straightforward, which is the foundation is the eBay GMV growth rate and particularly non-vehicles in GMV growth rate and Laurie and her team are doing a very nice job, as I mentioned earlier, I think stabilizing that business and taking the actions we need to get that business in strong and healthy shape.

And then you simply have to add to that PayPal's penetration on eBay and so the reason PayPal's on-eBay growth rate is higher than our addressable GMV is simply just penetration and as I mentioned earlier, we think there is still 10 to 15 points of penetration left.

Robert H. Swan

Imran, if I could elaborate a little bit, as Scott indicated a couple months back at analyst day, we believe that we are going to be able to double this business, the PayPal business, over the next three years and he kind of laid out three components that was going to drive that growth.

The on eBay growth, we said that we had assumed it was in the low-single-digits over the next three years, which as John indicated is a function of increased protections -- I’m sorry, increased penetration because we continue to leverage our fraud models to increased protections on eBay without really increasing our fraud losses on PayPal -- that’s enabled us to get more protection.

And we’ve assumed a relatively low growth in eBay and by going from 58% penetration last year up to roughly 75% in 2011, eBay would contribute a good chunk of growth to PayPal.

But the PayPal growth platform over the next three years we said is going to primarily be from merchant services growth and we said it would grow at 30% CAGR over the next three years and the first quarter we grew by 34% in a very tough environment globally. In the second quarter, as John indicated earlier, merchant services grew by 32% and in my commentary on guidance for the third quarter, we said we expected modest momentum in TPV in the third quarter, a reflection of what we experienced in Q2 but also easier comps as we go into the second half of the year.

Imran Khan - J.P. Morgan

Great. Thank you.


Our next question comes from Scott Devitt at Morgan Stanley.

Scott Devitt - Stifel Nicolaus

Thank you. I have two, please. It looks like you’ve done a good job of repairing the core marketplace business and I was just wondering as you continue to improve the experience on the marketplace, how you are thinking about segment margin in that business over the long-term?

And then secondly, as it relates to G-market, it looks like you included the full quarter GMV but then just the last two weeks in terms of the income statement, so correct me if that’s wrong.

But if that’s correct, on slide 14 of your deck, if you could just tell me which of the -- if it was international non-vehicle GMV that was down 1% ex G-market or if that’s the total global number? Thanks.

John J. Donahoe

Sure, Scott. Why don’t I take the first and Bob will take the second -- as you mentioned, we feel good about the progress we made in the core marketplace business in the second quarter, and I think Laurie and her team are doing a nice job of steady progress in addressing the fundamentals of that business. And the user metrics and the customer metrics are showing signs of improvement.

With respect to the segment margin, I’ll just go to what we talked about at our analyst day and we gave a fairly wide range -- we said we thought the business would be between $5 billion and $7 billion in 2011 and 35% to 45% margins. And what’s behind that is simply a commitment to do what it takes to succeed in that business, and our Q2 margins, Bob can talk a little bit about but they -- on an apples-to-apples basis, on the core, we are holding those. They were impacted by advertising and some other areas but we are aggressively pushing on the turnaround and we’ll do what it takes to get that business in the right place and thus far, we’ve been able to fund any investment through productivity.

Robert H. Swan

And Scott, relative to just G-market, as you know we closed the transaction mid-June, contributed about $10 million in revenue. We only included in both GMV and revenue the results for the last whatever it was, 17 or 18 days, 18 days in the quarter, so it’s just since it’s been part of the portfolio.

If I could, just a little bit more about the deal -- you know, Laurie and the team closed it mid-June, a unique opportunity to combine the two leading players in the fifth largest market, e-commerce market in the world. Laurie and I were over there a week ago and I tell you, we couldn’t feel better about what those two teams who have been vicious competitors for a long time, how they are integrating, leveraging each others’ capabilities to build a stronger business together than either of them could be on their own in the Korean market, and I would just reiterate that we believe that this transaction will be accretive to our performance in 2009.

So the combination is off -- relatively early off to a good start, stronger together and leveraging each other to drive synergies in the business.


Our next question comes from Mark Mahaney from Citi.

Mark Mahaney - Citi

Thanks. Back on the marketplace business, almost all of the metrics here did show positive momentum from Q1 to Q2, so I wanted to ask, is there anything you are seeing overall in e-commerce that suggests that we’ve seen things actually get better, not stabilize or bottom but actually get better in e-commerce? Or do you believe with the pretty broad view that you have that’s just eBay's platform that’s seeing that? Thank you.

John J. Donahoe

Yeah, Mark, you know -- here’s what we see across all of our platforms, and I’ll use that as a proxy for e-commerce, this is across eBay and PayPal platforms on and off eBay. We said in our Q1 earnings call that after several months of decline in mid-February, we saw things stabilized and they stayed more or less at that rate throughout Q2 at that stable rate, although we did see a relatively modest pick-up during the second half of June, where it kind of moved up across all platforms and then it sort of stayed at that level.

So I would say that the market, as best we can tell, is stable and as I said, we saw some modest improvement in the second half in June.

Then within our eBay business, again as I said, we feel very good. This is a multi-year process. If -- second quarter were slightly easier comps -- that said, you know, I look at three outcome-based metrics on the marketplaces -- net promoter score, sold items, and market share. And our net promoter score, which is a measure or really customer sentiment, our seller MTS had some very positive progress in Q2, so sellers are beginning to I think respond to the changes we’ve made. And our top buyer MTS also went up nicely, so I think buyers are also seeing the benefits of some changes.

As Bob mentioned, our successful items, which is really the velocity on eBay, made progress in Q2. The reason I think that’s important is in a tough economy, ASPs are coming down and people are trading down, so one of the health metrics we are very focused on is velocity and successful items were up almost -- up to almost 3% growth before adding the affect of G-market.

And then our market share, we’re still not growing as fast as the market in at least two of the three major markets and that’s what we are focused on making changes to so that we catch that in the next couple of years.

So I think the early indicators are strong. That said, we have a lot of work to do. This is going to be a process of I think steady, consistent progress.

Mark Mahaney - Citi

Thanks for the detail.

Robert H. Swan

If I were to try to, relative to the external data that we do have, I think ComScore Q1 to Q2 here in the U.S. saw about a one point improvement and our results had about a three point improvement. Now, our expectation when the U.S. census data comes out is the acceleration from Q1 to Q2 will be a little bit better. But I would say we are in line, maybe a little better here in the U.S.

Geographically, we highlighted a seven point improvement quarter over quarter and there we don’t have as good external data but I think that acceleration outside the U.S. was pretty strong. We feel pretty good about it.

Mark Mahaney - Citi

Thank you, Bob.


Our next question comes from James Mitchell with Goldman Sachs.

James Mitchell - Goldman Sachs

Great. Thank you very much for taking the question. You mentioned that unit sales improved in the United Kingdom, Germany, Korea, and I think China cross-border. Can you discuss those markets improving sooner than the United States due to local economic conditions or due to local competitive conditions?

And then separately on PayPal, I think you mentioned that consumers were turning away from funding with credit cards, which is good for you. Is that consumer shift in response to the macroeconomic environment or is it in response to eBay initiatives?

John J. Donahoe

I’ll try to take the first and I’m sure I won't remember all of it, but if I do market by market, James, China I think is a combination of two things. Yeah, it was cross-border trade in China -- a combination of two things; one, more feet on the street and identifying great selection, great deals out of China and getting them listed on the site. And secondly, just currencies around the globe, net effect wants to put more demand on great deals in China.

So that’s what is driving China cross-border trade -- I think a combination of steps we’re taking and a combination of relative attractiveness vis-à-vis currencies.

In the U.K., I’m going to put it in the I don’t know category in terms of what the economy is in the U.K. trendwise vis-à-vis where we see other things in the world. I think we are still trying to understand that.

Robert H. Swan

But the Pound -- I mean, the U.K., if you take the first half of the year in aggregate, the Pound was quite strong.

John J. Donahoe

I think in Korea, it’s a combination of two things -- I think the economy in the second quarter is a bit stronger than the first and I think these two teams, IAC and G-market, continue to execute very well and individually gaining share, so I think in Korea it’s a combination of both those things.

Robert H. Swan

And then on your second question, James, as much as Scott Thompson and his team would love to take credit for brilliant execution on the PayPal initiatives, I think even they would have to say that a good part of the funding mix shift is simply more a macro movement away from credit toward debit, which it almost doesn’t matter what is causing it. I think in this case it’s a movement that’s likely to continue for some period of time and certainly one that benefits our business.


Our next question comes from Douglas Anmuth from Barclays Capital.

Douglas Anmuth - Barclays Capital

Thanks for taking my question. A couple of things on the marketplace business -- first if you could comment on the early impact of multi-SKU listings. I know it hasn’t been in place for that long -- I would be curious to get your interpretations there so far.

And then also, if you could comment on how free shipping is holding up after the end of the double final value fee discounts and then when you expect to launch more of a broader marketing campaign around the marketplace business? Thanks.

John J. Donahoe

Sure, Doug. On multi-SKU, as you said, it’s still very early. It’s only gone in for a couple of weeks, but for those that have done it, particularly in the shoes category, very positive feedback because it simply makes selling more efficient and it makes buying easier. So we are excited about it and early feedback has been quite positive.

Free shipping -- free shipping has basically held up because in many ways, all we did was to use a carrot to make our sellers aware of how much buyers were responding to free shipping. And now our sellers are aware of it and they will respond and they are responding, so in certain categories it’s essential and it makes a big difference. In other categories, it makes less of a difference and we will do what we usually do, is we’ll let the market, you know, we’ll let the marketplace determine the right level of free shipping by category and sellers will respond to what buyers do.

So we haven’t seen any real material move since we’ve taken away the incentive because sellers do what is rational.

And lastly, marketing -- you know, we’ll do in Q4 like we have the last couple of Q4s, is do what we need to to support our sellers to be successful. A couple of years ago that was TV advertising, last year we used coupons and we’ll make the decision going into Q4 about what elements of the marketing mix we’ll do to support our sellers during the holiday season.

One thing I mentioned earlier is we will continue to do a fair amount on the loyalty programs, because we think that we saw a nice traction on.


Our next question comes from Justin Post at Merrill Lynch.

Justin Post - Merrill Lynch

Thank you. I was wondering if you could talk a little bit about the planned marketplace improvement announcements for the back half. Obviously you’ve contemplated that into your guidance but is there any magnitude in there in your guidance -- you know, are those going to be big changes we should think about?

And then maybe you could just talk about sequential revenues -- I think you said G-market will help you $50 million. Are there any other abnormal things as we think about second quarter to third quarter -- are you a little bit cautious on back-to-school or do you think back-to-school season could be good for eBay? Thank you.

John J. Donahoe

Justin, let me comment on the first and Bob on the second -- as I mentioned, we are making the second half announcements next week to our sellers. The short answer to your question is any impact was reflected in our guidance.

I will make an editorial comment -- one of the things we have gotten better at is not surprising our sellers with a set of constant changes, and so as you know, we are only making two sets of changes a year and we have pre-wired or previewed these changes with several sellers and gotten good feedback and you’ll hear things around rolling out our resolution, buyers resolution process and rolling out multi-SKU and a variety of other things that will be announced on Monday, and the impact has been reflected in our guidance.

Robert H. Swan

And Justin, just in terms of the Q2, Q3 dynamics, which are I broaden [would be] kind of first half to second half dynamics and not dramatically different than what we flagged last time, I think on the positive side as we indicated, we see modest momentum on GMV and TPV through Q2, continuing into Q3, and comps being easier.

Secondly, we do see a weaker dollar exiting the quarter than we did entering the quarter and that will be a modest plus.

And third, you know, two weeks of G-market in Q2 results and a full quarter in Q2 results, so all three of those things will work for us.

The things that will work against us are we do expect our take rate on the core eBay platform to continue to come down. We are expecting continued softness in advertising in the second half vis-à-vis the first half. And then the third, just more Q3 is just seasonal dynamics with our big international, particularly European business will work against us. So those are the plus and minus dynamics that we see going from Q2 into Q3 and the take rate in advertising things we expect to be second half kind of trends.

Mark Rowen

Operator, we have time for one more question.


All right, that will come from Steve Weinstein at Pacific Crest.

Steve Weinstein - Pacific Crest Securities

Great. Thanks a lot. You know, when you were trying to originally do the G-market deal, you had to make certain concessions with the government there I guess to get the deal done. I’m wondering, now that you are into it, can you just highlight -- see the real synergies and opportunities to maximize the benefits of really pretty much kind of controlling the marketplace there?

John J. Donahoe

In terms of -- with the KFTC, given the strength of each of the individual businesses, the primary concession we made is we would not take -- we would not increase take rates, and I think it was for a two-year period, although I don’t exactly remember.

In terms of where we see the synergies, first it’s a heavy discount market where both companies used coupons to vigorously compete against one another. We believe that less coupon on contra related expenditures will require for us to compete and grow in the market.

Secondly, from a cost perspective, processing fees, bank related fees are a big component of both businesses’ P&L.

Third, customer service is a big component of both businesses’ P&L and combined we get more leverage on both of those cost elements.

And last, just back office functions -- we see a significant opportunity from a back office perspective to eliminate some of the redundancies that exist between the two businesses.

So there’s less spending to compete directly against each other and then secondly, more leveraging scale to get more efficient spend with our partners and with some internal maneuvering.

Steve Weinstein - Pacific Crest Securities

Okay. Thank you.

Mark Rowen

Thank you, everybody, for joining us. We’ll see you next time around.


Once again, ladies and gentlemen, that will conclude the conference call. Thanks for joining us. Have a good day.

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