Sell-Side Reaction to eBay Earnings -- Scott Devitt (EBAY)

| About: eBay Inc. (EBAY)
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scott devittFrom Stifel Nicolaus analyst Scott Devitt's note to clients on eBay Inc.'s (NASDAQ:EBAY) earnings (see also the eBay conference call transcript) Wednesday night:

In-Line Quarter, Guidance Light (again); Maintain Buy

• We continue to rate eBay shares Buy. We are lowering our 12-month target price to $45 as we are beginning to believe the company's conservative guidance. Our target valuation of 35x 2007 cash earnings equates to a 1.4x PEG ratio on eBay's three-year anticipated FCF growth of 25%, in line with the S&P 500 multiple of growth.

• eBay reported first quarter gross merchandise value of $12.5 billion, net revenues of $1.39 billion, and cash EPS of $0.24. We were expecting net revenues of $1.355 billion and cash EPS of $0.23.

• In the quarter, listings grew by 33%, gross merchandise value by 18%, revenue by 35%, and sales and marketing accounted for 29% of revenue. In the prior quarter, the same metrics were 35%, 22%, 42%, and 28%, respectively.

• Management's guidance for 2006 is for revenues to be between $5.7 billion to $5.9 billion, with GAAP diluted EPS range between $0.65 and $0.71, with pro forma EPS between $0.96 and $1.01, unchanged from last quarter's guidance.

• Our 2006 and 2007 EPS estimates remain unchanged at $1.02, and $1.27, respectively. Our 2006 revenue estimate has decreased slightly to $5.95 billion from $5.96 billion.

Our Thoughts

In early February eBay modified the display of its search results to more prominently display fixed price (eBay Stores) listings. The company recently announced that it was rolling back the changes in the domestic market as the impact had not been as anticipated. We were aware of the change and the rollback and chose to ignore it heading into 1Q06 results as we did not believe it would have a material impact on the marketplace. As it turns out, the modification was relevant to reported results although it was not the only story of the quarter. The rollback occurred only in the domestic market, a market in which eBay grew annually at a quite respectable rate of 24% (excluding Shopping.com). We were actually quite happy with the U.S results in the quarter even with the search issues but for us the international market is where the rest of the story resides.

In the quarter, the number of eBay Stores grew by an astounding 27% sequentially to 486,000 stores worldwide. The Stores growth domestically was 17% and internationally the growth was 40%, in a quarter in which international transaction revenue growth slowed from 35% to 25%. In the quarter, 68,000 Stores were added in international markets while 35,000 were added domestically. With this growth, now 49% of transaction revenue comes from overseas and 49% of Stores reside overseas. eBay Stores is particularly relevant this quarter because of the search result change favoring Stores and the coming launch of eBay Express. Given that the rollback occurred domestically while two-thirds of the Stores growth came internationally is still a bit confusing to us. We know that eBay is facing increased competition in Korea and we also know that the UK growth slowed in the quarter. We cannot point to any particular country that would have been responsible for disproportionate Stores growth but we believe, if there is a pricing incentive driving the Stores activity, eBay should act to close it with a price adjustment. International to us is more important than domestic and the international Stores growth is more important than the rollback in the U.S., in our opinion.

We believe eBay shares will be choppy throughout the second quarter, with the launch of eBay Express, the rollback impacts, the international story, and analyst day, being the drivers of share moves. As an investment in a business, we view the eBay franchise as a dominant global brand with two well-protected core businesses, eBay and PayPal, and another building nicely in Skype. The days of unlimited stock upside and earnings outperformance are behind the company but we think the merits of the investment still exist for long-term investors. In our view, over the next three-to-five years we believe earnings for eBay will grow at a faster rate than its market valuation (a belief we have with all large cap Internet names), allowing for some amount of multiple compression, and we continue to be opportunistic buyers within this framework.

1Q06

eBay reported 1Q06 quarter results that were slightly ahead of our revenue expectations and our bottom line expectations. eBay reported first quarter gross merchandise value of $12.5 billion, net revenues of $1.390 billion, transaction revenue of $1.354 billion, and cash EPS of $0.24. We were expecting net revenues of $1.355 billion, and cash EPS of $0.23. Free cash flow for the quarter was $450.6 million.

Gross profit (GAAP) was $1.112 billion, or 80% of net revenues, lower than the 82% reported in 1Q05. Gross profit would have been $1.121 billion in the quarter, excluding expensing for stock comp, or 81% of net revenues. The decline in gross profit was due to the inclusion of telecommunications costs related to Skype.

Consolidated net revenues in 1Q, which showed growth of 35% year/year, was negatively impacted by foreign currency translation of approximately $50.2 million in this quarter as compared to 1Q05. On a sequential basis, consolidated net revenues was positively impacted by foreign currency translation in 1Q06 by approximately $8.3 million. Continued strong consolidated net revenues growth is attributed primarily to the results of marketplaces and PayPal.

The GAAP effective tax rate for 1Q06 was 29% (pro forma 28%), unchanged from the previous quarter but up slightly from the 28% level in the year-ago quarter. The higher tax rate for 1Q06 as compared to 1Q05 results primarily from changes in the company's geographic mix.

At the end of the March quarter, the company had approximately $3.5 billion in aggregate cash and investments.

Growth Rates

U.S. transaction revenue growth rate was 30% year-over-year down from 39% last quarter. Fixed price trading contributed 34%, or $4.3 billion of total GMV, driven primarily from eBay's "Buy It Now" feature. International growth decelerated to 25% year-over-year from 35% last quarter. Finally, payment revenue growth rate was 44% year-over-year down from 49% in the last quarter.

Shopping.com also performed well in 1Q. Traffic was strong, which led to 33% year-over-year growth in clicks to merchants, including continued traction in eBay's international markets.

Skype Performance

Communications revenue, consisting of the newly acquired Skype Technologies, was $35.2 million from the acquisition date of October 14, 2005 through the end of the quarter generating 23% sequential revenue growth. Management noted that Skype is adding new users at record pace at more than 220,000 per day and finished 1Q with more than 94.6 million users, up 76% since the acquisition. Approximately 87% of communications revenue is derived internationally.

In China, nearly 25% of eBay's listings already include Skype.

Domestic

U.S. marketplaces net revenues totaled $527.2 million, showing 30% year/year growth. In the U.S., strong user activity led to record GMV of more than $6.2 billion, the first time the U.S. marketplace has surpassed the $6 billion mark in a single quarter

Additionally, the growth of eBay stores also contributed to increased trade on the site. eBay had a record 247,000 stores in the U.S., and now has 486,000 stores worldwide.

International

International marketplaces net revenues were $493 million in the quarter, showing 25% year/year growth. Excluding the impact of foreign exchange rate fluctuation, net revenues would have increased 32% year/year. Excluding the impact of foreign exchange, international GMV grew 26% versus 1Q05.

eBay U.K. added more than 1 million new users to surpass 15 million for the first time. eBay Germany also reached a new milestone, ending the quarter with more than 20 million registered users. eBay France and eBay Italy continued to be the fastest-growing sites in terms of GMV.

On a year-over-year basis, eBay Australia grew new listings by more than 55%, contributing to GMV growth of more than 60%. Internet Auction Company, eBay's business in Korea, topped 16 million registered users in 1Q with record listings growth and strong GMV. In China, eBay EachNet added 2.3 million new users, more than any market outside the United States, to reach a total of 20.3 million users. eBay India surpassed the 2 million user mark and listings jumped threefold from the year-ago quarter.

PayPal

Payments net revenues totaled $335.1 million in the quarter, up 44%, or 47% excluding the impact of foreign exchange movements. PayPal had 105.0 million accounts in total at the end of the quarter, up 47% from the same period last year, with 29.2 million active accounts. The transaction processing expense rate in the quarter was 1.04%, while the transaction loss rate was 0.29%. Total payment volume was $8.769 billion in the quarter, up by roughly 41% year/year. PayPal's fastest-growing segment, merchant services, generated 2.9 billion in TPV, up 59% year over year.

In France, Italy, Germany, and Australia, eBay saw triple-digit TPV growth year over year. Auctions accounted for 67% of total payment volume. In the eBay marketplaces business, 1Q addressable GMV penetration in eBay's two largest markets, the U.S. and U.K., penetration rates grew to 78.8% and 69.1% in the quarter. In Canada, the penetration reached 82.7%.

Business Metrics

Gross merchandise volume (GMV) for 1Q06 expanded 18% versus the year ago quarter to $12.5 billion. Excluding the impact of foreign currency translation, 1Q06 GMV increased 22% year over year.

Other important metrics in the quarter included:
• confirmed registered users are now 192.9 million, up 31%;
• active users increased to 75.4 million, up 25%;
• non-store listings increased 23% to 490.8 million;
• store listings grew to 84.6 million, up 164%;
• new listings in the quarter reached 575 million, representing year-over-year growth of 33%;
• total payment accounts of 105 million, up 47%;
• total number of payments of $149.2 billion, up 35%;
• Skype had 94.6 million total registered users;
• eBay Stores totaled 486,000 stores worldwide, with 247,000 in the U.S.

Category Performance

eBay has thirteen categories that delivered $1 billion or more in worldwide annualized GMV- eBay Motors at $14.8 billion; Clothing & Accessories at $3.9 billion; Consumer Electronics at $3.9 billion; Computers at $3.6 billion; Books/Movies/Music at $3.0 billion; Home & Garden at $2.9 billion; Sports at $2.3 billion; Collectibles at $2.5 billion; Jewelry & Watches at $1.7 billion; Business & Industrial at $1.9 billion; Toys at $1.9 billion; Cameras & Photo at $1.4 billion; and Antiques and Art at $1.2 billion.

Outlook and Summary

Management's guidance for 2006 is for revenues to be between $5.7 billion to $5.9 billion, with GAAP diluted EPS range between $0.65 and $0.71, with pro forma EPS between $0.96 and $1.01. Revenue guidance for the second quarter of 2006 is for approximately $1.37 billion to $1.415 billion, with pro forma diluted EPS estimates of $0.22 to $0.23. Management noted that the company is on track to achieve its full year revenue guidance of approximately $200 million for Skype.

Our 2006 and 2007 EPS estimates remain unchanged at $1.02, and $1.27, respectively. Our 2006 revenue estimate has decreased slightly to $5.950 billion. from $5.96 billion.

We continue to rate shares of EBAY Buy. We are lowering our 12-month target price to $45 as we are beginning to believe the company's conservative guidance. Our target valuations equates to a 1.4x on eBay's three-year anticipated FCF growth of 25%, in line with the S&P 500.