eBay (EBAY) – Stock Analysis

Introduction:

eBay while fast gaining grounds as a household name is also the ultimate Internet platform provider and a key player in the three fields of retail, credit, and communications:
  1. Retail: In this space, though they play second fiddle as they are involved only in the secondary market (small retail, liquidation, used, out-of-season, etc.), they cover about 60% of the overall market. The bulk of this business is done through eBay.com. The primary market is controlled by the large retailers.
  2. Credit: PayPal is marketed as the global Internet payment network – the eventual aim is to establish themselves as the de facto online payment process for all transactions conducted between buyers and sellers. Logically this business belonged in the aisle controlled by the large credit-card networks such as Visa, MasterCard, and American Express for whom the infrastructure was already in place. Capitalizing on their inability to accommodate the Internet transaction processing model, PayPal scored perfectly by providing a platform for flexible payments that requires only an email address and password.
  3. Communication: Skype aims for fundamental change by enabling conversations between people using software and Internet. This compares very favorably to the business model of large-cap companies in the communication space that primarily rely on monetizing private networks which are by nature capital-intensive.

The sparkle behind eBay.com is that in spite of their vast presence in the secondary retail space, they carry neither inventory nor compete with other retailers. This essentially exempts them from the capital-intensive nature of the retail business. The platform they provide does ensure a fee from every transaction conducted between buyers and sellers. Their formula for a successful growth business is a reliable platform without any scalability or performance issues and focus on customer satisfaction. The first-mover advantage, especially pronounced in the Internet arena, should help them grow at a steady pace as merchants and buyers increasingly flock to the Internet to tap in the key advantage eBay platform holds over the brick-and-mortar model: World-wide market place access. More than 50% of eBay’s revenue is derived from this business.

PayPal is another remarkable business where eBay repeats its hands-off approach to perfection – a large presence in that sector on the Internet without directly issuing credit. The PayPal platform provides buyers with a PayPal account allowing for payment from their existing bank accounts or credit cards. This spares PayPal from agonizing over issuing credit, managing interest rates, etc and instead streamline by making the platform reliable and increasing customer focus. The business model parallels that of eBay.com in that every transaction between buyers and sellers conducted through a PayPal account adds to their revenue. Likewise, the first-mover advantage should again allow growth at a healthy pace.

Skype sports the biggest addressable market among eBay’s businesses. Though not quite as seasoned as eBay.com and PayPal, it is growing at a faster pace. Minimal capital requirements and customer acquisition costs make for a high-margin business. Skype is very much an independent entity and there is no real synergy compared to eBay’s other businesses. Sell-side analysts of eBay tout this in negative favor.

Business Issues:

Failure to innovate has landed eBay.com in a brutally competitive environment. They completely missed the local market allowing Craigslist to seize monopoly in that space. eBay’s management failed to recognize the immense potential of that market as a gateway into contextual ads – on the outward, transactions are one on one reducing the odds of monetizing and that closed mind-set cost them that market. eBay.com is also subjected to immense pressure from sites specializing in certain areas of the secondary market. A comparison of the number of active listings in one of those specialty sites and the same category within eBay easily demonstrates how short eBay.com comes. For e.g, on comparing the active listing at stampwants.com, a site specializing in philately and the listing with that of eBay category “stamps” it is evident that stampwants.com can easily trump eBay stamps category by a margin of almost 1:2. This fundamental problem can be traced to eBay management not recognizing the intricacy behind the specialized needs of individual categories within eBay and failing to provide a platform geared towards the requirements of that market.

PayPal has a few of strategic issues:
  1. Merchant fees: PayPal charges a flat fee independent of the source of payment. Credit card payments involve a cost to PayPal as they don the guise of a giant merchant, processing transactions on their merchant’s behalf. The fee charged by the credit card company on the transaction volume is borne by PayPal. For payments from a bank account, such a fee is absent. Should an overwhelming number of customers resort to making payments using their credit card instead of using their bank account/PayPal account balance (default), then PayPal earnings dip. Writing is on the wall for that shift since credit cards offer the dual benefit of earning credit card rewards and added protection. PayPal recently announced a rewards program called eBay Bucks for buyers who pay with PayPal. While this is indeed a start, it still skirts the core issue - the rewards program should be dependent on the funding mode.
  2. PayPal Plus: PayPal Plus is PayPal branded credit card. It is a MasterCard issued by GE Money Bank. The benefit of such a branded card is not obvious especially when the credit (GE Money Bank) and the infrastructure (MasterCard) are both provided by partners. The associated rewards program is average – roughly 1% (slightly tiered) as vouchers that can be used for PayPal purchases. Higher incentives need to be in place for purchases at eBay.com to get customers into using this card.
  3. PayPal use outside eBay.com: During 2008, PayPal’s payment volume off eBay equaled volume on eBay. This underscores PayPal’s huge growth potential in the general eCommerce area. eBay needs to be especially aggressive in this area as the risks and rewards are huge.
  4. Bill Me Later: eBay acquired this business in October 2008 marking their entry into the consumer credit business. Their business model is very different compared to the rest of the PayPal and eBay business. The arrangement is indirect – though the credit is funded by CIT bank, the associated risk remains as Bill Me Later purchases the receivable on the consumer loan extended by the bank. It remains to be seen how this purchase will pan out as it is a completely new area, although admittedly, it complements PayPal’ payment platform. The loan portfolio currently stands at around $600M and directly dependent on its movement is the associated risk or reward. This dependency lays bare eBay’s vulnerability to the vagaries of consumer credit environment.
Skype has a very large addressable market, but there is no denying that their playing field is very crowded and dominated by phone companies with deep pockets. The existing infrastructure investments of these companies are immense giving them all the more reason to protect their territory. Skype on the other hand celebrates its low capex spending and high margins. Sooner than later, Skype will hit a brick wall worldwide as the competition offers high loyalty incentives. For Skype to continue growing at the startup pace, they will require a strategy aimed towards building clientele at a rapid pace. As Skype’s business has little or no synergies with the rest of the eBay, eBay has announced the intent of spinning off Skype as an IPO.

Finances:

Below is a table that summarizes eBay’s financial position:


Year200620072008
Revenue5.97B7.67B8.54B
Net Earnings1.125B1.74B1.80B
Shares Outstanding1.425B1.376B1.303B
Earnings per Share0.791.26*1.38
YOY PE Growth11.3%59%9.5%
YOY Revenue Growth33%28.5%11.34%
Net Margin18.8422.6921.08


*Impairment of good will is excluded.

It is obvious from the YOY (year over year) growth rates in the spreadsheet that eBay’s overall business has slowed over the last three years. This is particularly of concern considering the 2.2B spent on acquisitions over that same period. This tallies eBay’s problems with respect to Business Issues discussed. Despite this, cash equivalents (after taking out debt) have remained strong at close to $3B as net margin has remained steady at around the 20% range.

Summary:

eBay has a very strong business model with an exemplary balance sheet. Despite several business hiccups over the years, the fact remains their assets are extremely valuable. Going forward, if management focuses on providing a better platform that addresses both merchant and buyer issues, there is potential for growth in both their primary businesses. Overall, the Skype spin-off is a good strategy as that should allow for Skype to raise capital to invest in acquiring customers into the Skype platform worldwide – a plan sorely in need.

On a valuation basis, eBay has traded at a compelling valuation of just one-time revenue within the last year. It has since bounced back 70% beating the overall market bounce by a wide margin. Even now, the stock trades at under two-times revenue and a PE ratio in the low-teens. This is one of the few technology companies in our watch list and we continue to scout for a good entry point.

2 comments :

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