Time to Bid On: eBay [Barrons]
The online auction colossus is expanding briskly and eyeing some big opportunities. With the stock down 35% this year, a nice rebound could be in store.
By ERIC J. SAVITZ
LAST WEEK, EBAY HIT THE BID. In a deal designed to boost the online auction giant's flagging domestic growth rate, eBay agreed to pay $620 million in cash to acquire Shopping.com, which operates an online shopping-comparison service.
It was the latest in a series of moves that have dramatically expanded eBay beyond its original business of providing an online auction market for collectibles. Via its 2002 acquisition of PayPal, for instance, eBay became a key provider of online payment services, competing with the credit-card companies. Through other acquisitions, eBay has expanded aggressively overseas, and now gets half of its revenues outside the U.S.
To reach buyers uncomfortable with auctions, eBay added a wildly popular feature called "Buy It Now" that enables fixed-price transactions. To make the site more attractive for sellers with large inventories of slow-moving goods, the company added eBay Stores. To gain a foothold in the real-estate market, it acquired rental-listings firm Rent.com. And, to explore the market for local services, eBay took a 25% stake in Craigslist, a massive electronic bulletin board, and launched an expanding network of local-market classified-advertising sites called Kijiji, which now operates sites in more than 90 cities in nine countries.
Put it all together, and eBay has become the world's most important e-commerce company. It's also a company the stock market has become extraordinarily worried about -- and therein lies an investment opportunity.
Since the end of December, eBay shares (ticker: EBAY) have tumbled about 35%, falling to $38 from $58, in the process slicing the company's market capitalization by about $27 billion. To put that loss in perspective, it is considerably more than the entire valuation of Costco Wholesale, and close to twice the valuation of Amazon.com. And the situation recently looked even worse: In late April, the stock flirted with 30, the lowest level in 18 months.
The obvious question is, what the heck happened? And the simple answer is, a lot. Investors fretted when eBay's chief executive officer, Meg Whitman, interviewed for the top job at Disney. They grumbled when eBay sellers staged a mini-revolt over auction-fee increases, causing tremors in the company's closely watched auction-listings count. They complained when eBay announced plans to boost spending by an extra $100 million this year -- spending that comes right out of the bottom line -- to bolster expansion in China. Most significant, investors have begun to wonder whether eBay's best growth may now be behind it in its most important markets, the U.S. and Germany.
The grousing may well have gone too far. Although eBay has clearly been facing challenges, it's taking firm steps to address them and keep the streak alive. If it succeeds, the stock could easily climb 20%.
SOME OF THE PROBLEMS ALREADY ARE FADING. Whitman didn't move to Disney, of course, and now swears she isn't going anywhere. "Disney is the only company I would even have considered leaving eBay for," Whitman explained late last month in a presentation at a Goldman Sachs Internet conference in Las Vegas. "A number of their board members came after me hard, and I will tell you frankly I was flattered. I went down, spent an afternoon. Within a few days, I decided I was better off staying at eBay, that this was the place I need to be."
Meanwhile, eBay has confessed to communications screw-ups on the latest round of price increases, and responded by taking steps to improve relations with sellers. For instance, it has abandoned a hated automated-response system for customer service in favor of actual people. All is apparently forgiven, and the listings count is growing robustly again.
Those issues, however, pale in comparison with the biggest one holding down eBay shares: slowing growth. "About 95% of the investor concern is around the growth rate," says Heath Terry, an analyst with Credit Suisse First Boston. "For four years post the bubble, eBay defied expectations on how quickly the growth would slow. And then, starting in the September quarter, they started seeing a more normal deceleration."
Now, make no mistake, this remains one of the great growth stocks. The apparently disappointing first-quarter report featured overall revenue growth of 36%, to more than $1 billion. GAAP net income grew 28% in the quarter, to $256 million. The company projects full-year revenue of $4.27 to $4.36 billion, with GAAP per-share earnings of 71 to 73 cents a share.
In the months and years to come, eBay will continue to build its U.S. business, expand the reach of PayPal, gain ground in Europe, increase its presence in Asia and move aggressively into China and India. So the question isn't whether eBay will grow. It can. It will. The question is whether eBay grows fast enough to justify a still-rich earnings multiple, now about 38 times expected earnings for 2006 of about $1 a share.
The key is the U.S. In the March quarter, domestic revenues ex-PayPal increased by a slightly disappointing 19%. There are fears eBay might actually be losing a little of its big share of the overall domestic e-commerce pie -- the total market likely grew faster than 19% in the quarter -- perhaps to sellers using targeted ads on search engines.
But as it happens, there is evidence things have since improved. Mary Meeker, Internet analyst at Morgan Stanley, reports that so far this quarter, eBay's U.S. auction listings are up about 23% over the same period last year. Other analysts have made similar observations and goosed their earnings estimates to reflect improving fundamentals.
Meeker thinks eBay's top-line growth could accelerate next year, as the company continues to see strong revenue growth from both PayPal and most of the company's international markets. The domestic market should keep growing, too: Whitman has said repeatedly that eBay's U.S. growth can continue to exceed that for domestic e-commerce overall, which increased 24% in 2004 and should rise similarly this year.
In an interview on Memorial Day, eBay Chief Financial Officer Rajiv Dutta asserted that the domestic-growth story remains intact. The U.S. "will remain the largest contributor to growth in dollar terms for this year and the next several years," he says. "It may not have the highest percentage growth, but it will still account for most of the growth. The U.S. business still has lots of running room."
For one thing, Dutta notes that only about 5% of overall commerce is conducted online. Of that slice, about a quarter is conducted on eBay. "We can grow even without any share gains," he says. "I believe quite strongly that the 95% of commerce happening offline will move online quite rapidly." He notes, by way of comparison, that catalog sales account for about 10% to 12% of total domestic commerce, and that the buying experience is better online. The upshot: he thinks online sales could end up exceeding catalog sales. "We're in the very early innings of a very long-term secular trend," he says.
Dutta certainly sees no evidence of market saturation. Of the 50,000 or so merchandise categories in which eBay participates, the company accounts for no more than 6% to 7% of overall trade in any single category, he says. That's even true in niches ideally suited for eBay -- easy-to-ship goods with high average price points, like stamps and coins. In eBay Motors, where cars, boats and even planes are sold, the company has less than 1% of the market, he says. "And in auto parts, which should be a sweet spot, it's even less," Dutta says.
"When we compare the addressable market relative to the market opportunity that should be out there, we have a long, long way to go," he says. "We feel more confident now than we did two to three years ago."
The domestic-growth strategy involves several elements, some of which are reflected in the acquisition of Shopping.com (SHOP). EBay plans to integrate its listings into Shopping.com, which generates revenue from companies that pay to have product information included on the site, as a way for eBay's sellers to reach more potential buyers. In particular, the deal should give eBay a way to increase sales of current-run, in-season merchandise; the core eBay site continues to be strongest with unique goods, or end-of-run and close-out products. The expanded lineup could help reach the 40% of online shoppers who have yet to transact business on eBay.
WHITMAN SAYS THE COMPANY is equally focused on increasing "wallet share" among current buyers. For example, it has been quietly tweaking its Website: eBay's search function has been fine-tuned to make it easier to look for very specific merchandise. Search for U2 tickets in Chicago, and you get listings back for U2 tickets in Chicago -- not ads for other related merchandise.
Another initiative, Dutta says, will be to close the gap "between safety and trust" on the site. While Dutta contends eBay is a "remarkably safe" place to buy and sell goods, he concedes that many shoppers still feel less secure on eBay than they do on a more traditional retail site like Amazon.com or Walmart.com. Dutta contends that PayPal, which lets people send and receive secure payments by e-mail, can help with its buyer-protection program for merchandise valued at up to $1,000. At the Goldman conference, Whitman pledged to "dial up" marketing around the issue.
Meanwhile, slowing growth in Germany has eBay executives frustrated, particularly given the historic success the company has had in that country. In Germany, eBay has become synonymous with e-commerce, with a 35% share of online commerce, exceeding even the roughly 25% share in the U.S. Whitman noted in Las Vegas that eBay was recently voted the best corporate brand in Germany, ahead of German icons like BMW, Volkswagen and Lufthansa. "We're even more ubiquitous in Germany than we are here," Whitman said. "We can re-accelerate our growth with innovation."
Dutta says eBay has been disappointed by the weak results in Germany of eBay Motors. He notes that the used-car market is far more fragmented in Germany than it is in the U.S., which he says should have given eBay an opportunity to consolidate the market. But it hasn't worked that way. One new policy change that could help: the installation of a reserve, or minimum, prices for auctions. Previously, sellers were vulnerable to low-ball bids from single bidders.
THE COMBINATION OF the promise and uncertainty of eBay's position in China provides the biggest wild card in trying to forecast eBay's long-term growth. To state the obvious, it's a huge potential market that has barely started growing: Bob Peck, the Internet analyst at Bear Stearns, figures there are about 300 million middle-class Chinese, a market larger than the entire U.S. population. Dutta says the overall e-commerce market in China will be larger than the German market in two years, and will exceed Japan in two or three years.
The problem is, while China could be huge for eBay, it also could be a zero. Investors haven't forgotten that eBay had its biggest failure in Asia, when it tried but failed to make a dent in Japan, where the online auction market is controlled by Yahoo! Japan. EBay exited Japan in 2002. And as it did in Japan, eBay now faces a serious competitor in China, this time from a site called Taobao.com, owned by the business-to-business e-commerce company Alibaba.com.
Meeker thinks one big advantage eBay has is its connection with the global network of eBay sites. While cross-border transactions now account for about 15% of sales, Meeker thinks the total could climb to 20% to 25%. "The ability to connect to the rest of the world is a powerful idea, in time," she says.
Dutta concedes that eBay's decision to invest $100 million in China this year will have a direct impact on per-share earnings of about 2.5 cents a share. He notes that the investment in China flows through eBay's income statement, rather than its balance sheet: The company is spending money on marketing and software, as opposed to capital goods.
Another wild card for eBay's growth rate will be the ability of PayPal to spread beyond eBay to become a commonly accepted payment mechanism for online commerce. It's making headway. Payment volume grew 44% in the first quarter, while total accounts increased 57% to 71.6 million. There are more PayPal accounts now than there are American Express or Discover accounts.
Bear Stearns' Peck considers PayPal, which already accounts for close to 30% of the company's revenues, to be a hidden gem. He notes that PayPal offers smaller merchants a cheaper payment alternative to accepting major credit cards. PayPal accounts for about 75% of eBay transactions; The question is how much of the overall online-transactions market PayPal can eventually take. "There's no reason, as far as I can tell, that all merchants shouldn't eventually use PayPal," says an analyst at one large institutional investor in the stock. "Over time, there's an opportunity for them to handle a very high percentage of e-commerce sales."
Randy Befumo, an analyst at Legg Mason Capital Management, among the largest investors in the company, thinks strictly looking at eBay's forward price-earnings ratio is a mistake. "Our view is that businesses with sustainable growth, even low-double-digit growth over long periods of time, can appear overvalued in the near term, then actually turn out to be quite cheap," he says.
Befumo notes that while Google seemed expensive to some people at its $85 initial public offering price, the stock turned out to have been a raging bargain, thanks to steadily rising earnings estimates. It now trades at $285. He thinks a similar scenario could play out for eBay, although he points out that managing eBay is a far more subtle task than running most online businesses. "They have to manage a giant global market," he says. "It's very different than just managing a business where one controls all of one's employees and makes them do things."
Anthony Noto, the Internet analyst at Goldman Sachs, says the perception of eBay's growth and profitability prospects tends to ebb and flow over time, as the company navigates through key "choke points" in its expansion, staking out new geographies, new-product categories and new pricing formats. Now that it's headed for expansion in China, the aggressive rollout of PayPal and the acquisition of Shopping.com, among other things, investors are nervous.
Noto, however, thinks the company can continue to grow at least 25% a year, compounded through 2009. For that, he thinks investors should be willing to pay a premium multiple: He thinks the stock price could hit 46 -- or about 45 times next year's profits. And if growth can reach 30% compounded, he figures, the bidding could go even higher.
Either way, the stock looks as cheap as anything you'll find on eBay.
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