******OT********
A Tulip investing craze has decended upon the market. I wish I had bought so I could sell tomorrow. How big can a flea market get? I hope some of this action happens to CMPL. At least it is a going business on the net.
NW
THE RAGING BULL'S CYBERSTOCK INVESTOR REPORT
"Your Weekly Internet Stock Newsletter"
November 23, 1998
Editor: Matthew W. Ragas
ragingbull.com
Talk about your favorite Internet stocks with Matt Ragas and
other investors onThe Raging Bull's CyberStock Board-
ragingbull.com
**Special Article by RB Staff Writer**
What Does the Future Really Hold for eBay?
by Timothy J. Mullaney
Rakesh Sood must be crazy. After Goldman Sachs' e-commerce analyst told the
world that eBay Inc. would be worth $150 a share within 18 months (which in
Internet-speak means it went there in 18 minutes), there was a bigger chorus of
"what was he thinking?" than anyplace this side of a Christine Lavin concert.
But was Mr. Sood crazy like a fox? Let's lay things out and see what you
think. A disclaimer first: Goldman was a lead underwriter of eBay's initial
public offering in September, so they could be biased. Now, the numbers:
eBay went public in September, selling 4 million shares (out of about 27
million outstanding) for $18 each. The online flea-market auction company's
market capitalization, based on Friday's close of $147, was $3.9 billion based
on primary shares. Justified? Well, eBay's sales reached a record in the third
quarter - at $12.9 million, with profits of 2 cents a share, or $663,000. If
annual earnings are 8 cents a share, eBay traded at 1875 times earnings. And
that's modest -- NASDAQ's Web site put eBay's earnings at a 3 cents a share
estimate for eBay, and a 4900 multiple. So, naturally, the stock went up $46 on
Monday - on no news. Clearly, it was overdue.
Even in a market like this, multiples like these are fightin' words.
Especially for a company best known for helping people buy and sell Beanie
Babies. You can trade other stuff on eBay's site: on Sunday, there were 973,741
items for sale. Almost 125,000 were toys and Beanies, more than 93,000 were
(mostly used) books, movies and music and 341,128 fell under the catchall of
"collectibles." Most were the kind of cheap stuff found at garage sales (my
favorites: a $10 silver Hanson bracelet and some curved picture of golden
retrievers that's supposed to sit in a corner of a room). Think garage sale,
flea market, or local classifieds: that's eBay's real competition. Sotheby's it
mostly ain't.
So why does Goldman love eBay so? Sood says for two big reasons. Basically,
eBay does for tchotchkes what organized markets do for stocks: bring buyers
and sellers together at almost no cost. This benefits the seller of garage-sale
junk, but adds an even bigger premium for people hawking collectibles that are
actually worth something (like that hotly bid-upon Virginia Woolf first edition
on eBay last weekend) because people interested in such things tend to be
spread out geographically. Sood says Americans spent $100 billion on
collectibles last year bought from other consumers, and he says the online
portion of that market could reach $3.8 billion annually by 2001. And eBay
claims to have 89 percent of that market.
If the market does grow as Sood expects, and eBay comes close to holding its
share, then he says it's all gravy because of eBay's business model. Remember,
eBay never owns all those beanies and Hanson bracelets - it just collects
listing fees ranging from a quarter (for items that cost less than $10) to $2
for items that cost 50 bucks or more, plus success fees ranging from 1.25
percent (for goods costing more than $1,000) to 5 percent (on deals up to $25)
after bids come in. Since the average eBay transaction is $40, the most popular
commission is the 2.5 percent that cover anything between $25 and $1,000.
Sood says this strategy offers phenomenal margins and serious ability to make
profits grow even faster than sales as eBay gets bigger. It's, at least, a
plausible argument.
First, look at eBay's gross margins, the amount left over after the cost of
providing eBay's goods and services is subtracted from its sales. Since eBay
doesn't produce goods, almost the only cost it has is running the Web site
itself. That's why eBay could turn $12.9 million of sales into $10.8 million of
gross profit. If you grant Sood his implicit assumptions: the market hits $3.8
billion and eBay holds close to 90 percent, that means eBay is selling $3.4
billion of goods just three years from now. eBay gets commissions averaging 2.5
percent ($85 million), plus listing fees and other marketing opportunities. And
at least 80 percent is gross profit.
Moving down eBay's income statement, you get to advertising expenses, product
development spending and general overhead costs. Sood's report is a
straightforward bet that eBay's sales will grow far faster than these costs
will (though that hasn't happened this year) -- allowing an ever increasing
share of those remarkable gross margins to fall to the bottom line.
That's not a terrible bet. Indeed, the point of spending on advertising is to
generate more money than you spend; people do it successfully all the time.
And it's also fairly easy to grow sales faster than you grow overhead. Sood
figures that if eBay triples ad spending by 2000, that means sales of $125.7
million and pre-tax profits of almost $25 million. That's still an excellent
margin, but many technology companies do better.
Ultimately, Sood's valuation can't seriously rest on his published numbers.
His case calls for 37 cents a share of net income in 2000 -- making his $150
price target almost 400 times earnings two years out. eBay's valuation makes
sense only if you grant Sood his implicit assumptions -- that the market
explodes rather than grows smartly, while eBay holds its leadership share and
its gross margins -- rather than his published forecast.
And there are good reasons not to agree with Sood's assumptions.
· First, it's hard to see how eBay protects a 90 percent market share now that
everyone else has been shown how much gold is in them thar Beanies. There are
already new competitors, including Times Mirror, and eBay's prospectus
pointedly fails to mention any patents in its section on intellectual property.
That means the barbarians won't have to climb a gate - there is none.
In eBay's defense, they made the smart move of neutralizing their most
dangerous potential competitor by allying with America Online, whose online
communities posed the biggest threat to eBay's status as a must-visit site. But
the absence of patents means eBay's prices and margins are sure to drop
substantially. It happens to software companies all the time.
eBay was smart, eBay was early, and eBay is good. But so is everybody else.
And how deep can anyone's commitment to a two-year old brand be?
· Second, junk is still junk, no matter how attractively packaged. I've never
before read a prospectus that discussed the risk of Beanie Babies going out of
style. In eBay's defense again, they don't own the merchandise, and they offer
a nicely diversified portfolio of junk that will let them ride whatever new
fads emerge.
But anyone who follows baseball knows there are a lot of hurting baseball card
dealers. Fads change. That doesn't necessarily make you go broke, but it can
easily leave you well short of being worth 150 times sales, which Sood thinks
eBay is.
· Third, no good burst of publicity goes unpunished. One interesting thing
about eBay's prospectus was its claim that more than 50 percent of the auctions
agreed to online are actually consummated. That means up to 50 percent (the
number in the S-1 wasn't specific) aren't. Wait for the publicity backlash when
some people don't get what they expect from eBay. And God help them when they
blow a quarter. Live by the buzz, die by the buzz. You read it here first.
· Fourth, for a company whose raison d'etre is liquidity, eBay doesn't offer
much. Its average 30-day trading volume is a full 60 percent of its float.
Monday, it was 70 percent. That drives the stock higher, faster, when the news
is good. It will do exactly the opposite if the worm ever turns.
The early bird in technology doesn't always get the worm. Apple is a great
example, Lotus even better. eBay could be the stock that can run a marathon,
as well as a sprint. But not every investor would pay $150 a share for 8 cents
of earnings to bet on that.
Indeed, for an example of the last point, you only have to look as far as
1997's top IPO -- Ciena Corp. Its machine to multiply capacity of phone
networks was innovative and well made, its customer loyalty (albeit on a much
smaller base) was intense, and its managers are honest and smart. Its stock
went to $92 a share, its market cap to almost $10 billion.
But a year after the IPO, Ciena was facing 13 competitors, not one. New
players got big new customers, fancy margins (double eBay's operating margins)
eroded even more than management expected, and the stock went to about $10. The
IPO game is harder than it looks, and the second act is the hardest.
Then again, for every few Netscape's or Ciena's, there's a Compaq. Even
Netscape isn't exactly a disaster story- apparently, it's worth $4 billion to
AOL, and not yet five years old.
So what do you think? After all, you're the market.
The Raging BullTM aims to provide a forum for investment ideas. Our articles
and columns should not be construed as investment advice, nor does their
appearance imply an endorsement by Raging Bull, Inc. of any specific security
or
trading strategy. An investor's best course of action must be based on
individual circumstances. This material is for personal use only.
Copyright 1998, RagingBull.Com
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