Ebay as a Bond

Yesterday we valued Ebay as a profitable business that will produce moderately increasingly cash flows over time, by using a NPV analysis of those flows. However, as you may notice from the links on the sidebar, there are a fair number of bears out there who find Ebay’s business stagnant and the stock overvalued.

So, to assuage the worries of the most pessimistic investor, I propose that today we value Ebay as if the company itself were a bond and its future cash flows would consistently pay out at the same rate of 2008—that is, 2.32 billion.

Two decades of 2.32 billion “pay-outs” would return 46.322 billion. Of course, we wouldn’t be willing to pay 46 billion today for that amount to dribble back to us over twenty years. Keeping yesterday’s discount rate of 15% (our desired return), we should be willing to pay 14.497 billion today for those “pay-outs,” plus the current book value of the company (11.08 billion as of 12/31/08). In sum, $19.49 per share.

Let’s say you are still worried about your valuation of your Ebay “bond.” If you add a 25% margin of safety, that means you should be willing to buy the Ebay “bond” today for $14.62, providing even more cushion for your 15% expected return. Today, Ebay closed at $13.35.

To assume no growth for a premier company with a demonstrated love for acquisitions strikes me as unreasonable. Such an assumption also implies that Ebay’s cash flows will decline relative to population growth and inflation. Even if these highly unlikely scenarios came about, buying Ebay today should still generate an above average return on capital for a long-term investor.

Coming up next—Relative Valuation.

Disclosure: I, or persons whose accounts I manage, own shares of Ebay at the time of this writing.


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