So far, we’ve argued that auctions are a great business, because they propel sales and do not require the auction house to hold inventory. eBay is far and away the leader in online auctions, with over 77.4 million unique visitors last month. eBay, in addition to its auction business, has a portfolio of growing businesses—some great profit generators (e.g., Paypal), others not so much (e.g., Shopping.com). And eBay is cheap, relative to its future earnings power, and relative to competitors.
Yet, eBay’s recent actions may portend potential problems. Contrary to other analysts and commentators, I do not find the decline in auction GMV concerning. However, three other problems do trouble me as a shareholder.
First, management has an potent desire for acquisitions. This desire has, along the way, led to some excellent uses of its free cash flow, but there has also been some serious duds. Their most recent large acquisition of Bill Me Later is interesting and will require some time to fairly evaluate. But given the current credit environment and consumer defaults, it does not strike me as a particularly opportune time to be entering this business. Looking forward though, with eBay priced at this level, it will be very difficult for management to find better uses of capital than to buy back its own stock. If management keeps up its acquisition spree with the stock at these levels, I will increasingly question the wisdom of their capital allocation.
Second, management is compensated very well. And perhaps excessively so. In 2007, stock-based compensation was 302 million, or about 14% of its 2.187 billion free cash flow. In 2008, stock-based compensation was 352 million, or about 15.2% of its 2.316 billion free cash. In short, compensation grew faster than cash flow; this is not a trend that an owner likes to see. Without getting too deeply into the details, an owner needs to keep a close eye on this trend.
Third, eBay’s recent emphasis on providing buyers with a ‘safer’ and ‘more reliable’ purchasing experience has pushed eBay to excessively favor its largest sellers in a potential buyer’s search results. Though the reasons for this move may be justifiable and good for the business, it does create a basic inequity among sellers that will alienate. This relatively new policy should be watched carefully, and management may need to adapt its strategy if the costs outweigh the expected benefits.
So there you have it. These are the real problems for eBay as a business. In my lights, prospective owners who buy at these prices are getting a bargain. But if these three problems continue to fester and grow, eBay’s intrinsic value may decline. And we would need to revisit our valuation.
Disclosure: I, or persons whose accounts I manage, own shares of eBay at the time of this writing.