eBay filed its first quarter 10-Q at the end of April, and the stock price launched. With two highly lucrative toll-booth businesses—brokered sales and payment services (Paypal)—and an exceedingly low price (briefly selling below $10 per share earlier this year), it caught our attention earlier this year. Though we haven’t found the recent decline in eBay’s GMV (gross merchandise value) concerning, we do continue to worry about eBay’s capital allocation, its managerial compensation, and its emphasis on favoring high volume sellers (see our previous analysis of pretended problems, potential problems, and rejoinders).
Regarding capital allocation, eBay repurchased no shares in the first quarter, despite seeing its lowest share price since early 2001. And true to habit, eBay entered a definitive agreement to acquire Gmarket Inc. after the first quarter closed, in April. Over the years, eBay’s management has clearly preferred acquisitions to share repurchases, and not all of the acquisitions have been prudent uses of capital (see e.g., their recent sale of Stumbleupon back to its founders for less than their purchase price). Though it is possible that Gmarket at 27x trailing earnings is a better investment than eBay’s own shares at 13x trailing earnings, the former clearly anticipates robust growth that may not materialize. In my view, buying Gmarket rather than eBay’s own shares is the riskier route.
Our second worry has been eBay’s managerial compensation. Despite sub-par performance in their core marketplace business in recent years, compensation has decidedly increased. And the first quarter confirms the trend. Year over year, stock-based compensation expense grew from $87.4 million to $113.8 million, or a 30% increase. This in a quarter in which both net income and free cash flow were down significantly YOY. Though one should acknowledge that stock-based compensation expense can be lumpy and not consistently spread across all quarters, the first glance does not offer a pretty picture. We’ll be keeping watch in the quarters to come.
Our third and last lingering worry—that favoring high volume sellers may alienate too many sellers—is difficult to assess from quarter to quarter. Over at eBay Strategies, Scot Wingo has highlighted some of the recent changes in eBay’s marketplace business. Early indications show that buyers appreciate the reliability of eBay’s largest and favored sellers, and buyers consistently show their preferences for free shipping. Though management’s push for ‘free shipping’ strikes me as nothing more than silly irrationality (i.e., sellers will just increase list prices to compensate), the data so far seems to confirm management’s side.
All told, I must say that I was disappointed with eBay’s capital allocation and stock compensation expense for the quarter. Though their actions fit seamlessly with their past, I had hoped that a $10 share would have been too tempting not to bite. Given these three worries, the unexpected comprehensive income loss of $27.7 million for the quarter, the broad macroeconomic picture, and the recent 70% run-up in eBay’s share price, we have closed our position and will now watch from the sidelines.
Disclosure: No Position.