Yesterday, reader and fellow blogger Eboro and I chatted over email about eBay, one of my favored wide moat businesses and the subject of a extended blog series. In my view, Eboro’s observations and questions reflect the current majority view about eBay and highlight important worries. With permission, I have edited and posted some of the conversation here.
EBORO: “Recently, I started going over [eBay’s] annual reports as well as well as using various models (FCFE, Relative, Expectations) to value the business. Although this is an important part of my process, I spend even more time “scuttle-buttin” to discover what the users (buyers, sellers etc…) think about the company. Although I only started my examination a month ago, I’ve spent hours on the eBay forums reading over thoughts and comments, as well as asking questions. Out of interest, have you done this?”
WIDE MOAT: Yes, I’ve done this and have been impressed by the indiscriminate vitriol toward eBay. In general, I’ve found seemingly impartial assessments criticized as dishonest and meritless. Any critique becomes an invitation for a new chorus of boos. This article at SeekingAlpha and the comments strike me as standard fare. Or, see this WSJ blog post. My impression is that there is a significant group of former sellers that are very upset with recent changes. It’s almost as if they feel personally violated in some way. Rather than quietly take their business elsewhere, they want others to know that they have been (morally?) wronged, and eBay’s management are fools. Really, very odd…
EBORO: “I only ask because it was during this process that I realized something was not quite right at eBay: buyers and sellers were complaining, in huge numbers, about the business; literally thousands of sellers are leaving the site. It seems as though this could have a negative effect on one of the key elements of eBay’s moat: its network. In my opinion, eBay’s growth potential relies heavily on the following: buyers come to eBay because they know that there are an abundance of sellers; sellers come to eBay because they know there are an abundance of buyers. Buyers don’t find the selection they used to, they don’t find the low prices they used to, and eventually, they start leaving. What happens when there is a reduction in the number and type of sellers? … What I’m focusing on is the future trend for users: is management suffering from “confirmation bias” or “overconfidence bias”, by blaming all their problems on the macro-economy, as opposed to their decisions? Have they tried to focus on elements that they have control over (such as user experience, fees etc.) to try and improve?”
WIDE MOAT: I agree with your observations. Many sellers have left and are leaving. Though I would note that new sellers are joining up as well. If there were a significant and sustained reduction in the total number of buyers and sellers at eBay, I would be increasingly worried about its auction business, so that is something that I definitely want to watch closely. Any data on this would welcome.
I know some sellers who did a lot of business with eBay and have left to sell from their own websites. This is smart business decision and should be expected. If sellers don’t need eBay to drive traffic and sales, then eBay won’t have much to offer.
I know other sellers who were upset by the fee increases. Pricing is tricky. When you are in the dominate market position, you want your fees to be as high as you can get them, without going too far. There will always be cheaper alternatives–e.g., Craigslist, OnlineAuction.com, etc. Those competitors have to offer something that eBay does not, and without traffic, they have to offer a lower price. Again, this is something that I want to watch carefully. If eBay drives off too many sellers with high prices, they will eventually have to cut fees to reverse the trend, and that is a time-consuming process.
My own view is that management is too brash and too insular, and their record of acquisitions is spotty. In the end, I would like to see new management in place. However, and I say this over and over–even while receiving repeated and dismissive scoffs–there are incentives in place for current management to change, or for them to be replaced. If the stock continues to trade where it is, with options under water, and the company so cheap, eventually the numbers have to hit someone on the head. The stock price is screaming that there are problems, and that, I’ve found, is typically one of the most effective generators of corporate change. Now, I’m not saying that change is imminent, but I know of no other mechanism that consistently propels change like a low stock price.
EBORO: “On paper, eBay is indeed extremely cheap, and they indeed own a variety of businesses that have various moats in place. As you well know, however, having stellar management that is responsive to change is just as important as the moat. eBay’s management, in my opinion, does not posses the necessary qualities. It seems as though Omidiyar may have made a mistake in hiring Donahoe. Although his CV is indeed impressive, that does not mean that he has the temperament and character to run this type of business. In fact, he has no experience in the industry whatsoever: he spent years in the consulting business, which as you know, is great at getting huge fees but not as good at providing tangible results. The changes he has put into place have begun to have a serious negative effects on the core part of the business. He’s running the business like a consultant, and not like a business owner and user. They can blame the macro-economy if they so choose, but the question then becomes, why did Amazon (a somewhat similar business) have their strongest quarter to date in such a bad economic period?”
WIDE MOAT: His performance thusfar suggests that he cannot do the job well. Blaming the macro economy is embarassing; a competent CEO focuses on things they can control, defines relevant metrics for evaluating success, and then does the job. Currently Donahoe seems obsessed with “buyer safety” and making an eBay purchase as reliable as a Wal-mart purchase. I haven’t see enough data to show me that this should be his primary concern, nor have I seen data showing that his changes have been successful. So, I agree, Omidiyar may have made a mistake with Donahoe.
EBORO: “The reason, for me, is self evident: Bezos and Amazon focus on their customers and their customers wants/needs, as opposed to their competitors, and their competitors’ actions. As Bezos has pointed out: “we set our strategy around what we perceive are the big customer needs, and we know that what customers really want is stable over time. If you base your business strategy on things that are going to change, then you have to constantly change your strategy, whereas if you formulate your strategy around customer needs, those tend to be stable in time.” This is the type of CEO I want when I’m thinking of investing in a business…”
WIDE MOAT: At the risk of sounding like a cynic, I would first say that Bezos uses his golden tongue well. And at some level, he’s right; you have to serve your customers’ needs to have any business at all. But saying it so simplistically masks the complexities involved. I suspect that what customers really would want are lower seller fees, better inventory, and better service. These needs are costly for Amazon. So the truth of the matter is that there always has to be a balance struck between buyers, sellers, Amazon’s shareholders, and management. Signs suggest that they have struck a good balance with their current strategy, and the stock price reflects that. It could always go higher, but I see more risk to the downside than potential gain to the upside.
EBORO: “This is not to say that examining your competitors is not important, but when you neglect the very people who make up the “network moat” that your business enjoys, you stand to seriously harm the fundamentals of your business. It seems as though eBay has been trying to imitate Amazon, at the expense of its customer’s needs. Their customers want low fees (fees have seriously increased as of late, final value fees on Buy it Now are 12-15% on top of monthly fees and listing fees, they also introduced a minimum listing fee), they want a reliable bidding system (anonymous bidding allows for people to organize “fake” bids to help increase the prices of their products), they want excellent customer support (you should read the eBay boards to see how people feel about this; it’s not good) they want reliable, cheap and fast shipping (eBay has set maximum fees and shipping costs) and they also want reliable and easy payment methods (eBay has removed money orders and checks etc… and leaves paypal as the only option, which has caused huge negative feedback from users).”
WIDE MOAT: To extend on my previous point, yes, customers want everything. In my experience, eBay’s customer service happens almost wholly on the Paypal side. As a buyer, I have had some instances of fraud on big ticket items, and I did have to make a phone call, but refunds were quickly forthcoming. I like their dispute resolution mechanism, since it gives the buyer and seller a lot of time and opportunity to reconcile without eBay and Paypal getting involved. In terms of Paypal’s resources, you do NOT want to be getting involved as Judge Judy in all of these little spats until it is absolutely necessary. So, if people want eBay to immediately resolve everything in their favor, I see that as unsurprising, but relatively juvenile.
And there’s the rub. In most “problem” transactions, one party is going to feel like they got a raw deal, so after every such transaction, you created someone who can potentially go on an Internet forum and complain. With million of transactions, a lot of people will have reasons to be angry. I’ve had some bad transactions there myself, but you try to resolve it, leave negative feedback, and live on; it’s the buyer or seller’s fault, not eBay’s. I see eBay’s marketplace a little like the Wild West in that respect, and most buyers seem willing to accept that. And like I’ve said, I’ve never had a problem getting a full refund with Paypal’s buyer protection policy, so the risks seem relatively low.
EBORO: “Amazon tried imitating eBay years ago, but this didn’t work, so they stopped (instead, they launched something similar, but different: their “third party retailer” business. This isn’t an auction type business, it’s simply a “used items” business. It’s working very well thus far). The point that I’m focusing on is the fact that Bezos truly understands his business, loves the business and it’s customers, and does everything in his power to be innovative and adaptable to demands – there’s a huge incentive for him to do so, as he owns 23% of the company. Donahue simply doesn’t seem to grasp this yet, and until he does, I can’t see myself buying into the company. I’d at least like to see him acknowledge this, and begin making the changes that will make users happy. This is the key part of this business, and buy catering to larger power sellers, at the expense of others, they may get larger sales for the huge volume sellers, but will lose the variety and diversity the smaller ones bring.
It’s interesting to note that the success of an investment is as much about the actual value of the business as it is about the speculative value of the business. Until others eventually agree with an analysis, the investment cannot be successful. It’s possible that many investors will continue to shy away from Ebay shares until their core business adapts to it’s customers and starts growing again. These, in my opinion, are the best bargains one can get: when management has already realized that changes need to be made, and are moving in this direction, and yet the market doesn’t price this in yet at all. A simple example of this would be Apple. The shares were a great buy at $15 in 2004, simply because you could see what Jobs was doing, and thought: he’s got it right, he’s bringing back the “style” that made Apple so successful to begin with, he’s got excellent products in the pipeline (that people clearly want), he provides a one of a kind “experience” with a very innovative platform (OSX) and he’s listened to customer wants/needs; and yet, the market isn’t pricing this in at all yet.”
WIDE MOAT: It strikes me that your last points are more about market timing. And you may be absolutely right. Perhaps pessimism surrounding eBay could increase. Perhaps we’ll see evidence that management is changing its plan. Perhaps then we’ll have the ideal opportunity to buy. It definitely would be a better investment if new management were in place, with a smart plan, and the stock still trading at these levels. I just don’t have the confidence that the stars will all align in this way. Or, that I’ll be able to enter the stock at the most opportune time.
I like your assessment of what it takes for an investment to appreciate in price. If you are buying a share of a business, rather than the whole business, then yes, you have to get other people to agree with your assessment of a business’ value in order to sell. So when I buy, one strategy is to be a contrarian, and find a decent business inundated with pessimism. Most of the time, of course, the pessimism is warranted, and the company’s problems intractable. Here I don’t think that is the case.
The worst case scenario that I foresee is eBay continuing to lose GMV, beginning to lose users, seeing cash flows decline while expenses stay high, and the stock price continuing to fall. Then the company gets taken out by Microsoft, or Yahoo, or someone else, at a lower price than I paid. It is a risk, and it is possible. It’s hard for me to imagine the stock price going much lower without someone buying the whole thing, but it could. If I had 17 billion, I would have my unsolicited offer at their door by Monday morning.
Thanks for the questions, Eboro. It’s been fun.
Disclosure: I, or persons whose accounts I manage, own shares of eBay at the time of this writing.
Many value investors scoff at the use of relative valuation techniques.
So far we’ve argued that auctions are unique–often exciting–shopping experiences that build in a time constraint.
Wide Moat Investing 