Tag Archives: eBay

eBay’s “Problems”

The cacophony of eBay critics have been talking down the company’s value for over a year. The voices worry aloud about lower gross merchandise volume (GMV), lower auction revenue, and fewer eBay stores. I am not Pollyannaish; these are real concerns that portend real trends. But investors need to keep their eye on the ball. Will these concerns materially erode the business? What will be their likely effect on eBay’s free cash flow?

A few points. Critics often fixate on the worst number that they can find (often related to sales), rather than the most relevant (in my lights, free cash flow). For example, in the latest quarter (Q408), eBay’s marketplaces business unit (which excludes Paypal and Skype) recorded $1.27 billion in revenue, for a 16% YOY decline. Ah, woe, the sky is falling!

This is a big number, but two important caveats are essential for our analysis. First, a huge chunk of the drop in GMV (over a third) is a result of falling GMV for vehicles. Everyone knows that new auto sales are down nearly 50% YOY. Comparatively, eBay’s vehicle GMV was down 30%, or about $1 billion YOY. A second caveat—over half of eBay’s marketplace revenue is international. During the fourth quarter, the U.S. dollar increased significantly relative to most currencies. In their quarterly conference call, Bob Swan, eBay’s CFO, noted that excluding currencies and excluding autos, GMV in the core marketplace business was down 4%.

I would contend that a 4% decline in the core marketplace business, considered in itself, is not particularly significant for valuing the whole of eBay as a business. Active users at eBay increased 4% year over year. Active registered accounts at Paypal and Bill Me Later were up 23% YOY. The number of items sold were up 3% YOY. More customers bought more items, but at lower prices.

It is too soon then to conclude that eBay’s core marketplace business is in serial decline. Despite a terrible fourth quarter for retailers around the world, eBay’s annual free cash flow and earnings were up YOY. As the recession persists, and even if it deepens, eBay should weather the changes as well or better than its competitors in ecommerce. As we’ve seen, the 2008 numbers simply don’t show a significant problem in its marketplace business. But be assured, we’ll keep watching…

Coming up next—eBay’s “Problems,” Cont’d.

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

Ebay’s Relative Value

logoebay_x452Many value investors scoff at the use of relative valuation techniques. At some basic level, the concept of intrinsic value resists any broader concern for prevailing market values. The sharp investor values only this business—relative to its assets or earnings power—and doesn’t worry about what Mr. Market thinks of it and its competitors. And historical stock market valuations would seem to confirm the intuitions of the saavy value investor. Just look at the NASDAQ bubble—what help would it have been to compare the value of a business to its insanely overpriced competitors?

However, recent research suggests that relative value arbitrage does provide market-beating returns. In addition, both Benjamin Graham and Warren Buffett used relative valuation at various points in their investing careers (though one should note that Buffett gave it up relatively quickly). In fact, in the 1960s, Buffett would borrow shares to short from the Treasurer of Columbia, and when asked which shares he wanted, Buffett said “just give me any of them.”

Most simply, the key to relative valuation, and long-short pair trading, is to find two businesses whose prospects are highly correlated. The standard example is Ford and General Motors. For two highly correlated businesses that are priced differently, the assumption is that business correlation will eventually filter into the businesses’ prices, and the arbitrageur can capture this spread.

For Ebay, many point to Amazon as its most correlated competitor. Both generate a substantial portion of their revenue from internet commerce, via the fixed-price sale of a wide array of consumer goods. As of today (2/12/09), Ebay trades at 7.4x its 2008 free cash flow, 1.55x book value, and 5.16x net tangible asset value. Amazon, on the other hand, trades at 20.15x its 2008 FCF, 10.27x book value, and 12.27x its net tangible asset value.

The best aspect about a paired trade is that it gives the investor multiple ways of being right—not only when Ebay’s value increases, but also when Amazon’s decreases. With multiple ways of being right, a value disparity is likely to fade more quickly. And more quickly realizing returns boosts a portfolio’s internal rate of return. It’s hard not to like that.

Coming up next—Ebay’s “Problems”

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

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.

Ebay–What’s it Worth? Part II

Yesterday we noted Seth Klarman’s three methods for valuing businesses and observed that a net present value logoebay_x45(NPV) analysis of future cash flows is most appropriate for a business with demonstrated earnings power.

With the help of Morningstar’s free cash flow data and the NPV function of Microsoft Excel, a NPV analysis is not a difficult exercise.

Since 2000, Ebay has grown its free cash flow from 50.4 million to 2.32 billion (2008). And from 2001-2008, Ebay grew its free cash flow at a 42% rate. These are simply phenomenal numbers—the result of starting from scratch and growing into a sector leader. More recently, the growth of Ebay’s free cash flow has slowed. In 2007, it grew about 23.2%, and in 2008, it grew about 5.6%.

As many know, in a NPV analysis of future cash flows, one must make a reasonable estimate of those future flows. Particularly in the case of Ebay, it is reasonable to expect those flows to be greater than today’s, given the company’s record of growing cash flows at a high rate. However, if one overestimates Ebay’s future growth, the NPV analysis will overvalue those flows. Thus, for those looking to buy a business’ future cash flows at a discount, it is very important to estimate future growth conservatively.

For today’s analysis, I will conservatively project that Ebay will grow its free cash flow at 10% over the next ten years, and then grow it at 5% for the following ten years. Given Ebay’s history of acquisitions, I expect 10% to be a reasonably conservative estimate for the next decade. 5% growth in my lights represents a business treading water—not gaining or losing market share—since 5% is a reasonable estimate of what the population growth plus the inflation rate will be for that decade.

Using these estimates, the net present value of the next two decades of Ebay’s cash flows, discounted at 15%, should be 27.6 billion. Add the 27.6 billion to Ebay’s book value, and you get a total value for Ebay of 38.68 billion. 

In other words, Ebay should throw off 119.94 billion in cash over the next two decades. However, we don’t want to pay that much solely to have it trickle back to us over twenty years; instead, we want a decent return on our capital outlay—say 15%. Thus, we should be willing to pay 38.68 billion today for 119.94 billion in cash outflows over the next two decades. Per share of Ebay, that amounts to a price of $29.47.

However, for any investment, one should only deploy cash when one has a substantial margin of safety. Estimates prove mistaken; management gets lazy; competitors spring up.  Given Ebay’s size and moat, a 25% margin of safety should be sufficient.

All told then, we should be willing to pay $22.10 per share for Ebay, expecting a 15% return on investment, with a 25% margin of safety. As of Friday, Feb. 6th, Ebay traded at $13.63 per share.

Coming up next—Valuation (even more conservatively), continued.

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

Ebay–What’s It Worth?

Ebay, we’ve found, operates an auction business that generates recurring sales on the widest variety of products. Its auction model renders substantial cost savings that retailers do not generally enjoy. Because it is the market-leading auction site, sellers can find the buyer willing to pay the most, and buyers find the largest selection of goods available for sale. At some level, this may all be marginally interesting, but the typical investor is most interested in what this business is worth.  Let’s get to it.

Valuations methods vary. Seth Klarman of The Baupost Group, in his Margin of Safety (Harper Collins, 1991), highlights the three methods of valuation he finds useful: a) going-concern value, which employs net present value (NPV) analysis of a business’ future cash flows, b) liquidation value, which prices the sum total of the business’ assets, as if its parts were sold and the business dissolved, and c) stock market value, which is the price at which a business and its subsidiaries would trade in the stock market (121-122). NPV analysis is best suited for evaluating profitable businesses with a consistently demonstrated earnings power; liquidation value works best for evaluating unprofitable businesses that retain assets of some value; stock market value makes sense when evaluating closed-end funds whose net asset value differs from their market value.

Given Ebay’s earnings power, NPV analysis is the best tool for determining the value of Ebay’s business. In future posts, we will offer a NPV analysis of Ebay’s cash flows.

For today, I thought it would be instructive and informative to quickly observe the portfolio of businesses that Ebay has acquired over the last decade and their acquisition prices. In itself, the price that Ebay paid for these businesses is not particularly useful for our valuation of Ebay as a whole. To tip my own hand a bit, I would argue that Ebay has overpaid for some acquisitions; thankfully though, it got a great deal on others.

Since 1999, Ebay has acquired the following businesses (and I will only list those acquisitions greater than 200 million)

Butterfield and Butterfield (1999) ~ 260 million

Half.com (2000) ~ 350 million

Paypal (2002) ~1.5 billion

Marktplaats (2004) ~ 290 million

Rent.com (2004) ~415 million

Shopping.com (2005) ~ 620 million

Skype (2005) ~2.6 billion

Stubhub (2007) ~ 310 million

BillMeLater (2008)~ 945 million

Other misc. small transactions (minimum cost of 600 million)

TOTAL COST ~ 7.89 billion

MARKET CAP of Ebay (as of 2/6/09) ~17.4 billion

In addition, another important acquisition for Ebay was a 25% stake in Craiglist in 2004 for about 13.5 million. The private market value of Craigslist could range anywhere from 2-5 billion, which would value Ebay’s stake in the range of .5 to 1.25 billion.

Most simply, we see that Ebay has a wealth of assets.  Insofar as we can break out and separately value each of these parts, we should be able to come up with a sharper and better valuation.

Coming up next—Valuation, continued.

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

Ebay and Inventory II

logoebay_x451A brief recap: so far we’ve found Ebay’s auction business to be a unique selling machine—one which has the benefit of never having to evaluate, purchase, store, market, or exchange the merchandise that it sells. Relative to other retailers—physical or virtual—this fact keeps their costs relative to sales far below all others.

But we should look closer at their sales. What do they sell? Everything, or at least everything legal (sorry, no kidneys)—autographed LeBron James memorabilia, a grilled cheese sandwich marked by the divine, lunch with Warren Buffett, executive jets, Ford Pintos, canned tomatoes, and dental floss. Not only can they sell all the basic consumer merchandise of an Amazon, but they can sell the one-of-a-kind discretionary items that often fetch premium prices. The range of goods that you can sell on Ebay far exceeds that available to any other broker (save perhaps Craigslist).

Even better is that each of these goods can be re-sold on Ebay almost ad infinitum. Ebay is not limited to selling new items, and consequently, it can facilitate the exchange of the same item, cutting its fee each time. Though Amazon does offer used items, their used market is still constrained only to those items which they also sell new—greatly reducing their ability to compete with Ebay for used items.

Ebay can sell almost everything, and it can sell it again and again and again.

Personally, I have taken advantage of this with some discretionary purchases, particularly the DVDs of TV shows. Buy the set used for a discount, watch the shows at your leisure, and then resell the set for nearly the same price you originally paid. I lose some frictional costs on the exchange, and I waste some of my time on the sale. But Ebay comes out very well.

Coming up next—Valuation. What’s this business worth?

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

Ebay and Inventory

imagesSo far we’ve argued that auctions are unique–often exciting–shopping experiences that build in a time constraint. Time constraints are a standard sales tactic that force a buyer to a decision, and depending on the length of the time constraint, it may also limit his ability to coolly deliberate about a purchase. From the perspective of the auction house, the hope is that these impositions erode buyers’ restraint, and propel them to a purchase.

Of course, Ebay is the premier auction house in the United States, and perhaps, the world. Other important, specialty auction houses include Christie’s (founded in 1766) and Sotheby’s (circa 1744). Clearly these are businesses with staying power. Consequently, we think that, as a class, auction houses represent unique business models worthy of additional scrutiny.

For example, in addition to the characteristics already noted, an online auction house like Ebay, contrary to other retailers, does not have to evaluate, purchase, store, or exchange the merchandise that it sells. For Ebay, the “merchandise” shows up as computer code. The seller lists the product, prices the product, and markets the product. It is hard to overstate the significance of this observation. One just has to examine an Amazon warehouse to appreciate the abundant layers of complexity that goes into that business. And for all that complexity, do they get compensated with a much larger gross margin? Hardly so! To be sure, Amazon does fine as a retailer, but as a business, I would argue that it is grossly undercompensated for its complexity compared to Ebay’s auction model.

Obvious too are the wealth of ancillary benefits in Ebay’s model. Ebay does not need a distribution network, purchasing agents, or merchandise suppliers. Its corporate headquarters can be at a single location—streamlining efficiency–and its location could be virtual or anywhere. Its merchandise never needs to seen, nor excessively scrutinized for optimization (see Wal-mart). Forget about inventory turnover, hard-to-move items, inventory management, and most of your customer service…

The simplicity is profound and elegant. Selling without goods—almost zen.

I don’t mean to imply that what Ebay does is easy, but it surely is simple.

Coming up tomorrow—Ebay and Inventory, Part II.

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

Ebay and Auctions II — The Deadline

Following from yesterday’s post, I want to further explore my hunch that Ebay is a great business. One of its major sources of revenues are its auctions, which bring unique excitement to what has become an increasingly homogenous experience of shopping. Additionally, it has attained that critical mass of buyers and sellers (often called the “network effect“), making it the optimal marketplace for buyer hunters or bargain hunters.

Yet another critical feature of auctions is that they offer a transaction structure that exploits an important selling strategy—the deadline. As all good sales representatives know, one of the most difficult hurdles for a buyer to jump is the last one—the one which concentrates his will in a yes. Hence most sales promotions employ this strategy’s advantage by pummeling their buyer with the knowledge that their purchase price will only be available for a limited time.

The deadline, coupled with a bidding format, almost guarantees that interest will transfer into sales at a very high rate. At a brick-and-mortar store, a buyer rightly assumes that the product will be there whenever they return. There is no time constraint; I’ll buy it later. Not so with Ebay. In fact, on Ebay, the opposite is closer to true; this particular item will never be available again. Of course, many auctions and fixed-price listings on Ebay offer identical commodity goods that you could find in Wal-mart. But, unlike Wal-mart, a substantial percentage of its market’s goods are unique items. This fact, coupled with the deadline, means that Ebay has a selling format uniquely geared toward propelling sales.

Coming up tomorrow—Ebay and inventory.

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

Ebay and Auctions

One business that strikes me as potentially great is EBAY.logoebay_x45

Though Ebay has a wide variety of businesses under its umbrella–Paypal, Skype, BillmeLater–it is primarily known as an auction site.  So, let’s step back a moment, what makes an auction desirable?

Most generally, people like auctions because they are exciting–with outcomes unknown until the very end–and they give the buyer a chance to snatch up a bargain.  They offer us a chance to play with our emotions, as they present a shopping experience far more exhilirating than the local grocery store’s.  And by always offering a bargain, they can command our near everpresent attention.  Got a moment to spare–search for a bargain!

For an online auction site, it can be difficult to replicate the excitement found in a brick-and-morter auction.  However, its inventory will likely be much greater.

With these insights, how should we see Ebay’s moat?  What is its durable competitive advantage?  What would prevent me from setting up a knock-off site and challenging them tomorrow?

For one, inventory.  In order to fulfill a buyer’s thirst for the bargain, there must be a LOT of items for sale.  Any new competitor would have a very difficult time building the necessary cadre of sellers.  Ebay–being one of the most well-known internet sites on the web–has wide brand recognition and deep brand capital.  Since sellers want to sell where there are buyers, and since buyers want to shop where there are bargains, there is a sort of chicken-and-egg problem for any would-be competitor.

What does Ebay’s auction lack?  It lacks some of the palpable excitement that bubbles at a brick-and-morter auction.  Let’s be frank–an auction is a social event.  You compete with other buyers to pay the lowest price you can.  It is human sociality at its most pecuniary.

What does Ebay need to do?  It needs to recreate–as best as it can–that excitement of the auction.  In the age of Web 2.0, the task is not insurmountable.  Blogging, tweeting… the tools are there.  Ebay just needs to better deploy them.

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