eBay: Growth at the Right Bid

eBay (EBAY) is a truly great American success story. According to eBay’s March 2009 Three-Year Roadmap for Growth:

"We are positioning this company to compete and win across a range of profitable ecommerce platforms focused on connecting buyers and sellers across the platform of their choice."

Founded in San Jose, California on September 3, 1995, eBay has carved out a unique position in the retail space based on e-commerce. Earnings growth has averaged an incredible compounded 48% per year (See purple circle in Figure 1 below).

In many ways, eBay (EBAY) has become a victim of its own success. eBay first set the bar high with its IPO on September 24, 1998. Within only a few months its stock value peaked at close to a thirty-fold increase and earnings were doubling almost every year and sometimes more than doubling. (See red arrow and red circle on Figure 1).

After eBay’s stock price peaked at just under $32 per split adjusted share in 2000, its value was almost cut in half throughout 2001-2002.

However, from the period 2001-2004 eBay established itself as a growth stock extraordinaire. Earnings grew by 80% during the recession of 2001 and averaged over 85% per year compounded through 2001-2004. Even though eBay’s (EBAY) shares started out overvalued with a PE ratio of roughly 135 times earnings (orange circle) at the beginning of 2001, shareholders enjoyed an incredible return of 48.6% per annum (See purple circle in Figure 2 below) for the four-year period. This exeplary performance occurred during one of the worst bear markets on record.

When contrasted to the performance of the S&P 500 over the same time frame, it’s clear that eBay’s results were astonishing. See Figure 3 below.

The point we are striving to make is that eBay (EBAY) created a new and unique category of retail selling that it had all to itself for the better part of a decade. Therefore, explosive growth was easily achieved. Common sense says that those glory growth days are forever gone, however, that does not mean that attractive above-average growth for eBay is over. In Figure 4 below, we plot the consensus five-year growth forecast of 18% (15-20% as we see it) for eBay by 20 leading analysts reporting to Zacks. This depicts what we mean by “growth at the right bid”. In other words, we see eBay as very attractively valued today based on realistic assumptions for achievable future growth.

The thesis for eBay’s (EBAY) growth is admittedly somewhat cloudy, but not without plenty of opportunity. Legitimate questions remain as their business model transitions from pure auction to a blend of auction and fixed pricing. Due to competition for auction from formidable competitors with cost advantages, developing a successful fixed business is important. After struggling for several quarters due to the recession, recent sales indications for their fixed-pricing business models appear promising.

The current desire to sell Skype is being challenged by its founders. Frankly, we are ambivalent towards the transaction. On the one hand eBay can focus more on core strategies sans Skype. While on the other hand, Skype offers strong growth potential in our view. Therefore, keeping Skype would not be all that bad, especially since eBay does not need the cash. eBay’s enormous free cash flow generation, strong cash hoard and healthy balance sheet puts them in the catbird seat. eBay enjoys the luxury of not needing to tap credit markets to fund its growth. See Figure 5 below which plots eBay’s free cash flow over earnings. (Orange shaded area with “F”).

We believe the real growth story today for eBay (EBAY) is PayPal. As online shopping continues to proliferate and expand worldwide, the need and world-wide potential for PayPal appears limitless. eBay certainly possesses the financial resources and we believe business acumen to exploit this opportunity.

At the end of the day, eBay (EBAY) is an extraordinary company with enormous resources at their disposal. This allows them to explore numerous avenues of future growth. Promising business lines such as StubHub, Kijiji, Shopping.com, Half.com, ProStores, Rent.com, and many others are merely scratching the surface of what’s possible for eBay. They may not all pan out as hoped, but odds are that enough will to generate the growth that validates today’s attractive valuation.

eBay (EBAY) is a fast growing company whose tentacles reach into 30 countries worldwide. Consequently, we believe eBay is a sound investment for prudent long-term investors seeking growth of capital. Although its future growth will likely not be as fast as its past, it should, in our view, remain an above-average grower currently selling at an attractive entry point.