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Thesis Ebay (EBAY US – Market Cap $61Bn) Is a Company That Is Currently Cheap Due to One-Time Events That Depressed the Stock

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Thesis Ebay (EBAY US – Market Cap $61Bn) Is a Company That Is Currently Cheap Due to One-Time Events That Depressed the Stock EBAY US Thomas Li Long eBay (EBAY US) Thesis eBay (EBAY US – market cap $61bn) is a company that is currently cheap due to one-time events that depressed the stock. The company generates a tremendous amount of cash (8% FCF yield), management is shareholder friendly, the 2 main businesses have large economic moats and many channels to grow. Multiple catalysts down the next 12-18 months can also quickly increase the returns to investors. eBay is currently trading at 18x EBIT. The combination of great qualities in the business makes the stock a rare find for its price. The underlying sustainable cash flow generator with multiple levers for growth justifies a higher multiple. Business Description eBay is an easily misunderstood business. There is a large consumer facing side, or eBay.com, which internally is known as Marketplace. To the rest of us, we know it as the largest auction site in the world. There are 2 more main divisions in the company, PayPal (technically referred to as Payments) and Enterprise. In 2009, CEO John Donahoe has embarked on a turnaround to change eBay from a online marketplace to a dominant player in mobile transactions and eCommerce, and created eBay Inc. Most investors today do not see past the fact that the eBay is no longer eBay.com but really eBay Inc., a different company from what many of us are used to. Marketplace has defined for most of us what an online auction site is. Most of us are familiar with the business model of online auctions and “Buy-it-now”. Marketplace currently has over 180mm active members. 52% of eBay’s revenue comes from Marketplace and it makes that revenue from the sellers on the site. When someone goes to eBay and lists an item, he has the choice to pay certain fees to increase his selling page. Some of these could include having more pictures, larger pictures, more descriptive information etc. Once the item is listed and sold, eBay takes a cut off the sale price. Different items will cost the seller a different amount, for most products that are not books or CDs etc., eBay will take a $0.30 fee. For books and CDs the fee is $0.05. On top of that flat fee, eBay will take 10% of the selling price with a ceiling of $250. Marketplace has steadily been doing 40% EBIT margins for the past 5 years. That is in stark contrast with the 0% EBIT Amazon currently has, mainly due to the fact that Marketplace is not a retailer and takes a fee from transactions. PayPal is the payment service provided by eBay, and currently represents 41% of revenues to the firm. The company was known as Confinity and was founded by the (currently known as PayPal gang) Peter Thiel, Max Levchin, Luke Nosek and Ken Howery in 1999, before Elon Musk bought it to merge with X.com. In 2000, its name was changed to PayPal and the company went public right after the market crashed following the 9/11 tragedy. eBay promptly bought PayPal for $1.5bn. PayPal provides users with a secure way of paying each other, allowing for the first time, individuals to accept payments from credit cards. In order to have a PayPal account, one simply needed an email address and a credit card. For every transaction on PayPal, the company will take a 2.9% transaction fee and that makes up the bulk of 1 | P a g e EBAY US Thomas Li PayPal’s revenues, even till today. Depending on how a customer funds his PayPal account, the cost for PayPal will differ, largely due to having to pay out interchange fees. PayPal has recently branched out to an offline presence, which allows user to use PayPal’s app to pay at traditional stores and reduce the exposure to Mastercard and Visa, therefore starting on a path to improving margins. According to channel checks, 80% to 90% of PayPal’s transaction cost are currently related to interchange fees and around 90% of interchange fees are paid to Visa and Mastercard. American Express, Discovery make up most of the reminder. When someone uses a credit card to fund his PayPal account for a transaction, Visa/Mastercard will charge an interchange fee from the acquiring bank, for PayPal’s case, since PayPal is the “merchant”, PayPal will have to pay this fee. Interchange fee calculation has various simple formulas for various products but most of the time it is a fee of $0.05 + 0.21% of sale. According to data compiled by the Federal Reserve Bank, MasterCard has an average fee of 1.49% and Visa has an average of 1.33% in 2013. Paypal has been making 20% EBIT margins over the last 5 years, with most of the cost being interchange fees. The current drive to attempt to turn consumers away from using credit card funding accounts is likely to improve (if not at least maintain) these margins. Enterprise currently is 7% of revenue. This division provides marketing, and omnIcahnnel operation solutions to customers. Most of the customers are large retailers such as Levi’s, GNC, Calvin Klein, Aeropostale etc. Effectively, Enterprise runs the online shopping sites of traditional retailers. Currently, this does not play into any significant part of the valuation, but it likely represents significant value if it grows. Why eBay stock is Cheap eBay stock is cheap for multiple unusual reasons. Most value screens will not bring it up since the stock is trading at a 22x PE. On top of that, value investors flock away from anything with a tech-ish slant to it, eBay falls squarely in the zone of tech stocks where value investors would miss. Growth investors on the other hand, gravitate away from eBay due to favor for companies better “growth prospects”. No reputable growth fund wants to participate in a stock with top line recently getting hit and whose stock has not moved from 1Q 2013 (The market is up over 40% in the meantime). Growth funds are not usually a fan of stocks that are “dead money” through 2013 and 2014. Said differently, regardless of whether you belong to the “value” or “growth” school of investing, you will likely look bad if you bought eBay and lost money, and therefore you rather not give it a miss. On top of falling into an unloved category for a stock, eBay also experienced several corporate events that no doubt chased away some investors. Below, I will lay out just 2 of the most significant issues 1. Google Panda 4.0 Google Panda is a search algorithm released in 2011. The update was designed to improve on the previous algorithm. Unsurprisingly, the algorithm itself is very tightly guarded by Google and Search Engine Optimizers (SEOs) have spent a heavy amount of resources to understand this new code. What 2 | P a g e EBAY US Thomas Li was quickly understood by SEOs was Panda’s preference for content sites, articles and social media sites. What was less understood was how Panda reacts to sites with heavy search optimization. Before the latest iteration of Panda, the Panda 4.0, it is widely believed that hiring an SEO to help with website design will improve one’s site rankings on a Google search. A decade ago, SEOs will pull simple tricks such as hiding key word text using the same color as the background so the human eye misses it but the Google Bot will catch it. As Google’s search algorithm became more advanced, these SEOs tactics will actually punish a website for “over-optimization”. The ongoing game of cat and mouse has been going on for over the last 10 years. My conversation with an SEO in New York regarding the latest Panda 4.0 revealed that this new iteration was one of Google’s biggest step-ups in the search algorithm. Not only will Panda 4.0 identify quality content sites, but it will also attempt to judge sites for the amount of SEO participation. In other words, sites with heavy optimization and designed to consistently hit top rankings in a Google search will be normalized so that other websites will stand a chance. For eBay, that meant lower search rankings for many of their products. When Panda 4.0 was released in 2Q, it created fear in the investor base. The heat of press reports that came out on May 21st revealed that eBay’s rankings had indeed declined on Google’s new Panda 4.0 algorithm 2. Security If you have an active eBay account, you will notice that sometime in May (21st to be specific), eBay asked you to change your password due to a security breach commonly known as Heartbleed. This bug exploits a common vulnerability called buffer over-read where the boundaries of what data can be read and cannot be read by an external party are changed due to some exploits. Simply put, Heartbleed steals password information. Large websites (eBay, Amazon etc.) were extremely quick in reacting to plug the exploit and secure their data, however, eBay still asked all members to change their passwords for additional protection. This resulted in a degree of inconvenience and mistrust in the use of eBay (and eCommerce in general). For eBay, this meant there was a need to increase marketing expense to bring customers and sellers back to the website. The back-to-back Heartbleed and Google Panda hit on eBay brought stock down from $60 to sub-$50 levels in May.
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