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Home , Carl Icahn, Confinity

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 . 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) , , and Ken Howery in 1999, before 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

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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 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. 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

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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 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.

Competitive Advantages The sustainability of the Marketplace and PayPal business are underappreciated. Marketplace relies heavily on what is known as Powersellers – these are people (or small businesses) that receive a high rating and have sold sufficient products over a period of time such that eBay endorses them with a special tag to their name when they list an item. For the buyer, buying from a Powerseller is often an additional check on security. 4% of sellers make it to become a Powerseller. The requirements to become and maintain a Powerseller status is not only stringent, but requires a heavy investment in time to become one. The requirements are:

 Be an active member for 90 days.

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 Average a minimum of $1,000 in sales per month, for three consecutive months.  Maintain a minimum of 4 average monthly listings for three consecutive months.  Have an overall feedback rating of 100, of which 98% or more is positive.  Have an account in good financial standing.  Uphold the eBay community values, including honesty, timeliness and mutual respect  Comply with all eBay listing and marketplace policies.

In addition, there are 5 tiers of Powersellers. Increasing monthly sales allows one to move up the status tiers and the key advantage is obtaining different types of support from eBay for free. Also, customers are more trusting of a Powerseller of a higher tier than of a lower one.

This means that eBay has a stickiness to sellers where the switching cost for many of these sellers are extremely high. Moving to another platform would mean them losing the status of trust and support that eBay has granted them and will significantly affect their sales and operations. As for buyers, buying from a site where payment is protected (by PayPal) and there are thousands of reviews for the Powersellers means buyers feel safer buying from eBay and these Powersellers.

Around 70% of transactions of eBay are done over the PayPal platform, which means that buyers do not need to provide their credit card information to eBay and keep it encrypted and secure with only PayPal. A key advantage especially considering the air of distrust of online retail after the Heartbleed bug.

An example of how the eCommerce industry has high switching cost is manifested in eBay’s 2001 unsuccessful attempt to take on Yahoo! Japan. eBay attempted to set up their platform in Japan when Yahoo! Japan had previously established such a platform and within a year, eBay learnt of the difficultly to penetrate a market without the first mover advantage. They subsequently withdrew their resources from Japan.

PayPal PayPal is arguably the first to enter the mobile payment industry in 1998. Several players have attempted to break into the industry but have been unsuccessful. Notably, Google has attempted to create Google Wallet but received very little traction. In order to understand why, we have to notice that the so-called network effects are unique for mobile payments. There are effectively 2 types of payments someone would make using a mobile platform, a payment to a person or a payment to a corporation. A payment to a person requires both people to be on the same platform, and therefore represents high switching costs to other platforms (e.g. Facebook). On the other hand, payments to a corporation should be a many-to- one system where the corporation (e.g. Starbucks) wants to be able to accept payment regardless of the platform. eBay has managed to capture both of these markets. PayPal has been able to perform individual-to-corporate payments for a long time, essentially acting as a credit card. It now is running a dual platform on the individual to individual payment system, both using PayPal’s own platform and using Venmo, a Braintree platform which was bought in 3Q13. The current plan is to integrate Venmo and

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PayPal, the 2 largest p2p transaction platforms. One could even argue that eBay bought Venmo not to grow PayPal but to defend it. Most “network effects” are slogans thrown out to attract funding rounds. PayPal and Venmo together however, are probably going to be one of the rare cases where the network effect is realistically there. Based on a Comscore report, PayPal represents has 72% of all digital wallet transactions, a market that will grow to $1tn by 2017. In the separate report by Forrester, it is reported that mobile transactions are expected to hit $90bn by 2017, a huge market for Venmo to take advantage of. In the last year, PayPal managed to grow user base by 19% to 143mm users and is currently the largest mobile payment platform. PayPal offers its users 2 main attributes, simplicity and security. Anyone who has used PayPal can attest to the simplicity of performing a transaction. From clicking on the iconic PayPal icon to approving the transaction usually does not take more than 2 clicks. Doing so using a credit card requires typing in the card number and filling out personal details for verification. On top of that, PayPal is a trusted secure payment website, and is significantly more secure than a commercial shopping website. eBay-PayPal Separation Analysis owns almost 1% of the stock and has publicly written up a letter urging for the separation of eBay and PayPal and publicly accussed and Scott Cook from personally benefitting from various eBay transactions, often at the expense of eBay. He believes that a separation will allow both businesses to grow and for shareholders to appreciate the value in the company. Said differently, PayPal deserves a higher multiple than eBay Inc. eBay, over the course of a few months, went from publicly decrying Icahn and issuing statements as to why Icahn’s nominated board members are not fit for eBay’s board to issuing a statement conceding that Icahn has a point. Perhaps the most telling data point is how the company is aggressively buying back stock using cash on hand, a key point to be discussed below under “Capital Allocation”.

While Icahn still believes that the best value creation is in the spinoff of PayPal, he agrees that the current board is in fact being shareholder friendly. eBay has said that they are not looking for large acquisitions (which is good in since it is common to severely overpay for very large acquisitions) and management’s current capital allocation priorities are in buying back its own stock.

I also noticed several interesting cultural significance in the eBay PayPal relationship. eBay has 3 campuses, the South Campus which houses the team at Marketplace, the North Campus which houses PayPal and a small Orchard campus which houses some support roles. The first thing an outsider to the company will realize walking the grounds is how much nicer the North Campus is than the South Campus. The next interesting observation in North Campus is how eBay and PayPal are in different buildings. For a company that has been part of eBay for the past 13 years, it seems weird that office is still separate from the rest of eBay. Things become more interesting when I start to realize that the culture in PayPal and eBay are not only different, but almost to the point where one group tries to exclude the other. PayPal employees have name cards that are branded PayPal and most corporate documentation and corporate gifts are not shared between eBay and PayPal, even the ID cards the employees have

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EBAY US Thomas Li identify them by “eBay” or “PayPal”. When I asked some people if they worked for eBay, I would often get corrected that they work for PayPal, with one saying “not really, I actually work for PayPal but eBay owns our company”. From just a simple grounds tour, it seems that the 2 companies never truly integrated together and separation for shareholder value creation is not the craziest thought.

Capital Allocation One reason value investors shun away from technology companies is the lack of capital allocation discipline in many Silicon Valley firms. Lots of firms are acquisition friendly and have little concern in protecting shareholder’s cash. eBay is different. Having survived the tech bubble, 9/11 market crash, and the recent 2008 recession, management has learnt a thing or two about the detriments of poor capital allocation and even their earnings transcript reads much more like a Malone than a Zuckerberg.

1. Buyback

In June 2012, eBay begun to buy back their own shares with a $2bn authorization with no expiration date for the repurchase. Initially, it was not a means to return capital to shareholders but was meant to offset dilution from stock based compensation. In 2013, $1.3bn was repurchased under this program. In Jan 2014, management decided to authorize $5bn of share repurchase and has promised to aggressively buyback stock. This round of repurchase was motivated by management believing that good acquisitions and investments are scarce and return of capital to shareholders was favorable. That brings the total repurchase approval to $5.6bn at the beginning of 2014.

It is also notable that there will be an additional 10m of preferred shares issued this year. The dilution effect of that on 1.3bn shares currently outstanding is likely to be minimal, especially since eBay is buying back potentially 85 to 100mm shares (depending on the price of the buyback).

2. Debt issuance eBay issued $3bn of debt in 2Q14, increasing its cash position. That is in additional to the current $1.1bn of debt averaging a cost of 2.4%. The new debt issued are as follows:

 $250m of 0.7% due 2015  $1bn of 1.35% due 2017  $1bn of 2.6% due 2022  $750m of 4% due 2042

The interest for the new debt comes up to 2.4%, the same as what their current interest is. Despite this issue happened at a period when 10-yr treasury yield was at a 3 year high (2.95%), eBay managed to issue 3x the amount of their current debt outstanding at the same yield as before, a testament to their cash generating ability. The total debt outstanding of $4.1bn is less than the $5.6bn in buybacks to be expected. Buying back undervalued shares at a debt cost of 2.4% while still maintaining a net cash position is certainly good capital allocation at work.

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3. Credit facility eBay has a $2bn commercial paper program that is currently untapped and a $3bn credit facility since 2011. Currently untapped with no management indication that they plan to use the facility, the facility provides a significant cushion to any short term volatility that could happen in the markets and severely reduces the risk from the bonds eBay sold. eBay is well protected against credit events that could severely harm the company.

4. Acquisition history

For technology firms to survive, they often have to acquire other firms. However, overpaying or being too willing to acquire would lead to painful write-downs and value destruction. eBay so far has a good track record at making purchases. Unsurprising, given the resume of the 2 CEOs during the past 15 years (notes on their resume at the end of the document). Here are some example acquisitions.

In a widely publicized sale, eBay sold Skype at what appeared to be a loss. It was initially released that eBay bought Skype for $4.1bn but in reality, the price was lower. eBay paid $2.6bn and $530m total in earn outs for the 2 Skype founders. The total transaction value was $3.1bn. After a disastrous attempt to integrate Skype, eBay gave up and decided to sell. They first sold 70% for $1.9bn to a consortium of investors and the Skype founders and the remaining 30% was sold to Microsoft for $2.5bn. In eBay’s worst transaction to date, they made $1.4bn on a $4.1bn investment. I understand I am being optimistic by not accounting for cash burnt to integrate Skype, but taking the business at face value. It represents a 5% CAGR. Their best ROI investment to date is PayPal, which was bought for $1.5bn. Its current value is likely between $30bn to $40bn. Additional details on PayPal valuation will be in the later section, “Valuation”

5. Offshore Cash eBay has recently announced that it will repatriate its cash offshore back to the US. This gives the company an additional $6bn of cash in US but also incurs a $3bn tax bill (30% cost). The cash is expected to be used for small acquisitions or further buybacks. Many technology companies are used to having their cash stranded offshore but are unwilling to pay the repatriation tax (the difference between US tax and foreign jurisdiction tax) on the cash brought back. I believe that the proper way to think about whether the act of repatriation should be carried out is as a typical corporate finance NPV exercise. The tax bill is the cost of the exercise and the amount of net cash obtained in the process is dry powder for investing. If you can invest the cash to give a higher NPV than the cost of the taxes, then you should repatriate the cash. While some might point to how offshore cash is usually invested in money market funds, I believe that is not too material in low interest rate environment. eBay’s current acquisitions and stock both represent 20% or higher ROIs. While I believe that the best use of the cash is to buyback more stock as it is likely to be of higher return than most investments, careful

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EBAY US Thomas Li and defensive acquisitions (such as acquiring Venmo to prevent market share erosion for PayPal) could also represent reasonable investments for shareholders.

Growth

1. Marketplace growth dynamics eCommerce is a concept that is fairly common in some countries such as the US and UK but it is largely seen as a new business plan in many less developed areas, including South America and most of Asia (Even in Hong Kong and Singapore, which are extremely developed Asian cities, eCommerce is still in its infancy)

According to a report by Americommerce, eCommerce is currently a $220bn industry and is expected to grow to $370 by 2017, or 20% per year growth. According to the US Census, eCommerce is expected to grow at 14% for the next few years, while eCommerce share of commerce is expected to grow at 7% per year. Using quarterly data, eBay SSS has been 20% over the last 3 years and 17.4% TTM. In contrast to Amazon’s 24.8% SSS, eBay is really not that far behind the “eCommerce behemoth” Amazon is today.

2. PayPal

PayPal is likely to be the prime business to grow in eBay and several examples add color to that claim:

a. Management Shakeup Paypal’s ex-President, David Marcus, left PayPal to lead Facebook messenger (not Whatsapp), a move widely seen in the industry as a step down. eBay’s management has said that Marcus was not fired despite multiple rumors that he is. Accordingly to primary rumors, Marcus does seem to have left on his own accord, but the reason he made that choice appears to be at the request of management. David Marcus had a small cult-like following in PayPal but did not receive high general approval in the company. His quirky character (he would ring a giant gong if he saw someone paying without using PayPal; he sent a scathing email to all PayPal employees berating some of them for not using PayPal) mixed with his drive to create a scatter of different products (as opposed to sticking to 1 plan that will work), resulted in a gradual loss of faith from both the senior management and junior employees. Interestingly, Marcus was one of the few top managers in eBay that came from a startup background (his startup Zong, was purchased by eBay as an add-on to PayPal).

Currently, PayPal does not have a president. The hiring of a good manager that thinks in line with management is likely to be highly beneficial for the business. PayPal is arguably at a point that so long as the manager does not destroy shareholder value, and choose to act more defensive than aggressively, the company is likely to continue its market dominant position.

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b. Marketing PayPal historically do not have a marketing presence and a lot of users started their first PayPal accounts because they were eBay users. Most of the benefits from using PayPal was not advertised explicitly. Today, with the new PayPal app and a concerted marketing effort, it is reasonable to believe that the company can increase their user base with appropriate placement of advertisements. Previously, PayPal attempted to draw in customers by providing them free credit, incentivizing people to set up a zombie account to reap the one- time gain. Today, marketing efforts reflect a new mentality, one where there is a prudence in the use of cash and an understanding of better means to attach people on to the platform.

Competition The market eBay Marketplace operates in is highly competitive, many brick and mortar stores are beginning to create an online presence while there are multiple online shopping websites that compete with eBay for market share. The most significant competitor is Amazon (AMZN US), while other more niche websites such as Zappos, Gilt etc. also pose a threat. A key difference between Amazon and eBay is the source of revenue. eBay is a platform provider and transaction facilitator, Amazon is an online retailer. Amazon for all its efficiency and innovation, is fundamentally is worse off business model and will not be able to generate or sustain the margins (40% EBIT) eBay can earn. Not only is Amazon’s business highly labor intensive, it also competes almost solely on price. On eBay, sellers are not always rational sellers, some of them are more interested in selling a product than for selling it at the best price (e.g. someone who wants to get rid of furniture quickly in preparation of new furniture coming in). When prices on eBay’s site is reduced, eBay will still make a 40% margin on that sale. For Amazon, running a 0% EBIT margin means a decline in sale price is likely to detrimental to margins.

PayPal’s competition landscape is currently scattered. Square might be the closes competition but it is still essentially a hardware producing company with a software product while PayPal is a software company that attempts to use currently available hardware. Square is also a startup with a $5bn valuation on paper and has been shunned by investment banks in 2014 when the owners tried to market the business for an IPO. However, operating in one of the hottest spaces in technology has a key problem, PayPal could be blind-sighted by a new and rapidly growing start-up, very much like how Facebook blind- sighted Friendster a decade ago. At the moment, the risk of that occurring cannot be accurately quantified but I am comfortable knowing that PayPal has a dominant market share position in a network- effect heavy industry.

Valuation Comparables

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The key thing to note about comparables for eBay is that the use of any traditional comps will make eBay’s valuation astronomical, and likely inaccurate. Arguably, the tech world is in experiencing frothy valuations multiples are very high. Comping Marketplace to Amazon’s 800x will create the world’s largest company. Comping marketplace to even its own minority owned company, MELI (60x earnings and 11x sales) will still severely overvalue the business. Using MELI’s multiples, Marketplace is worth $91bn, or 1.5x the total EV of eBay today.

For PayPal, the most obvious comp will be the (soon-to-be public) Square, which received a $5bn valuation when the private owners went on roadshow this year. Square did $550mm of revenue in 2013 and a $5bn valuation in January puts that at 10x Sales. Giving PayPal such a multiple will value PayPal at $66bn, or more than the EV of eBay today.

It is not difficult to agree that a good business and a business that can legitimately grow deserves a higher (sometimes significantly higher) multiple than old, even declining businesses. However, using comps to value eBay will clearly be a mistake.

Absolute Valuation Because of a lack of granular financial data relating to Marketplace and PayPal, prudence and care have is of utmost importance when considering the multiples to use for a technology stock like eBay. Some key points to reiterate when considering the valuation for eBay are:

 Management is shareholder friendly with a 10% buyback in place and plans to be “aggressive”  The company generated $4.6bn of FCF in the last 12 months, or 8% of EV  FCF has grown at 18% over the last 5 years  Industry for both mobile payments and ecommerce are expected to grow at around 20% until 2017  eBay recently raised $3bn of debt at a negligible spread over treasuries.  Carl Icahn is currently an activist in the position and has managed to appoint someone to the 12 person board.  The firm is currently and has historically been in net cash position. Net Cash stands at $2bn today (pro-forma for new debt issued post 2Q)  The company currently trades at 9x 2015 EBITDA

Capitalization Ticker EBAY US Price $53.75 Shares Out. 1,241.2

Market Capitalization 66,715.2 - Cash & Short Term Inv estments 9,969.0 + Total Debt 7,921.0 Net Cash 2,048.0 = Total Enterprise Value (TEV) 64,667.2

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Valuation EBIT Multiple Low High Low High Marketplace 35,185.5 70,371.0 10x 20x PayPal 20,008.8 41,685.0 12x 25x MELI 460.0 920.0 .5 mkt val mkt val Craigslist 350.0 700.0 .5 mkt val mkt val eBay Enterprise (300.0) 300.0 -1x sales 1x sales Net Cash 2,048.0 2,048.0 Equity Value 57,752.3 116,024.0 Upside -13.4% 73.9% eBay offers highly asymmetric risk-rewards. Using multiples for seasoned companies for Marketplace and PayPal, we get to a downside of (13%) before factoring the share buyback. Considering that 10% of the shares outstanding will be bought back, the buyback is likely to net off part of this downside. The upside can be tremendous. In the event of organic growth without using heroic M&A multiples or comps, we establish a very significant upside.

On top of the traditional valuation, there are several options in eBay to for shareholders to realize value. First is a spinoff of PayPal. Rumors in 2Q14 and 3Q14 are that PayPal is likely to be spun-out in 2015. If these rumors were to be true, we should see investors beginning to value PayPal at a significantly higher multiples given its dominant position in one of the fastest growing industries.

Aside from that, eBay has also options to sell its stake in several of the companies it owns, while many of them are difficult for an external investor to value due to the difficulty in breaking out their individual financials, we do know that an IPO of Craigslist which eBay has a 28% stake or continued earnings growth in MercadoLibre, which eBay has a 18% stake, will lead to increasing eBay’s cash position and reap shareholders short term value. eBay also owns multiple domains, and StubHub which could be spun out.

Other Notable Facts

1. Craigslist eBay has a 28.4% stake in Craigslist. Because the company is private, the latest observable revenue figures are in 2012 when Craigslist was involved with a lawsuit against eBay. The site made $130mm in revenue and $100mm in profits in 2012 according to court documents. Having under 30 employees and a simple website, Craigslist has been running a thick margin since inception. According to a call with someone educated in that lawsuit, analysts have valued the firm at $5bn. Currently, no sellside is modelling in or considering this stake and I have yet to come across a buyside report / conversation that discusses this. In the latest 10K, eBay mentions in passing in a section which includes all the domain

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EBAY US Thomas Li names they own that “we also own a non-controlling stake in Craigslist”. While immaterial to the stock now, Craigslist represents an optionality for upside.

2. MercadoLibre (MELI US)

MELI is no stranger to the long-short community, being a stock that has been widely discussed, shared and shorted during 1Q14 and subsequently bought by several other funds since its collapse. Known as the eBay of South America, MELI is 18.4% owned by eBay and based on today’s market cap, implies that eBay’s stake is worth $930m. Like the Craigslist position, sellside and buyside are almost ignoring the fact that eBay has this minority interest. More interestingly, we note that MELI trades at a >60x earnings. A quick visit to MELI’s website reveals a great amount of resemblance to eBay’s site. http://www.mercadolivre.com.br/

3. Bill Me Later eBay provides a credit service to buyers called Bill Me Later. It is effectively a system where the buyer of a product can purchase something on credit. The company facilitates the credit provision but passes on the immediate risk to banks. Bill Me Later will then later purchase the account receivable associated with the loan made from these banks. The reason for that is offshore cash management. Unlike other large technology companies with cash offshore, eBay has an efficient way of channeling it back into the business, effectively funding a bank which chose to front a customer purchase. Most of the credit in Bill Me Later (59%) is provided by 1 bank. Silicon Valley based financial analysts indicate that this bank is very likely to be Wells Fargo. In addition, PayPal has started on a similar program, working with WebBank to finance working capital for sellers on eBay. Not only is this another similar exercise in offshore cash management, the process should increase the stickiness of customers to both the eBay and PayPal platform.

4. Baupost

Recently, Baupost, the fund run by , declared in their 13F that they own over $220mm of eBay stock. Understanding that this would represent a small (<1%) position for Baupost and considering the fund heavily favors complex instruments, this could be an affirmation to my thesis but should be taken with a pinch of salt.

Downside The short term risk to eBay is a potential sell-off in tech. With most tech stocks granted a high multiple and the IPO market beginning to cool, a sell-off would often mean that anything with a tech slant will be dumped by investors and eBay is unlikely to be sparred. That does not affect the business model and investors would be well heeded to average down in such a scenario.

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In the longer term, value can be eroded if management begins to perform acquisitions many other technology firms have been guilty of performing, by purchasing companies at expensive valuations, or worse, by doing so using eBay’s own undervalued stock. Fortunately, we have not seen management exercise such decisions. If large and expensive acquisitions are announced, it would be wise to revisit the thesis for an investment in eBay.

Recently, the CTO of eBay, Mark Carges, has sold stock in the company worth $2m. Mark joined the company in 2009 and has a total compensation package of over $4m per year, most of it in restricted stock. It is likely that he is selling stock for non-material reasons. No other significant insider has sold stock.

Selected Management History eBay’s management is a mix of business minded corporate executives, very unlike what most people would expect of a tech firm. Significantly, the 2 CEOs the company has had over the last 15 years would have been comfortable on the board of almost any company.

1. Meg Whitman Whitman is a familiar face to the business crowd. Often cited as one of the most powerful women in business and frequently talked about as one of the top CEOs in America’s history, Whitman joined eBay after graduating from Harvard Business School when it was a startup with 30 people. In 10 years, Whitman grew it from a small startup to a firm that has $8bn in revenue. She then handed the baton over to John Donahoe. Under Whitman, eBay made multiple acquisitions, with the 2 significant acquisitions being PayPal and Skype.

2. John Donahoe Donahoe was CEO of Bain & Co. before he joined eBay as CEO. Donahoe spent the first 20 years of his career in Bain (6 of which as CEO), and his early mentor was none other than Mitt Romney. Donahoe was internally promoted to CEO and has been, and likely is still, close to members of Bain Capital. As many firms in Silicon Valley focus on expanding market share and growing revenues, Donahoe is known internally as a big cost controller and efficiency driver. There is an entire department in PayPal that Donahoe has set up which investigates the best way to route payments to make use of very small discrepancies between interchange fees in different countries. (When someone uses PayPal to make a purchase, often that payment is routed through a series of different countries based on an algorithm in order to eke out a few basis points of margin for that transaction). I understand that Donahoe has a tremendous amount of support from his staff. He is seen as highly intelligent, very inspiring and personable (apparently he is at the gym 630am every day and will talk to anyone if approached).

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