After picking Ebay on Monday’s stock pick (long Ebay & Short IACI), I had hinted as to how I valued the company. Ebay is one of the original dot coms, it was part of the huge internet boom and like a select few, emerged as a survivor while so many others like Altavista, Pets.com, Lycos and others either were bought or went bust. But Ebay had carefully selected its niche and was heads and shoulders above everyone else… Since then, a lot has changed and while Ebay still has a promising future, it might now have almost nothing to do with the niche it had originally selected; Peer-to-Peer ecommerce.
Ebay was founded in 1995 and quickly became one of the best examples of how the internet would change the world. Suddenly, buying a used cd, a computer or even car was only a few clicks away. Ebay’s revenues came from modest listing fees as well as small commission on the successfully sold items. The business grew very fast and to be honest there was very little competition out there. The growing business was helped by a new Ebay division: Paypal. It became, thanks to Ebay the standard method to exchange money electronically online. It was convenient because it helped buyers and sellers settle trades more easily and with confidence. Who would have guessed that the side business would eventually overtake the whole business..
Ebay then became briefly involved with Skype, a start-up bought in Estonia in 2005 that quickly became the standard in terms of VOIP communications. It seemed like a promising project but it wasn’t clear how Skype would be integrated into the global Ebay strategy, a problem that Paypal did not have. Thus, Ebay decided to tell most of its stake back in November and concentrate itself on its core business…
Like any other company, Ebay was trying to generate more top and bottom line growth and took the wrong approach. Instead of putting efforts into gaining more users and more transactions, it decided that another strategy would be more successful. Ebay raised fees charged to sellers in an effort to increase its own revenues. That backfired big time and while Ebay did eventually bring back smaller fees eventually, but not before losing many users and a lot of momentum. Many of the sellers fled to “free listing” websites such as Craigslist. Ebay did battle it out but things have not been the same since. It might have happened anyway but it certainly happened a lot more quickly because of that momentum and Ebay has been very defensive ever since…Ebay decided to put more focus into other websites and became owner of Kijjiji and also a shareholder in Craigslist. Both moves have certainly looked a lot more like defensive moves as they helped Ebay hold on to its market share but revenue and profit growth has never been the same since…
But that other division, Paypal has done much better
Paypal, which had been created to help the auction & ecommerce portion of the company has continued to experience strong growth as it has been at the center of ecommerce throughout the web, not simply for auctions. Even businesses such as our own company use Paypal for most of their online transactions and that has resulted in climbing revenues as commerce moves online. Many services also do business with Paypal which creates recurring income streams with little to no intervention necessary… a perfect business right?
The most surprising aspect of Paypal is that no major competition has tried to compete for this huge market. Players like Google, Microsoft and Yahoo have remained on the sideline and while some solutions such as Google Checkout have been tested, they did not:
-Gain as much popularity as expected
-Offer the complete range of solutions to compete with Paypal
Because of that, Paypal has kept a significant pricing power and continues to charge high fees thus bringing high margins. Paypal now represents almost 50% of Ebay’s revenues and most of the revenue and profit growth comes from the payments unit. Ebay has talked on and off about spinning off the unit but frankly that would not make much sense.At some point, I don’t think it makes sense to consider Ebay an ecommerce/auction website and that moment is right now in my opinion. Looking at the last quarterly results, it becomes clear that Ebay will go as far as Paypal can take it.
The one company that seems to be ready to go ahead to compete with Paypal is Facebook as it prepares the launch of its Facebook credits, a virtual currency. This could be a real threat given the number of Facebook users (now over 500 million) and how much users have been trusting the social network with so much information. This could become a real threat to Paypal and will need to be monitored very closely. Paypal already knows it will lose market share because many of the games used through Facebook have been forced to use Facebook credits exclusively in the near future… how much damage it will do is difficult to judge for now but I am certain that Paypal executive are following the situation very closely.
Change of strategy…
In the past, Ebay would open its flagship websites in countries and then later on offer Paypal to those citizens. That is starting to change and in fact Ebay’s recent announcement to open Paypal to Japan is the first time that Paypal is offered to a major country without the auction website. This clearly supports our conclusion and we would now consider Paypal much more as an online bank.
Ebay trades at a very low P/E ratio, around 14 which is comparable to stocks such as AOL (AOL) and Microsoft (MSFT). I tend to find the stock attractive based on that valuation, especially considering the fact that as Paypal gains importance in the company, the growth should follow.
Here are the main pros and cons of the “new” Ebay:
-Many outstanding opportunities
-Arrival of Facebook as a competitor
-Still over half of its business from the slow growth auction/ecommerce
So I am generally bullish on Ebay, how about you? Any thoughts?