EBay Inc (NASDAQ: EBAY) manages eBay, an online auction and shopping website. EBAY was founded in 1995 and now has a presence in 40 countries. Over the years it has expanded to include standard shopping, barcode shopping (Half.com), online classified advertisements (Kijiji or eBay Classifieds), online event ticket trading (StubHub), online apartment listing (Rent.com), online shopping comparison (Shopping.com) online money transfers (PayPal), local sales (Milo.com) and fashion sales (Brands4Friends). EBAY has 17,700 employees and is based in San Jose California. The company generates revenue through various fees including a fee to list an item and another fee once the item is sold. PayPal also charges fees to the seller for payment processing services.
EBAY is cashing in on the growth in e-commerce and will continue to do so for years to come. E-commerce has grown massively particularly over the last 10 years, and it is expected to continue to grow at a decent rate many years to come. This massive growth in the e-commerce marketplace is being fought over between EBAY, Amazon (AMZN), Google (GOOG), and Yahoo (YHOO).
As a technology company EBAY needs to keep evolving in order to keep up with ever changing trends and demands. EBAY, through its numerous acquisitions (both large and small) gains revenue through a variety of sources which the company categorizes under 2 business segments – Marketplaces and Payments. Importantly, the company is a good generator of cash – over the last 10 years the company has reported net earnings of over $10B, and achieved Free Cash Flow of over $14B. This cash allows the company to acquire smaller companies that have perhaps come up with a new solution that will complement EBAY’s existing operations – it helps allow EBAY to keep up with the competition.
Consumers are shopping more and more on mobile devices, and EBAY has positioned itself well to capitalize on that growing market. By the end of 2010, EBAY mobile apps had been downloaded more than 30 million times, in eight languages, across 190 countries. In 2010 mobile payment volume was 5 times that of 2009. More than 2.5 million people have downloaded PayPal’s mobile apps.
EBAY's earnings have been a bit erratic over recent years probably due to acquisitions being bought (increasing revenue), and other acquisitions being sold (decreasing revenue). The sale of skype benefited EBAY through a big wad of cash on the balance sheet, but the sale also reduced revenue.
The glaringly obvious issue with EBAY’s Quality Rating is its poor Normalized Return on Equity. A company with a poor Return on Equity is not one that is particularly profitable with the use of Shareholders Equity. EBAY’s reported Shareholders Equity is around $16, and it also reports goodwill of $8B. It may need to write down some of its goodwill over the coming years. Its poor NROE has serious implications on the calculation of Intrinsic Value:
If an investors’ Required Return for the stock is higher than its Return on Equity, such as the case here (EBAY’s Forecast Average Normalized Return on Equity is 12.6%, rounded up in the Intrinsic Value display), then the Intrinsic Value of the company is less than its book value. The easiest way to explain this is for you to consider a business that is available for you to buy for $1M in cash, and it makes $100K per year (10% return on your equity), but you want to receive a 12% return on your $1M. In this case you wouldn’t pay the $1M because the $100k per year does not meet your required return of investing in the business. This is obviously a simplified example, but important none-the-less.
EBAY has been popular with market participants because it is one of the leaders in e-commerce, an industry in the spotlight and one likely to continue to grow. The performance of EBAY has not matched the expectations of the market. If EBAY can achieve higher rates of Return on Equity in coming years its Intrinsic Value will appreciate considerably.
A lot has been written recently regarding the likely introduction of an online sales tax bill which will bring online retailers in line with traditional retailers.
The rules as they currently stand are: For the majority of states, if an individual or entity sell goods via the internet and ship them to the consumer in the same state, then they will need to collect sales tax from the buyer, and in turn pay that tax to the state. This applies when the seller has a physical presence in the state. The reason that the rule typically only applies when the seller has a physical presence in the state is that for a small online retailer, collecting sales tax from all buyers, then distributing the correct amount to each of the 50 states would be a nightmare.
Already around 5 states have introduced requirements that out of state retailers collect sales tax and pay those states the amount collected, but this practice is messy and is not commonly adhered to.
The new legislation in the US Senate proposes that internet retailers collect sales tax on all purchases from all states, regardless of whether or not they have a physical presence in the state. The bill proposes to simplify and streamline the process and give more authority to the states in enforcing the payment of sales taxes from online sellers. The states would need to adopt the standardized administrative procedures laid out at Federal level. Each state would have the option of joining the new system or keeping things the way they are.
If passed, the new bill will create more paperwork for eBay sellers (although the intent of the bill is to make it simple – there will certainly be some headaches for smaller online retailers, at least initially), as well as making purchases more expensive (due to the additional tax) and hence slightly less attractive to the consumer.
Under the current proposal, sellers with less than $500k in sales per year would be exempt, but there aren’t many businesses that have less than $500k in sales. At a 10% net margin, $500k in sales provides net income of only $50k. It would only be Moms and Dads selling their used goods on eBay who won’t be affected by the bill.
Amazon is all for the bill – they know that they offer the best prices with or without sales tax added on. Amazon knows that the sales tax bill would be applied also to all of its competitors – such as retailers on eBay. The bill would make Amazon’s competitive position stronger, and every small online retailer slightly weaker.
Both eBay and PayPal collect fees based on a percentage of the total purchase price, so with the additional price caused by a sales tax, their fees and margins would actually increase.
The new legislation would have implications to EBAY, as a lot of its retailers would be affected. The competitiveness of online retailers as a whole would not be expected to change dramatically though – due to other cost advantages, online retailers would still provide better prices than traditional retailers. And though the increase in prices due to the tax will bring online prices closer to that of physical retailers, the convenience of buying online is not diminished. Currently consumers enjoy the convenience of buying online paying prices at a large discount to physical retailers, and if the bill is passed consumers will still enjoy the convenience of buying online but will be paying prices at a smaller discount to physical retailers.
Based on the premise that as time goes by more and more people will shop online, EBAY will be expected to continue to grow their business. But investors keen on EBAY will be looking for 2 things before they consider a purchase – 1) the company increases its profitability as measured by Return on Equity, and 2) a decent Margin of Safety emerges through either a decrease in the share-price, or an increase in the Intrinsic Value of the business (which will come about if point 1 comes to fruition).