eBay’s Demand Problem Worsens; Should They Revisit Yahoo If Microsoft Doesn’t?

According to Jeffries & Co analyst Youssef Squali, while eBay’s quarter to date listings is growing a healthy 39% YoY and is above his estimate for the quarter, traffic to the site has fallen by 11% year-over-year in October and November. eBay continues to have difficulty attracting users to the site mainly because the auction’s business has lost favor with consumers who are shifting to fix price platforms like Amazon.

Squali also points to weakness in autos, which represents 30% of GMV as a big negative. However, he expects eBay to meet the lower end of guidance.

If the business does not improve, the analyst thinks that portends the sale of both PayPal and Skype, both of which would be catalysts for the shares. I assume he means management would use the cash to repurchase shares or make a special one-time payment to investors rather than plow it back into acquisitions. Or that since both are low margin businesses, then their exit would imply a higher multiple for the company as whole, although I doubt that. I think the sale of Skype is inevitable given the lack of synergies with the core operations but I believe that the payments business should stay with the portfolio. If eBay sold the payments business, it would see the current synergies slowly erode due to lack of control.

eBay's business model is one of the few web models, like online personals, that has matured. What ultimately becomes of this company is still a mystery to me. Several options have floated around in the past like merging with Yahoo or Google. Both options are unlikely in the near-term, in my opinion, but if Microsoft fails to act on Yahoo in any capacity, then maybe the managements of both Yahoo and eBay can revisit that option in 2010. The rationale for combining the two is an exercise for a later date. But I leave it as just a thought for now.

There is still a market for online auctions so management can continue to bleed that business for cash while investing in growing the fixed price business to better compete with Amazon. I would also continue to invest in payments to build out the Merchant Services business. Now that Bill Me Later is in the portfolio, eBay can have a run of the payments business on the web given largely failed efforts by others such as Google. I would also continue to invest and make acquisitions along the classifieds businesses and focus on better monetizing traffic through advertising. Other things on the to do list include: 1) rehauling the website, and I don’t mean redesign, I mean a huge technology upgrade; 2) license either Yahoo or Google’s search technology in order to have better search on the site. Clearly, they haven’t been able to do it on their own; and 3) keep working on getting users back on the site.

If the overall market recovers, then eBay could likely recover with it – the rising tide thing. But on ts own, I think the shares remain range bound. Trading at 5x EBITDA, I think downside is limited here, but wouldn’t chase the stock as there are more attractive investment opportunities in the space. Certainly I see few near-term catalysts for the shares short of a takeover attempt.

From Jeffries & Co Analyst Youssef Squali
We are tweaking our estimates to reflect weakness in traffic and a
sharp slowdown in autos. We're maintaining a Buy rating and $22 PT.

• Our proprietary tracking of eBay shows that global listings are up a
solid 39% Y/Y QTD (with US +52% Y/Y), for an estimated total of
850-880M for 4Q (+36% Y/Y at the mid-point), and well ahead of
our initial projection of 723M. While this points to significant
improvement in selection, weaker traffic trend reported by
comScore (see Exhibit 2), and negative auto reports (~30% of
GMV) imply that conversion rates and average GMVs will trend
lower, both sequentially and Y/Y.

• Traffic data shows that unique visitors to eBay declined 11.2%Y/Y
in Oct. and 10.9% Y/Y in Nov. while total visits declined 21.9% and
24.6% in these periods. This trend continued into the
post-Thanksgiving shopping season, with last week's data showing
uniques declining 9% Y/Y between Dec.1-5.

• What's been ailing eBay has been a consumer shift to fixed prices
(as per Amazon's results) and away from auctions. With the
maturation of eBay's core auction (down 8% Y/Y in 3Q08), it's
taking the company some time to move to a predominantly fixed
price format where it is doing relatively well (up 11% in 3Q08).

• Also positive, payments should show healthy growth from a) higher
penetration of PayPal on eBay, b) growth in Merchant services and
c) acquisition of Bill Me Later. For 4Q, we're conservatively
expecting growth of ~8% Y/Y vs. 29% Y/Y in 3Q.

• Overtime, we expect GMV growth to improve as the economy
recovers, as fixed price becomes >50% of GMV and as tweaks to
marketplace take effect. Failing this, a recap. through a sale of
Skype and/or a spin-off of PayPal becomes inevitable. Such a
move should prove positive for the stock.

• Bottom line, we expect eBay to make the quarter, albeit towards the
low-end most likely. We are tweaking our 4Q revenue estimate to
$2.09B from $2.12B while leaving PFEPS unchanged. For FY09,
our revenues remain unchanged but our PFEPS goes to $1.48 from
$1.53, on lower interest income and correction for a charge.

• The current valuation of $14.61/share implies a mere 2.0x our FY09
estimated EBITDA for the marketplace biz (Exhibit 1.) Our analysis
applies a market multiple of 9x for Paypal (the average EV/EBITDA
multiple for Visa and MasterCard), 8x for marketing services and
$1B for Skype. A more reasonable multiple for marketplace of ~5x
would imply $21 fair value, roughly in line with our DCF valuation.

Valuation/Risks
EBAY is trading at 4.8x EV/EBITDA and P/E (GAAP, FT) of 16.7x on
FY09 estimates vs. the avg. for big Cap. Internets at 7.4x and 25.7x.
Our $22 PT is derived using a 5-year DCF. Risks include protracted
economic slowdown/lack of traction on newer initiatives.