Here Are The Key Drivers And Barriers For eBay’s Business (Part 1/2)

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eBay’s (NASDAQ:EBAY) business has under-performed during the recent past, with revenue growth particularly stumbling in its marketplaces segment. This has also caused weakness in its stock price, which has barely appreciated during 2014; after correcting to $48 post the third-quarter earnings release, its stock price has now returned back to $55 levels. In this first part of a series of two notes we are publishing on eBay, we analyze the principal tailwinds in eBay’s business and in the second part, we stack them against the key barriers to assess where the company could gain or lose going forward. We also call out our views against each of these factors, to underscore our $67 valuation for the company’s stock.

We believe the rapidly growing payments business represents one the leading drivers for eBay’s business. We expect the over 20% growth rate in this segment to persist in the future driven by massive demand in the mobile commerce market, which is expected to be valued at $721 billion globally by 2017 (according to Gartner). PayPal’s leading market position and product innovations will enable it to capture a large chunk of this opportunity. In addition, the marketplaces segment will gain significantly from the secular shift towards e-commerce being seen in the retail market. The global business-to-consumer (B2C) e-commerce market could surpass $2.3 trillion by 2017 (according to eMarketer). Notwithstanding the current headwinds being faced in this segment — eBay has several competitive advantages which include a  strong network effect and brand recognition, and this will magnify demand in the marketplaces segment.

eBay’s asset-light business model delivers high cash flows and margins — its trailing twelve months free cash flow and operating margins were recorded at 26% and 20%, respectively. Moreover, the upcoming spin-off of PayPal next year will unlock additional shareholder value.. Both segments face unique challenges  and a separation will allow them to better align their strategies, capital allocation, and cost structure. 

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Payments Business Is Growing Rapidly: Despite the recent weakness being seen in the marketplaces segment, eBay’s payments business is showing promising growth. The segment’s revenue and total payment volume (TPV) rose by 20% and 29% respectively during the third quarter of 2014. And during the nine months ended September, 2014, the same metrics increased by 19% and 28% respectively.

We expect the high growth rates in this segment to persist in the future, due to PayPal’s strong brand image and leading position in the mobile payments market. Mobile payments volume increased by 72% during the last quarter, and accounted for 20% of the total payment volume. The mobile payment market is expected to see explosive growth in the future — global mobile transactions value is forecast to rise from $235.4 billion in 2013 to $721 billion by 2017, according to Gartner. [1] Increased demand, combined with continued product innovations and higher flexibility post the spin-off, will allow PayPal to capitalize heavily on this market opportunity. Another positive trend is increasing proportion of merchant services in net TPV (as compared to on-eBay net TPV). Merchant services comprised for around 73% of overall net TPV during the nine months ended September 2014, as compared to 69% in a similar period a year ago. This means PayPal is less reliant on eBay for its business and could continue to grow at a strong pace, upon becoming an independent entity.

Robust Long-term Growth Opportunity In The Marketplaces Segment: The global business-to-consumer (B2C) e-commerce market is forecast to expand from $1,251 billion in 2013 to $2,357 billion by 2017, according to eMarketer. And sales in the North American market is expected to surge from $431 billion to $660 billion, during the same period.  ((Global B2C Ecommerce Sales to Hit $1.5 Trillion This Year Driven by Growth in Emerging Markets, eMarketer, February 3, 2014)) We expect eBay to gain from this secular shift towards e-commerce in the worldwide retail market. We believe the current weakness in the marketplaces segment is a short-term trend.  eBay has a tremendous economic moat in its business due to its network effect, which encompasses tens of millions of sellers and over 150 million active buyers.  It also possesses huge cash reserves and strong brand recognition — hence, we expect growth to accelerate in the marketplaces segment during 2015. In addition, the high growth in the e-commerce market will also result in incremental demand for PayPal.

Business Model Is Asset-light Leading To High Cash Flows And Margins: In contrast to Amazon’s inventory-owned model, eBay has a marketplace business model, which facilitates transactions between buyers and sellers. This model is asset-light, requiring fewer investments on warehousing, distribution, delivery centers, etc., which allows the company higher margins and cash flows. eBay’s trailing twelve-month free-cash flow and operating income as a percentage of revenue stood at 26% and 20%, respectively. In stark comparison, the same metrics for Amazon were seen at 1.3% and 0.1% respectively. Hence, even while eBay is currently facing challenges in its marketplaces segment, it’s not hard to see which company is more successful, when it comes to generating return for shareholders.

Spin-Off Could Unlock Shareholder Value For Both Businesses: In a previous note, we had highlighted that the recent decision to spin-off PayPal will unlock significant shareholder value. We believe the valuation of the two companies independently will be higher than as a whole. While PayPal has significantly benefited from its integration with eBay in 2002, the competitive landscape has now changed considerably in both the segments. The competition in the payments business will intensify with the recent launch of Apple Pay, and the spin-off will allow PayPal’s management to more closely tackle these risks. In addition, the separation from eBay  could also throw open the opportunity of PayPal partnering with other leading giants such as Google, Alibaba, Facebook, etc.

The resulting eBay will also benefit from this development as the opportunities and risks are much different in the e-commerce business. The recent cyber attack in May, which impacted eBay’s sales drastically, raised questions related to management’s ability to identify and mitigate these risks. Hence, post the spin-off, we expect eBay to more effectively deploy its resources in managing operations in the marketplaces segment.

In the second part of this series (soon to be published), we stack up these drivers against the barriers in the company’s business model. We’d highly encourage you to go through this second part as well.

Our $67 price estimate, represents near-20% premium to the current market price.

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Notes:
  1. Gartner Says Worldwide Mobile Payment Transaction Value to Surpass $235 Billion in 2013, Gartner, June 4, 2013 []