Are you an eBay addict?
Lately EBAY’s stock price has tumbled (down 20% since its mid-October high of just over $40/share), probably due to announcements regarding what some have termed “overpayment” for Skype. It’s also worth noting that the S&P 500 index has dropped just over 7% in that time frame. Sure, the purchase-Skype-move ought to be questioned, but does that make the stock not worth owning? Let’s take a look.
Quick P/E analysis
One of the first items I like to inspect when evaluating a stock is the P/E ratio, which relates the stock price to the profit the underlying company takes in. According to Yahoo! Finance, EBAY’s P/E sits at a whopping 273! To find out the Earnings portion of the P/E ratio, check out their income statement or look at their 10Q filed with the SEC. EBAY recorded a net loss of $935 million in 3Q2007, compared to many previous consecutive months of solid profit. Without the Q3 net loss, EBAY’s P/E would come back down to Earth.
Time to dig a little deeper
I’m no accounting guru, but I’ll explain my personal analysis of why EBAY lost so many peanuts in Q3: Skype. In the company’s 10Q for 3Q2007, they mention that upon analyzing their goodwill it was necessary to record a $1.4 billion goodwill impairment hit. Some might interpret that information to mean that EBAY bought Skype at a price that was $1.4 billion too high than what was fair. Ouch.
The 3Q2007 10Q explains that the final Skype-related payout will be recorded in 4Q2007, and that the payout amount is already reflected as a liability as of 3Q2007. Fair enough; I’m impressed by EBAY’s honesty here. I don’t care who you are, $1.4 billion is a lot of dough to “lose.” On the plus side, I like that the financially negative aspects of the Skype purchase will be done and over with by the end of 4Q2007. Whether Skype operations produce a profit is another issue, but the 10Q seems to indicate that, yes, Skype operations generate profit for EBAY. In fact, revenues at EBAY’s Communications segment are growing at a faster rate than any other EBAY business segment’s revenues. More numbers on this later.
What are EBAY’s business segments and how are they performing?
Speaking of business segments, what are EBAY’s business segments and how are they performing?
The 10Q breaks financial results down into three categories:
- Marketplaces (sites like www.ebay.com)
- Payments (Paypal?)
- Communications (Skype?)
Although the Communications segment lost $25 million in the 9 months Sept. 30, 2006, it generated $27 million in the 9 months ended Sept. 30, 2007. As of the 9 months ended Sept. 30, 2007, all three business segments currently are generating profits. Also, net revenues at the Marketplaces, Payments, and Communications segments are all increasing (by 25%, 33%, and 106%, respectively comparing the 9 months ended Sept. 30, 2007 vs. 9 months ended Sept 30, 2006). All this has to be good news for EBAY and EBAY shareholders.
Where does EBAY do business?
Given the recent weakness in the U.S. dollar, it makes sense to ask where – geographically – EBAY pulls in revenue. Under these circumstances I like businesses that do ... business ... overseas. According to the 10Q, as of the 9 months ended Sept. 30, 2007 international revenues made up over 50% of EBAY’s total revenues. In contrast, as of the 9 months ended Sept. 30, 2006, U.S. was the source of over 50% of total revenues. The 10Q directly states that their “foreign currency exposures have increased substantially and are expected to continue to grow.” I dig the shift.
Does the balance sheet look healthy?
EBAY’s balance sheet looks very healthy.
Long-term debt? Zero, zip, zilch.
Cash & cash equivalents + short-term investments? $4 billion on Sept. 30, 2007 vs. $3.2 billion a year ago Sept. 30, 2006, up 24%. Nice. I like cash.
How do this year’s financials compare to last year’s?
Let’s look at how much money EBAY is collecting and how much they’re spending.
Total revenue for the 9 months ending Sept. 30, 2007 totaled $5.5 billion vs. $4.2 billion a year ago same period (29% increase). Score.
Minus the Skype goodwill impairment charge, operating expenses for the 9 months ending Sept. 30, 2007 totaled $2.9 billion vs. $2.4 billion a year ago same period (20% increase).
EBAY is also netting more profit as time passes. According to Yahoo! Finance, analysts estimate 2007 EPS at 1.49 / share; for 2008 analysts estimated EPS of 1.66 / share. Take those numbers with a grain of salt; analysts can be wrong and have under-estimated EBAY’s EPS for the last few quarters.
Of course there are other factors to consider, but I really like that EBAY is increasing revenues faster than it’s increasing spending (29% vs. 20% respectively over the periods mentioned above). Oh yeah, and EBAY is making more profit.
Is management actively increasing shareholder value?
You bet. One common way to increase shareholder value is for the company to buy back shares. As of January 2007, EBAY’s board of directors had authorized share repurchases totaling up to $4 billion ($2 billion authorized in 2006; another $2 billion authorized in 2007). As of the end of 3Q 2007, EBAY had spent $2.8 billion buying back stock. $4 billion authorized - $2.8 billion spent = $1.2 billion: the amount the company may spend repurchasing shares through January 2009. The average price per share paid during these repurchases is $31.63, but in 2007 the average price per share paid for repurchases was $33.31.
Remember that decreasing the number of outstanding shares generally increases shareholder value. Think of shares as small slices that together make up a company ownership pie. If the company makes money and reduces the number of slices, then each slice is bigger – i.e., each share becomes more valuable.
With this in mind, like most public companies EBAY provides its employees a stock option compensation plan. In analyzing changes to the number of outstanding shares, we should also examine outstanding stock option grants. According to the 10Q, as of January 1, 2007 options grants could add up to 136 million shares into the pool. As of Sept. 30, 2007 options grants could add up to 125 million shares, with an average grant price of $10.51 / share, into the pool. Throughout the year, new options were granted (for 20 million shares), some were exercised (19 million shares), and some were forfeited/cancelled/expired (12 million). I find it interesting that so many shares were forfeited/cancelled/expired – only 7 million less than how many were exercised. Go figure.
Anyways, what does it all mean? It seems that the company has repurchased more shares than have been added to the pool in the form of exercised options, so overall there are fewer EBAY shares available now vs. a year ago (1.36 billion outstanding as of Sept 30, 2007 vs. 1.43 billion outstanding as of Sept 30, 2006 – a net reduction of 72 million shares). I wouldn’t be shocked if we were to see another repurchase authorization by 1Q2008, but of course I have no clue if that will happen.
Management is increasing shareholder value. Hooray!
Conclusion
EBAY looks to be a solid company that’s doing more business and making more money over time. With EBAY trading at just under $32 / share as I write this, is EBAY a good buy right now?
I could be wrong, but EBAY looks good to me, right here and right now. Always use your own judgment and conduct your own analysis before making investment decisions; what I’ve written here are my personal thoughts.
A fun exercise?
How high will EBAY trade within a year? I have no friggin’ clue and neither do you, but for fun I’ll take a guess. I think analysts’ estimates for profit (EPS of 1.66) next year are a little low, in part because I think we’re going to see another share buy-back announced soon. Solid profits + share buy back = increasing EPS.
Let’s suppose 2008 EPS is 10% higher than the predicted 1.66, which brings us to ~1.80.
Suppose analysts are right that 2007 EPS will be 5% higher than the analyst-predicted 1.49 => 1.56 (not including the Skype goodwill impairment charges). The EPS growth rate, then, could be (1.80 – 1.56) / 1.56 = 15% year over year.
Cramer (yes, I read Cramer’s insights and watch his show occasionally) often mentions that people pay a P/E of 2x the growth of a growing stock. This in mind, 15 (% growth rate) x 2 = 30 predicted P/E. Since EBAY has no long term debt and such a strong cash position, I think a P/E of 30 sounds reasonable.
EPS x P/E = share price.
1.80 x 30 = $54.00. There you have it. I’m probably wrong, but I’m officially guessing that EBAY will trade as high as $54.00 within the next year. I have no shame and I’m ready to be wrong!
Full disclosure: At the time of writing, I do not have any position (short or long) in EBAY. Admittedly, after writing this article I’m seriously considering initiating a small position.
Leave a comment