2012 2013 2014(E) 2015(E)
Cash And Equivalents 6,817 4,494 3,825 5,773
Total Debt 4,519 4,123 4,098 3,267
Interest Expense — — — —
EBITDA 4,089 4,771 5,370 6,052
Debt to Book Capital 0.2 0.1 0.2 0.1
Quick Ratio 2.0 1.8 1.7 1.8
Debt to EBITDA 1.1 0.9 0.8 0.5
EBITDA to Interest Expense — — — —
2012 2013 2014(E) 2015(E)
Sales 14,071 16,047 18,204 21,040
% Change 20.8 14.0 13.4 15.6
EBIT 2,889 3,371 3,788 4,315
% Net Sales 20.5 21.0 20.8 20.5
Net Income 3,100 3,555 3,716 4,211
% Net Sales 22.0 22.2 20.4 20.0
Free Cash Flow 1,957 2,132 156 3,657
% Net Sales 13.9 13.3 0.9 17.4
Prior Year Prior Quarter Current
Market Equity 70.21 Bil 71 Bil 69.99 Bil
Preferred — — —
Debt 4.52 Bil 4.12 Bil 4.13 Bil
EBay has some room to fund share repurchases with additional debt.
Joscelyn MacKay
joscelyn.mackay@morningstar.com
Credit Analysis as of 02 Jun 2014 Business Analysis as of 10 Jun 2014 Estimates as of 10 Jun 2014
Credit Perspective 02 Jun 2014
We view eBay's cash repatriation positively from a credit perspective, in light of its new share-repurchase authorization. In January, eBay added $5 billion to its share- repurchase authorization, bringing the total to $5.6 billion.
Given shareholder activist involvement in the company, there was concern that eBay would issue debt to fund share repurchases, perhaps to the detriment of its credit rating.
In our view, the cash repatriation diminishes, although does not eliminate, this risk. Management said the cash would be used for U.S. acquisitions and share repurchases.
Smaller, bolt-on acquisitions in the few hundred million range are a potential, but larger acquisitions such as Mercadolibre or Square (around $4.0 billion and $2.0 billion, respectively) may also be considered. A larger acquisition could lead to a debt issuance to save some dry powder for share repurchases and other investments. Still, eBay's leverage is below 1 times, and we believe the firm has at least $1 billion in additional debt capacity within its current rating.
Marketplace innovations and an expanded portfolio of payment technologies have reshaped wide-moat eBay into a major commerce hub. Amazon may hold the title of top destination for U.S. online shoppers, but we believe eBay will remain relevant in the years to come due to a desire to partner, not compete, with other merchants and enable them to compete in the converging world of online, offline, and mobile commerce. Our positive outlook is supported by recent PayPal and Marketplaces active user growth and resilient margins despite customer experience and engagement, cross-border, and PayPal investments. We're also intrigued by eBay's exposure to mobile commerce and estimate that around 40% of new Marketplaces and PayPal users in 2013 came from mobile devices.
EBay provides an online trading platform in more than 40 markets of various sizes across several product categories. With $76 billion in global gross merchandise volume in 2013, eBay facilitated around 8% of the $1 trillion-plus global e-commerce market. PayPal's net total payment volume was $180 billion in 2013, or roughly 20% of the global online payment business (excluding food/grocery and online travel). The 2011 acquisition of GSI Commerce expanded eBay's online commerce management, fulfillment, and marketing capabilities.
Issuer Profile
Credit Metrics (USD Mil)
Operating Summary (USD Mil)
Capital Structure
Source: Morningstar Committee members voting on rating do
not own securities issued by the company.
Currency amounts expressed with “$” are in U.S. dollars (USD) unless otherwise denoted.
Contents
Summary Credit Analysis Business Analysis Analyst Notes
Morningstar Analyst Forecasts Comparable Company Analysis Methodology
Updated Forecasts and Estimates from 10 Jun 2014
1 2 4 9 14 17 18
2014(E) 2015(E) 2016(E) 2017(E) 2018(E) Cash and Equivalents (beginning of period) 4,494 3,825 5,773 9,747 10,613
Adjusted Available Cash Flow 705 4,466 4,970 3,864 4,199
Total Cash Available before Debt Service 5,199 8,291 10,743 13,611 14,812
Principal Payments -413 -19 -850 — -1,000
Interest Payments — — — — —
Other Cash Obligations and Commitments -270 -294 -321 -331 -352
Total Cash Obligations and Commitments -683 -313 -1,171 -331 -1,352
USD Millions
% of Commitments
Beginning Cash Balance 4,494 116.7
Sum of 5-Year Adjusted Free Cash Flow 18,204 472.7
Sum of Cash and 5-Year Cash Generation 22,698 589.4
Revolver Availability 1,000 26.0
Asset Adjusted Borrowings (Repayment) — —
Sum of Cash, 5-Year Cash Generation, Revolver and Adjustments 23,698 615.3
Sum of 5-Year Cash Commitments -3,851 —
EBAY Sector Universe
Business Risk 2 5.2 5.1
Cash Flow Cushion 3 5.9 6.1
Solvency Score 5 5.2 4.8
Distance to Default 1 4.1 3.9
Credit Rating A+ BBB BBB+
Five Year Adjusted Cash Flow Forecast (USD Mil)
Cumulative Annual Cash Flow Cushion
Cash Flow Cushion Possible Liquidity Need
Adjusted Cash Flow Summary
Credit Rating Pillars Peer Group Comparison
Source: Morningstar Estimates
Note: Scoring is on a scale 1-10, 1 being Best, 10 being Worst
Financial Health & Capital Structure
EBay is in excellent financial shape. Total debt stood at approximately $4.1 billion as of March 2014 with an average effective interest rate of 2.3% against $11.9 billion in cash, short-term investments, and long-term investments (including approximately $9.7 billion held outside the U.S., which helps to finance its Bill Me Later loan receivables portfolio). With coupons ranging between 0.70% and 4.00%, we view eBay's July 2012 $3 billion bond deal as favorable for equity shareholders, as it provided the company with a low-cost vehicle to fund share repurchases as opposed to using cash currently held overseas (which would be taxed at the U.S. corporate rate of 35% upon repatriation).
Leverage stands at less than 1 times trailing 12-month EBITDA and net debt is negative. Cash on hand easily exceeds debt obligations, and we believe eBay will continue to generate strong free cash flow over the near future (we've forecast roughly 20% of total revenue over the next five years, excluding offshore cash repatriation tax charges), giving us little reason for liquidity concerns. With approximately $3.7 billion of free cash flow generated during fiscal 2013 and expectations of almost $4 billion annually over the next five years, we estimate eBay's Cash Flow Cushion (cash on the balance sheet and future cash flow divided by debt and debtlike commitments during the next five years) is around 7 times. This implies that the company should have little difficulty satisfying its debt obligations and more than enough liquidity to facilitate share repurchase activity. We assign an issuer credit rating of A+, implying low default risk.
EBay's capital structure strikes us as conservative, and we believe the company can simultaneously support additional leverage, invest in new technologies, accelerate share-repurchase activity, or consummate acquisitions.
We're intrigued by management's recent decision to take a
Credit Analysis
$3 billion foreign earnings tax charge to facilitate the potential repatriation of $9 billion in offshore cash, and free up $6 billion of cash availability. We agree with management's plan to use this cash for acquisitions to bolster its core businesses and extend its international reach, invest in new technologies, fund consumer credit initiatives, and repurchase shares, though we'd also prefer that eBay balances incremental leverage with repatriated cash to fund these initiatives given its current capital structure. We doubt eBay will return capital to shareholders in the form of a special or quarterly dividend in the immediate future, but the probability becomes greater as the company builds cash in the later years of our 10-year explicit forecast period.
Enterprise Risk
We have assigned eBay a medium uncertainty rating. A constantly evolving e-commerce landscape could also be disruptive to eBay's different networks. Additionally, with traditional growth drivers like auctions nearing maturity, eBay has turned to new platform innovations, acquisitions, and overseas expansion to reinvigorate top-line growth. The company has introduced several changes geared toward fueling growth in fixed-price transactions, including modified fee structures, new search functionality, and a loyalty program. Although the company has had some success with these measures, they could also alienate eBay's loyal auction community and diminish its network effect. We believe eBay's recent acquisitions have been complementary to its core business segments, but integrating so many businesses simultaneously can be distracting to other growth initiatives. International growth brings unique challenges, as foreign governing bodies are constantly amending online commerce laws. With respect to payment volumes, PayPal faces increased competition from Login and Pay with Amazon, V.me by Visa, Isis, PayPass by MasterCard, and ChaseNet from JPMorgan Chase.
PayPal's lending arm, Bill Me Later, also exposes the
company to increased consumer credit risk.Although Carl Icahn withdrew his proposal to spin off PayPal into a separate company in April 2014, we acknowledge that future activist shareholder involvement could lead to increased share price and free cash flow volatility over the near term. However, we agree with management that the Marketplaces and PayPal business units possess meaningful customer acquisition, data, and growth initiative funding synergies, and would consider a full separation of the Marketplaces and PayPal businesses to be value-destructive.
Investment Thesis
Marketplace innovations and an expanded portfolio of payment technologies have reshaped eBay into a major commerce hub. Amazon may hold the title of top destination for U.S. online shoppers, but we believe eBay will remain relevant in the years to come due to a desire to partner, not compete, with other merchants, and enable them to compete in the converging world of online, offline, and mobile commerce.
In our view, the market has underestimated eBay's potential as a commerce facilitator, the result of the revamped Cassini search engine, increased free and same-day shipping options, and store-level merchant tools. In our view, merchants also find eBay Enterprises' fulfillment, warehouse, payment, freight, and customer service offerings compelling, while mobile applications and payment services and in-store PayPal tests provide longer-term growth optionality.
Our positive long-term outlook is supported by recent PayPal and Marketplaces active user growth, and resilient margins despite customer experience and engagement, cross-border, and PayPal investments. We're also intrigued by eBay's exposure to mobile commerce, and estimate that around 40% of new Marketplaces and PayPal users in 2013 came from mobile devices. Many of these mobile users are younger customers with lower disposable incomes, often from emerging markets, but also a lifetime of potential transactions ahead.
In our view, planned take rate cuts to stimulate buyer and seller growth, additional payment enhancements, and offline channel investments will solidify eBay's network effect--the foundation of our wide economic moat rating.
We're also intrigued by the recent decision to take a $3 billion foreign earnings tax charge to facilitate the potential repatriation of $9 billion in offshore cash and free up $6
billion of cash availability. We agree with management plans to use this cash for acquisitions to bolster its core businesses and extend its international reach, invest in new technologies, fund consumer credit initiatives, and repurchase shares, though we'd also prefer that eBay balances incremental leverage with repatriated cash to fund these initiatives given its current capital structure.
Economic Moat
EBay's Marketplaces business unit is a classic example of a network effect, where the value of the network grows as the number of users increases. We believe this network effect is evident in Marketplaces' 145 million active buyers, which has grown at a low-double-digit clip the past two years. This network effect creates switching costs for buyers and sellers and barriers to entry for eBay rivals, which has forced several would-be competitors to shut down competing marketplace platforms. The network effect is not nearly as strong in the faster-growing, fixed-price transaction business as it is in eBay's legacy auction business, but we think the company's scalability and technology investments provide it with competitive advantages in this channel and should preserve the firm's wide moat. EBay's strong profitability and cash flow--we estimate that the Marketplaces segment's operating margins will continue to hover around 40% over the next several years--allow it to enhance its network effect by continuously reinvesting in technology and marketing enhancements to maintain a vibrant marketplace for third-party sellers.
We believe eBay's desire to partner, not compete, with other merchants makes it an intriguing player in the evolving world of commerce while also bolstering its network effect.
As eBay has shifted away from its auction business (which represented approximately 30% of Marketplaces volume and less than 20% of total revenue in 2013), it has reinvigorated its fixed-price platform (70% of marketplaces
Business Analysis
volume and one third of total revenue) through the overhauled Cassini search engine, free and expedited shipping offerings (including an expanded assortment of same-day delivery options), mobile applications capabilities as well as complementary acquisitions such as local shopping and private sale sites. As a result, eBay has experienced strong third-party growth in the clothing, shoes, and accessories (CSA), home/garden, and health/beauty categories in recent periods, and we expect other categories to see a similar lift over time. Our base case assumes that fixed-price transactions will grow at a low-teen average annual pace over the next five years, more than offsetting our expectations of flattish auction volume trends over the next decade.
PayPal, which represented 41% of eBay's revenue in 2013, also benefits from a strong network effect. Buyers are attracted by the convenience (one-click purchases and multiple options to fund transactions), security features, and mass acceptance of PayPal, while sellers are attracted to the large user base, lower fraud rates, and closed-loop payment system. This network effect was originally established among third-party sellers on eBay Marketplaces (where PayPal now processes 79% of eBay's global gross merchandise volume) but now extends across a much wider audience of online merchants. We estimate that PayPal is already accepted by approximately 11 million active online sellers worldwide (including 70 of the top 100 online retailers in the U.S. and more than 60 of the top online retailers in the European Union) and processes more than 20% of global online retail transactions (excluding food/grocery and online travel). With more than half of the world's Internet users coming from developing countries and with low emerging-market penetration rates, we also believe PayPal's network effect is well positioned for tremendous emerging-market growth. PayPal payment volumes have grown at a 25% compound annual rate the past five years--about 3 times as fast as the online retail
market, according to Forrester--and we anticipate this outperformance will continue.
We expect PayPal to sustain its strong momentum by capturing a larger share of the online, mobile, and offline payment market. With 148 million active accounts globally, PayPal is already a leading standard for online payments.
Although Visa and MasterCard boast a larger number of active general-purpose accounts on a global basis (according to PaymentsSource data), PayPal's payment volume continues to grow at a much faster clip. We expect PayPal's payment volumes to grow at an average annual rate in the high teens over the next five years, driven by increasing consumer adoption of mobile commerce (PayPal generated $27 billion in mobile payment volume during 2013), offline point-of-sale capabilities (including PayPal acceptance at more than 7 million U.S. retail point-of-sale systems--roughly 90% of all retailers in the country--through its partnership with Discover), and other payment innovations (including Zong's ability to verify and clear payments through existing wireless carriers). Through Bill Me Later, we also believe PayPal has a sizable opportunity in extending credit to consumers, which has an additive impact on transaction margins, average annual spending levels, funding costs, and conversion rates.
We believe PayPal's recent active user growth trends should help to assuage investor concerns about recent digital wallet launches from potential rivals, including Login and Pay with Amazon, V.me by Visa, Isis, PayPass from MasterCard, and ChaseNet from JPMorgan Chase. Because of the time and effort required for consumers to link bank accounts and upload credit card information to a new digital wallet, we believe it will be difficult for these emergent players to siphon customer traffic from PayPal unless they offer substantially more benefits to consumers, something that is not apparent at this time. Taking this all together, we think PayPal has also developed a wide economic moat.
The 2011 acquisition of GSI Commerce (now called eBay Enterprises) also augmented the company's network effect, in our view. eBay extended the reach of its merchant services offerings (which includes online payment processing, fulfillment/Ship-from-Store, warehouse, payment, freight, and other customer service solutions) by adding GSI's e-commerce client base, which currently includes almost 200 retailers and brands like Fifth & Pacific (the parent company of Juicy Couture, Lucky Brand, and Kate Spade), Ralph Lauren, and Victoria's Secret. Additionally, eBay Enterprises can offer its client base enhanced payment capabilities (approximately 95% of which offer PayPal and/or Bill Me Later), wider geographic reach, and access to any developing e-commerce trends. We expect that eBay Enterprises will become an increasingly important partner for traditional retailers and other large consumer brands looking to expand their electronic and mobile commerce presence, with a portfolio of commerce tools that could also be utilized by new Marketplaces sellers in the years to come.
Moat Trend
We assign eBay a positive moat trend, based primarily on expectations of continuing momentum in its payments ecosystem the next several years. PayPal's key operating metrics, including active users, transactions per active account, and sellers accepting PayPal, are all moving in the right direction and should maintain healthy growth trajectories in the years to come, especially when factoring in near-term investments in PayPal's customer experience, cross-border capabilities, and the Bill Me Later platform.
Although we can't count out emergent competition from Amazon, Google, Facebook, credit card companies, and banks, we believe PayPal's network bridging consumers, retailers, financial institutions, and leading technology platforms offers a substantive barrier to entry.
We're also intrigued by PayPal's efforts to take its business
offline, which has the potential to be a positive long-term catalyst for the stock. Adding PayPal to in-store point-of-sale terminals effectively expands this segment's addressable market from $630 billion (the amount of global online retail sales expected in 2013, excluding food/grocery and online travel) to approximately $10 trillion (the total value of all commerce transactions in 2013, according to Economist Intelligence Unit). By facilitating just 2% of the current payments made in the global commerce market, PayPal would effectively double its size. The company appears to be off to a good start toward becoming a ubiquitous payment alternative, most notably through its August 2012 partnership with Discover (which could enable PayPal's digital wallet at Discover's 7 million U.S. merchant locations). This follows previous arrangements with Verifone, Ingenico Worldwide, and Equinox; the rollout of PayPal as a payment option at in-store point-of-sale systems at several retail chains (including Home Depot, Abercrombie
& Fitch, Barnes & Noble, and Office Depot); and the introduction of PayPal Here (a mobile point of sale system that already has been ordered by 300,000 small and individual merchants). It will likely take time for consumers and merchants to fully embrace PayPal as an offline payment method, but we're encouraged that lower offline merchant take rates will be partly offset by lower loss rates, resulting in a benign hit to segment profitability. We also believe PayPal's wide reach, closed-loop payment system, funding option versatility, and portfolio of emergent technologies (including Beacon--a small device that connects a retailer's point-of-sale system to a consumer's payment app via Bluetooth Low Energy visual identification, voice recognition, and biometrics) will improve the competitive position of the PayPal network within the global payments processing marketplace in the years to come.
PayPal should also be a major facilitator for the rapidly growing field of payments from smartphones, tablets, and other mobile devices. According to Juniper Research, the
Business Analysis
total volume of global mobile payments for digital goods, physical goods, money transfers, and near field communications transactions was over $300 billion in 2012 and is expected to almost triple by 2015. With an expansive network of buyers and sellers and leading payment processing innovations, we've long held the position that eBay was well positioned to capitalize on consumers' gravitation toward mobile shopping and merchants' increasing acceptance of mobile payment processing. With
$22 billion in mobile gross merchandise volumes and $27 billion in mobile payment volumes in 2013, we continue to believe that eBay is one of the early leaders in this rapidly growing field.
We view the moat trend in eBay's Marketplaces segment as stable. Although auction volume has declined by roughly one fourth since peaking six years ago ($25 billion in 2013 compared with $35 billion in 2007), fixed-price volume has been growing at a midteens average annual clip during the same period and now represents a larger percentage of the marketplaces segment's composition. EBay's fixed-price competitive positioning may not be as significant as its auction business, but we believe many factors that made eBay's auction business a success will translate to new growth initiatives, including an expansive global network, a widely recognized brand, and ample advertising resources.
Adjacent business lines such as online classifieds, StubHub, local shopping, and mobile websites also benefit from these strengths and should help to offset diminishing auction volumes. However, we acknowledge that Amazon remains the starting point for most online transactions, akin to an anchor tenant in a mall, restricting the moat trend in this segment to stable.
Stewardship
After leading the Marketplaces business for three years, John Donahoe took over as CEO in 2008. Before joining eBay, Donahoe was CEO of Bain & Company and at one point had
worked for former CEO Meg Whitman. Overall, we believe eBay's corporate governance is exemplary, with a number of value-creating acquisitions, divestiture of non-core assets, and an underappreciated track record for technological innovation over the past several years. We also like that executive officers and directors are required to achieve ownership of eBay's common stock valued at 3 times their annual base salary (5 times in the case of the CEO). Management and the board beneficially own 12% of the stock, including an 11% stake for chairman and founder Pierre Omidyar. Although Donahoe owns less than 1% of outstanding shares, his stake is sufficient to align his interests with those of shareholders, in our view. These executives and directors have a solid record of doing right by shareholders, including excellent financial statement disclosures. The company also has adopted majority voting, which gives shareholders greater control over the composition of the board of directors. We do, however, take a dim view of the staggered board elections.
In the first quarter of 2014, management incurred a $3 billion foreign earnings tax charge to potentially repatriate $9 billion in cash held overseas--a move which will free up approximately $6 billion of cash availability within the United States--as well as other foreign tax elections that will allow for greater financial flexibility in the future.
Ultimately, the success of these decisions will depend on future cash uses, though we believe the additional cash availability can be used to enhance eBay's position as a facilitator of commerce. Management would not commit to explicit cash uses, other than saying it was not announcing a large U.S.-based acquisition but also outlining plans for acquisitions to strengthen its core business or extend its reach in international markets, invest in new technologies, fund consumer credit initiatives, and repurchase shares. We expect eBay will deploy the new capital primarily on two fronts: mobile payment and commerce technologies and expanding its portfolio of merchant commerce solutions
(including payment, fulfillment/ship from store, and local capabilities), which will make eBay a more attractive partner for merchants looking to refine omnichannel strategies.
Recent Notes from our Credit and Equity Analysts
Recent Volume Pressures, Leadership Changes Are Concerns, but They Don't Change eBay's Wide Moat 09 Jun 2014
Shares of eBay have come under pressure recently, which we attribute to a number of factors including the May 21 data breach statement, changes to Google's Panda 4.0 search algorithm that had a negative impact on the search ranking of many of eBay's webpages, the launch of Amazon Payments, and the June 9 announcement that PayPal president David Marcus is stepping down to lead Facebook's messaging products.
Based on ChannelAdvisor data, we acknowledge that the data breach and Google search changes likely pressured gross merchandise volume during the latter part of May. We plan to adjust our second-quarter and full-year 2014 revenue estimates, with both now likely in the lower half of management's guidance ranges ($4.325 million-$4.425 million for the quarter, and $18.0 billion-$18.5 billion for the year). These changes will not be significant enough to affect our $63 fair value estimate, and we believe eBay can adapt to the algorithm changes through new product ad listing purchasing strategies.
In our view, Amazon Payments may be a viable payment option for some of Amazon's smaller third-party sellers, but won't offer much disruption to PayPal due to funding source limitations and lingering merchant fears about sharing data with Amazon.
Marcus' departure is surprising, as he had helped shape PayPal into a mobile commerce leader and pioneered technologies such as PayPal Beacon and PayPal Here.
However, we've long thought PayPal had one of the deeper and more entrepreneurial benches in e-commerce (partly the result of recent acquisitions), and believe there are several qualified candidates to lead PayPal. We're encouraged that PayPal remains on track to meet its 2015
goals (including $9.5 billion-$10.5 billion in segment revenue), which is consistent with our model.
Despite the recent run of negative news, our wide moat rating and positive long-term thesis remains in place, and we believe the current valuation underappreciates eBay's portfolio of technologies.
Repatriated Cash Can Enhance EBay's Network Effect;
Valuation Underappreciates Long-Term Opportunity 30 Apr 2014
Our wide moat rating for eBay remains in place following the firm's first-quarter update, as active user and volume trends across PayPal and eBay's core fixed-price marketplaces (even after softer-than-expected auction and StubHub volume) and mobile user adoption trends suggest a strong network effect. More important, we believe eBay is taking steps to protect its competitive position in the converging world of online, offline, and mobile commerce, with the most notable development from the quarter being management's decision to take a $3 billion noncash foreign earnings tax charge--which will free up approximately $6 billion of cash availability within the United States--as well as other foreign tax elections that will allow for greater financial flexibility in the future.
Ultimately, the success of these tax decisions will depend on future capital-allocation strategies. Management would not commit to exact cash uses, other than saying it was not announcing a large U.S.-based acquisition but also outlining plans for acquisitions to strengthen its core business or extend its reach in international markets, invest in new technologies, fund consumer credit initiatives, and repurchase shares. We expect eBay will deploy the new capital primarily on two fronts: mobile technologies and expanding its portfolio of merchant commerce solutions (including payment, fulfillment/ship from store, and local
capabilities), which will make eBay a more attractive partner for merchants looking to refine omnichannel strategies.
There is no change to our $63 fair value estimate, which is aligned with management's full-year guidance ($18.0 billion-$18.5 billion in revenue, non-GAAP EPS of
$2.95-$3.00) and assumes low to mid-teens revenue growth and nominal margin expansion over the next five years. We believe the market continues to underappreciate eBay's potential as a facilitator of commerce, a position that can be solidified by management's capital-allocation decisions.
EBay Settles Proxy Fight With Icahn; No Plans to Separate PayPal, Shares Remain Undervalued 10 Apr 2014
On Thursday, eBay announced that it has ended its proxy fight with activist investor Carl Icahn ahead of its May 13 annual shareholder meeting, with Icahn withdrawing his proposal to separate PayPal from eBay's Marketplaces business and the company agreeing to appoint Icahn-proposed David Dorman to the board of directors. We view the decision positively, as Dorman brings a wealth of telecommunication and retail experience from his current role as chairman of CVS Caremark as well as previous roles as the lead independent director of Motorola Solutions and chairman and CEO of AT&T. We believe Dorman's experience, as well as management's decision to meet regularly with Icahn, will help to develop more comprehensive strategies for the rapidly converging world of online, offline, and mobile commerce while still allowing enough flexibility to consider future strategic alternatives to drive shareholder value. We continue to believe that eBay's Marketplaces segment provides PayPal a low-cost customer acquisition tool, data-sharing synergies, and growth capital, each of which strengthens the network effect that underpins our wide economic moat rating.
However, we would view alternatives that allowed
shareholders to participate more directly in PayPal's growth without destroying the longer-term benefits between the two business units as a positive.
There is no change to our $63 fair value estimate, which assumes average annual revenue growth in the low double digits (midteens for PayPal, high single digits for Marketplaces) and modest operating margin expansion over the next five years (22% in 2018 from 21% today). We continue to view eBay as an important commerce facilitator and think the market underappreciates eBay Marketplaces' portfolio of commerce technology and shipping alternatives, PayPal's longer-term opportunity in mobile and offline payments, and eBay Enterprises' fulfillment, payment, and other e-commerce customer solutions.
We Still View PayPal Separation as Value Destructive for eBay; Exemplary Stewardship Rating Intact 28 Feb 2014
Following this week's war of words between activist investor Carl Icahn and eBay's board, our view that Icahn's proposal to separate PayPal from eBay would be value destructive is unchanged. Though we are optimistic about the longer-term potential of PayPal in the evolving world of online, offline, and mobile commerce and believe that the segment could survive as a stand-alone entity, we think a separation of PayPal would be detrimental to the company's overall network effect, which is the foundation for our wide moat rating. We share management's views that its Marketplaces segment provides a low-cost customer acquisition tool for PayPal, there are data-sharing synergies between the two segments (particularly with respect to customer risk management), and cash flow from Marketplaces business can fund PayPal's growth. In our view, separating PayPal would be disruptive over a longer horizon, and would impair many of the synergies that underpin our $63 per share fair value estimate.
Recent Notes from our Credit and Equity Analysts
We also view Icahn's accusations about potential conflicts of interest within the eBay board as misguided. In letters to shareholders, Icahn laid out concerns that board members Marc Andreessen and Scott Cook own stakes in in companies that could be perceived as rivals to PayPal and benefit from having access to CEO John Donahoe as well as nonpublic information about the business. However, we don't view companies backed by Andreessen and Cook as direct competitors to PayPal, with applications well beyond online payments. Also, the flow of information works both ways, and we believe having a board with expertise in emerging payment technologies allows the company to better monitor emergent competitive threats and helps management develop business strategies to keep its moat intact. In our view, the board's expertise has also benefited management's acquisition strategy in recent years, which has been accretive to shareholder returns and played a role in our Exemplary stewardship rating.
EBay's 4Q Supports Positive Long-Term Outlook;
Proposed Separation of PayPal Value-Destructive 23 Jan 2014
Despite the competitive retail landscape this holiday season, we believe eBay's fourth-quarter results reinforce our positive long-term outlook, particularly the impact that mobile devices had on active user growth and volume trends across the PayPal and Marketplaces segments. Although management acknowledged that it had not monetized volume growth as much as it had anticipated when it laid out its previous targets at the March 2013 analyst day--a key reason behind the reduction in its 2015 targets--we believe eBay is taking prudent steps to maintain and stimulate buyer and seller growth at a time when offline and online commerce are rapidly converging.
We believe consumers' increasing acceptance of online
and mobile commerce (as well as Amazon's continued success) could serve as a wake-up call for many traditional retailers, which may look to eBay as a partner because of its wide variety of delivery (including eBay Now), payment, fulfillment/ship-from-store, and other commerce solutions.
For this reason, we believe an increase in near-term investments, including a number of core, omnichannel, PayPal reach, and cross-border enhancements, will help to solidify eBay's network effect and our wide moat rating. We had already assumed more conservative Marketplaces revenue than management's previous guidance and plan to tweak our base-case assumptions to reflect near-term investments, but the changes will not be enough to move our $63 fair value estimate.
The other notable development from the fourth-quarter update was that activist investor Carl Icahn has made a nonbinding proposal to spin off PayPal into a separate company. Although we share Icahn's view that the market is underestimating eBay's longer-term potential, we agree with management that the Marketplaces and PayPal business units possess meaningful customer acquisition, data, and growth initiative funding synergies, and we would consider a separation of the businesses to be value-destructive.
As in recent quarters, we believe active user growth was the key takeaway for investors during the fourth quarter, with Marketplaces users growing 14.1% to 128 million (the fifth consecutive quarter of double-digit growth) and PayPal users growing 16.2% to 143 million active accounts (representing more than 16 straight quarters of double-digit growth). New active user growth helped to drive enabled commerce volume of $61 billion during the quarter (an increase of 22% year over year) and validates recent investments to the Marketplaces and PayPal customer experience, cross-border capabilities, and the Bill Me Later platform. It also suggests that channel-diversification
efforts continue to gain traction and highlights the significant potential that mobile commerce offers;
management reported that mobile commerce volume increased 88% for the full year, supported by 14 million new mobile Marketplaces and PayPal users (roughly 40% of all new Marketplaces and PayPal users). We continue to believe that new mobile users are heavily skewed toward younger customers with lower disposable income, often from emerging markets. We believe this demographic will help to attract new merchant partners to eBay's various marketplaces and enhance its network effect. In turn, we expect mobile users to increase purchase frequency and average transaction/payment volume over time (backed by the aforementioned core business, omnichannel, payment technology and cross-border investments), supporting our five-year revenue growth forecast (2014-18) in the low teens.
Management's initial 2014 guidance, including full-year revenue of $18.0 billion-$18.5 billion and adjusted EPS of
$2.95-$3.00 (excluding stock-based compensation, amortization of intangibles, and acquisition-related expenses), strikes us as achievable based on current macroeconomic and industry trends as well as management's investment plans. We also believe management's updated 2015 targets, which now include more than $300 billion in enabled commerce volume (with mobile commerce volume growing at a 65% clip), revenue of $20.5 billion-$21.5 billion (down from $21.5 billion-$23.5 billion), adjusted earnings per share growth of greater than 10% in 2015 (suggesting at least $3.30), and more than $11 billion in cumulative free cash flow for the three-year period ending in 2015, appropriately highlight the company's opportunity in mobile commerce balanced with investments near-term investments designed to solidify eBay's position as a preferred commerce partner.
With the shares trading at approximately 18.5 times the midpoint of management's 2014 EPS forecast (or 16.5 times
forward earnings after stripping out the nearly $6.60 per share in net cash and equivalents on the balance sheet at the end of the quarter) after a modest uptick following the disclosure of the Icahn proposal, we still find eBay's risk/reward proposition to be compelling. While we don't expect Icahn's proposal to succeed, we think increased market awareness of how combined the eBay-PayPal platform enhances its network effect and strengthens its position in the rapidly evolving world of online, offline, and mobile commerce could serve as a positive share price catalyst over the near term. We also believe Icahn's proposal may have caused management to increase its emphasis on shareholder returns, evidenced by the $5 billion increase in its share-repurchase program announced in conjunction with the fourth-quarter results.
Taking Stock of eBay's 2015 Targets Ahead of its Fourth- Quarter Update 21 Jan 2014
We believe the market has taken a more cautious view on eBay heading into its fourth-quarter update after the market close on Jan. 22, likely stemming from ChannelAdvisor data suggesting a slowdown in third-party volumes (particularly during the latter part of December), and recent comments from traditional retailers about Amazon's competitiveness this holiday season. These have led to rumors that eBay may have to cut its 2015 targets, which include $300 billion in enabled commerce volume, revenue of $21.5 billion-$23.5 billion (including $10.5 billion-$11.5 billion for its marketplaces business, and $9.5 billion-$10.5 billion for PayPal), operating margins around 27%, and an implied adjusted EPS range between $3.60-$4.00.
We believe it is likely that Amazon will post "eye-opening"
holiday sales figures and acknowledge that eBay's GMV trends may have slowed, as other online retailers resorted to more aggressive promotions to compete with Amazon.
From this perspective, we believe eBay's 2015 targets are at risk, and expect management to guide investors to the lower half of its previously stated goals and moderate its
Recent Notes from our Credit and Equity Analysts
marketplaces unit's revenue expectations. This won't influence our $63 fair value estimate, however, as our 2015 marketplaces revenue assumption ($9.6 million) is already well below management's goals. We also believe too much emphasis on the marketplaces business may overshadow other positive elements of the long-term eBay investment story, including PayPal's innovative portfolio of payment technologies and solid network effect (which should drive revenue toward the high end of management's previous 2015 goals for PayPal), the company's strong mobile commerce platforms, and intriguing international opportunities. Based on the pessimism already priced into the stock, we'd encourage long-term investors to take a closer look at a name that we believe is still well-positioned to capitalize on longer-term online, offline, and mobile commerce trends.
Despite the expected fourth-quarter headwinds, we also believe Amazon's strong holiday showing could be a wake-up call for many traditional retailers, and prompt them to look to eBay as a commerce partner (including same-day delivery options offered by eBay now, as well as online payment processing, fulfillment/ship-from-store, warehouse, payment, freight, and other customer service solutions via eBay Enterprises). We also remain optimistic about the long-term potential of eBay's recent marketplaces unit's user growth. User growth has been one of the highlights for eBay the past several quarters, with marketplaces' active users averaging 13.4% growth the past four quarters. We attribute much of the new user growth contribution to increased mobile device usage, which has contributed to more than 40% of eBay's marketplace users this year, according to our calculations, and international expansion efforts. Many of these new users are younger customers with lower disposable incomes coming to the eBay platform for the first time, leading to a deceleration in GMV per active user and potentially depressing recent comparable volume trends. However, we do not believe the recent data is
indicative of the long-term spending potential of these customers, something we expect to become more apparent over the next several years as this cohort group becomes more engaged, resulting in greater purchase frequency and average merchandise volume growth.
2011 2012 2013 2014 2015
Revenue 11,652 14,071 16,047 18,204 21,040
Cost of Goods Sold 3,457 4,215 5,036 5,819 6,810
Gross Profit 8,195 9,856 11,011 12,385 14,230
Selling, General & Administrative Expenses 3,803 4,479 4,763 5,418 6,241
Research & Development 1,235 1,573 1,768 1,972 2,301
Other Operating Expense (Income) 784 915 1,109 1,206 1,374
Depreciation & Amortization (if reported separately) — — — — —
Operating Income (ex charges) 2,374 2,889 3,371 3,788 4,315
Restructuring & Other Cash Charges — — — — —
Impairment Charges (if reported separately) — — — — —
Other Non-Cash (Income)/Charges — — — — —
Operating Income (incl charges) 2,374 2,889 3,371 3,788 4,315
Interest Expense — — — — —
Interest Income 1,793 77 95 51 59
Pre-Tax Income 4,167 2,966 3,466 3,839 4,373
Income Tax Expense 681 474 610 3,822 875
Other After-Tax Cash Gains (Losses) — — — — —
Other After-Tax Non-Cash Gains (Losses) -257 118 — — —
(Minority Interest) — — — — —
(Preferred Dividends) — — — — —
Net Income 3,230 2,610 2,856 17 3,499
Weighted Average Diluted Shares Outstanding 1,313 1,313 1,313 1,256 1,253
Diluted Earnings Per Share 2.46 1.99 2.18 0.01 2.79
Adjusted Net Income 2,185 3,100 3,555 3,716 4,211
Diluted Earnings Per Share (Adjusted) 1.66 2.36 2.71 2.96 3.36
Dividends Per Common Share — — — — —
EBITDA 3,314 4,089 4,771 5,370 6,052
Adjusted EBITDA 3,314 4,089 4,771 5,370 6,052
Income Statement (USD Mil)
Fiscal Year Ends in December Forecast
2011 2012 2013 2014 2015
Cash and Equivalents 4,691 6,817 4,494 3,825 5,773
Investments 1,238 2,591 4,531 4,531 4,531
Accounts Receivable 682 822 899 997 1,153
Inventory — — — — —
Deferred Tax Assets (Current) — — — — —
Other Short Term Assets 6,050 11,168 13,359 15,154 17,516
Current Assets 12,661 21,398 23,283 24,508 28,973
Net Property Plant, and Equipment 1,986 2,491 2,760 2,587 2,307
Goodwill 8,365 8,537 9,267 9,267 9,267
Other Intangibles 1,406 1,128 941 941 941
Deferred Tax Assets (Long-Term) — — — — —
Other Long-Term Operating Assets 448 476 266 256 246
Long-Term Non-Operating Assets 2,453 3,044 4,971 4,971 4,971
Total Assets 27,320 37,074 41,488 42,530 46,704
Accounts Payable 283 301 309 357 418
Short-Term Debt 565 413 6 -19 -850
Deferred Tax Liabilities (Current) — — — — —
Other Short-Term Liabilities 5,887 10,210 12,324 13,980 16,159
Current Liabilities 6,734 10,924 12,639 14,318 15,726
Long-Term Debt 1,525 4,106 4,117 4,117 4,117
Deferred Tax Liabilities (Long-Term) 1,073 972 841 954 1,103
Other Long-Term Operating Liabilities 58 207 244 277 320
Long-Term Non-Operating Liabilities — — — — —
Total Liabilities 9,390 16,209 17,841 19,666 21,266
Preferred Stock — — — — —
Common Stock 2 2 2 2 2
Additional Paid-in Capital 11,145 12,062 12,062 12,062 12,062
Retained Earnings (Deficit) 13,389 15,998 18,780 18,797 22,296
(Treasury Stock) -7,155 -8,053 -8,053 -8,853 -9,778
Other Equity 549 856 856 856 856
Shareholder's Equity 17,930 20,865 23,647 22,864 25,438
Minority Interest — — — — —
Total Equity 17,930 20,865 23,647 22,864 25,438
Morningstar Analyst Forecasts
Balance Sheet (USD Mil)
Fiscal Year Ends in December Forecast
2011 2012 2013 2014 2015
Net Income 3,229 2,609 2,856 17 3,499
Depreciation 940 1,200 1,400 1,582 1,737
Amortization — — — — —
Stock-Based Compensation 458 488 609 548 603
Impairment of Goodwill — — — — —
Impairment of Other Intangibles — — — — —
Deferred Taxes 17 -35 -35 113 149
Other Non-Cash Adjustments -1,049 332 716 — —
(Increase) Decrease in Accounts Receivable -292 -207 -77 -98 -155
(Increase) Decrease in Inventory — — — — —
Change in Other Short-Term Assets — -406 -2,191 -1,795 -2,361
Increase (Decrease) in Accounts Payable 29 -16 8 48 61
Change in Other Short-Term Liabilities -59 -127 1,674 1,656 2,178
Cash From Operations 3,274 3,838 4,960 2,071 5,710
(Capital Expenditures) -963 -1,257 -1,250 -1,409 -1,456
Net (Acquisitions), Asset Sales, and Disposals -954 1 -869 — —
Net Sales (Purchases) of Investments -1,281 -2,434 -3,871 — —
Other Investing Cash Flows -109 -73 -22 43 53
Cash From Investing -3,307 -3,763 -6,012 -1,367 -1,403
Common Stock Issuance (or Repurchase) -822 -415 -905 -800 -925
Common Stock (Dividends) — — — — —
Short-Term Debt Issuance (or Retirement) 250 -550 — -25 -831
Long-Term Debt Issuance (or Retirement) -199 2,976 -400 — —
Other Financing Cash Flows -67 -60 -49 -548 -603
Cash From Financing -838 1,951 -1,354 -1,373 -2,358
Exchange Rates, Discontinued Ops, etc. (net) -15 100 48 — —
Net Change in Cash -886 2,126 -2,358 -669 1,948
Cash Flow (USD Mil)
Fiscal Year Ends in December Forecast
Company/Ticker Net Income
(Mil) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E)
Amazon.com Inc AMZN USA 273 USD 27.2 28.6 29.4 5.4 5.7 6.5 1.0 0.9 1.7 0.4 0.7 1.2 2.7 3.9 4.8
Mercadolibre Inc MELI USA 118 USD 72.5 72.2 72.5 35.0 32.5 33.5 32.5 30.0 30.8 24.9 23.4 23.1 6.0 19.9 24.2
Average 49.9 50.4 51.0 20.2 19.1 20.0 16.8 15.5 16.3 12.7 12.1 12.2 4.4 11.9 14.5
eBay Inc EBAY US 3,555 USD 68.6 68.0 67.6 29.7 29.5 28.8 21.0 20.8 20.5 22.2 20.4 20.0 23.1 3.6 20.2
Company/Ticker Total Debt
(Mil) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E)
Amazon.com Inc AMZN USA 3,191 USD 32.7 30.9 27.5 24.7 23.6 21.6 28.4 31.8 131.3 0.8 0.6 0.5 4.1 4.5 4.6
Mercadolibre Inc MELI USA 16 USD 4.6 0.0 0.0 4.4 0.0 0.0 70.2 39.2 48.0 0.1 0.0 0.0 1.7 1.6 1.5
Average 18.7 15.5 13.8 14.6 11.8 10.8 49.3 35.5 89.7 0.5 0.3 0.3 2.9 3.1 3.1
eBay Inc EBAY US 4,123 USD 17.4 17.9 12.8 14.9 15.2 11.4 — — — 0.9 0.8 0.5 1.8 1.9 1.8
Company/Ticker Market Cap
(Mil) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E) 2013 2014(E) 2015(E)
Amazon.com Inc AMZN USA 155,303 USD 18.79 22.32 29.01 1.07 1.07 1.11 0.75 0.75 0.79 — — — — — —
Mercadolibre Inc MELI USA 4,241 USD 3.18 4.30 6.17 1.46 1.81 2.02 1.46 1.81 2.02 10.49 1,897.14 2,726.41 20.2 25.2 25.8
Average 10.99 13.31 17.59 1.27 1.44 1.57 1.11 1.28 1.41 10.49 1,897.14 2,726.41 20.2 25.2 25.8
eBay Inc EBAY US 64,558 USD 3.42 3.05 4.61 1.84 1.71 1.84 1.84 1.71 1.84 749.00 -201.32 -6.79 — — —
Comparable Company Analysis
These companies are chosen by the analyst and the data are shown by nearest calendar year in descending market capitalization order.
Profitability Analysis
Leverage Analysis
Liquidity Analysis
Gross Margin % EBITDA Margin % Operating Margin % Net Margin % Free Cash Flow Margin %
Debt/Equity % Debt/Total Cap % EBITDA/Interest Exp. Total Debt/EBITDA Assets/Equity
Cash per Share Current Ratio Quick Ratio Cash/Short-Term Debt Payout Ratio %
Last Historical Year
Last Historical Year
