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STREET WISE By Amey Stone August 12, 1999


eBay: Short-Term Outages, Long-Term Power?
Technical glitches have the stock on a roller coaster, but it may have plenty of juice for the long haul

A string of recent system outages have shaken investor confidence in eBay (EBAY) and contributed to the steep decline in its share price over the past three months. The company did a lot to restore that confidence during a meeting with analysts on Aug. 9 and with the appointment of new technology chief on Aug. 10. The stock rose 12% on Aug. 10 to close at 89. But on Aug. 11, investors who were hoping the stock would resume its ascent were disappointed. Although in positive territory most of the day, eBay closed down 1 9/16 points at 87 11/16.

Clearly, the hand-wringing over eBay is far from done. At its meeting with analysts, eBay cautioned that it could take three to six months for it to fully resolve technical glitches that led to a 22-hour outage in June and a series of shorter interruptions in August, say people who attended the gathering. "The company indicated that some of the technical issues and challenges that it is addressing are not just going to be solved overnight," says Lauren Cooks Levitan, an analyst with BancBoston Robertson Stephens. That limits upside potential in the stock and augurs more volatility if site problems continue, she adds.

That doesn't mean investors shouldn't buy the stock, however. Levitan calls this is "an appealing time to be either building a position or adding to it." Despite the recent bounce, eBay is still down 62% from its 52-week high of $234 on Apr. 27. While the stock could not be called cheap (its p-e is over 1,000), it is a lot cheaper than it was, and Levitan thinks its long-term potential will keep it from falling much further from here.

eBay stands to grow not only by adding customers and merchandise and expanding globally but also by selling more expensive goods (much of its revenue comes from taking up to a 5% cut of transactions). In an Aug. 10 report, Mary Meeker of Morgan Stanley Dean Witter estimated at $600 billion eBay's total market -- $100 billion in the U.S. auction market, $250 billion in premium auctions, and $250 billion in international auctions. "When I think five years out who the major E-tailing players are going to be, I'm highly confident that eBay will remain one of those companies," says Levitan.

 

"It is a very good time to be buying eBay as well as a handful of other well-known brand Internet names," says Volpe's Brown
 

The truth is, a lot of institutional investors find eBay's business model compelling and have their eye on the stock, even if they aren't pouncing on it yet, says Derek Brown, an analyst with Volpe Brown Whelan, who attributes much of eBay's decline to general market conditions. "A lot of people are concerned about general market sluggishness during August and are trying to pick their spots heading into the holiday season," he says. While he, too, is cautious that eBay's site stability problems could lead to volatility in its stock, he thinks "it is a very good time to be buying eBay as well as a handful of other well-known brand Internet names." He expects the company to issue several announcements this fall regarding its international expansion, new regional sites, and partnership with America Online that will drive up the stock.

So far, the system outages haven't eroded eBay's dominance of the growing person-to-person auction market. Despite increased competition, an estimated 70% of auction transactions are done on eBay, estimates research firm Gomez Advisors, which tracks online auction sites. With 2.4 million items for sale on eBay, compared with 50,000 on Amazon.com's auction site and 30,000 on Auction Universe, eBay attracts by far the most buyers and sellers of any site -- and will continue to do so, say analysts. That's because sellers go where there are the most buyers, and buyers go where there are the most items for sale. "That is an extremely difficult cycle to break," says Brown.

There is a risk, though, if site problems persist, warns Sue Rothberg, a senior analyst at Gomez Advisors. eBay's "power sellers," the 20% of customers who sell 80% of the goods on the site, "are starting to get a little miffed" at the site problems and could potentially move to other sites, she says. Adds Rothberg: "If that happens, that's a bad spiral for eBay." But for now, eBay commands so much traffic that buyers and sellers are pretty much locked into the site." They are still the Goliath of the industry and are going to be for quite some time," Rothberg says.

RISING COSTS. A broader concern with technical problems is that eBay might not be able to grow into its vast potential. One reason investors fell in love with the stock is that the company's business model seems so "scalable," which means that it should be able to steadily add more customers and more merchandise with limited added costs.

But surprise! eBay's costs are rising. In the second quarter, gross profit margins declined to 77% from 85% in the prior quarter because of increased costs for site operation and customer service, and because the company gave customers credits to compensate for system outages. Net income, excluding merger-related and other costs, was $5.1 million, or 4 cents a share, down from $5.2 million, or 5 cents a share, reported in the prior year's second quarter. Analysts expect eBay's margins to improve, however, as it makes infrastructure improvements and starts selling more expensive items on the site.

 

Stein Roe's Brady commends the management at eBay for staying focused on the core business
 

Ultimately, the technical problems are a management issue, not a core business issue, says David Brady, a portfolio manager at Stein Roe & Farnham. With its management strength, huge market opportunity, and defensible position, he believes eBay has long-term potential that many other former Internet highfliers lack. Although it is too expensive for portfolios he manages, he commends its management for staying focused on its core business and emphasizing profitability. While many Internet businesses, even if they worked for many years, could never have a rational valuation, he thinks eBay could keep growing. "Years from now I could be scratching my head, thinking, 'why didn't I own that one?'"

Internet stocks may be in a lull now, but analysts emphasize that these are still the early days of E-commerce. "We're not even finished with the first inning," says Levitan. And for a company like eBay, "this might be a doubleheader going into extra innings."

Amey Stone is an associate editor at Business Week Online.


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Amey Stone covers the markets and investing for Business Week Online


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