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Get Four
|  | FEBRUARY 24, 2004
 FOCUS STOCK By Scott Kessler eBay: Where the Action Is Online [Page 2 of 2] MODEL ADVANTAGE. Another key advantage, in our view: Its technology platforms and infrastructure are difficult to replicate. Internet giants Amazon.com (AMZN; 3 STARS, or hold; $45) and Yahoo! (YHOO; 3 STARS; $46) have learned about the challenges of competing with eBay. Amazon's foray into online auctions failed. Yahoo shut down its European auction sites in 2002 and agreed to a marketing relationship with eBay. (Yahoo has had some success with online auctions in Asia.) We believe the first-mover advantage has been pivotal in online auctions, and eBay has capitalized accordingly. One of eBay's key strategic assets, in our opinion, is its business model. Unlike many of its competitors, it isn't a retailer and doesn't have expenses related to back-end functions such as order processing, fulfillment, and shipping. Perhaps most important, it has absolutely no inventory costs and minimal associated risk. As a result, eBay boasts what we believe are robust margins and significant free cash flow that enable it to reinvest in existing operations and pursue new growth initiatives. We expect eBay's annual pro forma operating margin to widen from 33.5% in 2003 to 35.6% in 2004, and to 37.2% in 2005. Net margins should improve from 23.7% in 2003 to 25.2% in 2004, and to 26.4% in 2005. These margins are well in excess of those of nearly all of its competitors. DETERMINING VALUE. Our estimates of Standard & Poor's Core Earnings are 35 cents a share for 2003 and 67 cents for 2004. These forecasts reflect estimated stock-option expense under accounting regulation SFAS 123 of $215 million (33 cents per share) in 2003 and $236.5 million (35 cents) in 2004. We expect the impact of stock options as a percentage of net income to continue to decline. eBay does not have any pension-related expenses, because it doesn't maintain a defined benefit plan. We believe the stock's current valuation is compelling. The shares recently had a p-e of 62, based on our 2004 estimate, considerably above that of the S&P 500-stock index. However, the stock's 2004 p-e-to-growth-rate (PEG) ratio of 1.5 was comparable to that of the S&P 500. And eBay's 2004 PEG ratio was 16% lower than that of the S&P 500 Info-Tech sector index. The stock also trades at notable discounts to Amazon and Yahoo, based on 2004 p-e and PEG. Employing comparative analysis, eBay appears attractive to us, particularly in light of its market leadership, growth prospects, and profitability. We think the best way to assess eBay's value is through intrinsic analysis. We project it will generate annual growth in free cash flow averaging 53% from 2004 to 2006, declining gradually thereafter. This growth should outpace the rise in revenues due to increasing scale and operating leverage, margin expansion, and relatively low levels of capital spending. We estimate the stock's intrinsic value at $83, based on our discounted cash-flow analysis. WORST-CASE SCENARIOS. Our 12-month target price is also $83, a 20% premium to the recent market price. We expect to the shares to notably outperform the S&P 500 over the next 12 months. Possible risks to our projections, target price, and investment opinion include anything that diverts users away from their customary level of activity on eBay's Web sites, challenges in international markets that are fraught with regulatory and cultural uncertainty, developments resulting in increasing taxation of its businesses, fraud or misappropriation involving the PayPal unit, negative publicity associated with eBay or its properties, or adverse litigation or rulings involving its intellectual property.
 Analyst Kessler follows Internet retail stocks for Standard & Poor's Equity Research All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc. Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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