By Rob Hof in San Mateo, Calif. Auction site eBay built its vast online marketplace on the lure of finding almost anything at a bargain price. But that success means its stock is anything but a bargain. At $63 a share, eBay is worth a bracing $19 billion, and its price-to-earnings ratio of 94 dwarfs those of much bigger businesses such as Microsoft and Wal-Mart. No wonder some analysts and investors are getting nosebleeds. "We've been very bullish on the business model," says analyst George Sutton of RBC Capital Markets. "But the stock price assumes everything to be perfect forever."
It's an assumption that a few analysts are starting to question. Sutton, for one, downgraded the stock on Sept. 30 to underperform, the Street's euphemism for sell. He worries that eBay's 50%-plus growth in sales and earnings can't continue too much longer. His is the only sell rating, but three other analysts rate the stock a hold, and 11 a buy or strong buy. Yet even the bulls are cautious. Merrill Lynch's Justin Baldauf lists a 12-month target price of $70 -- below the 52-week high of $72.74 reached last December.
"ALMOST FLAWLESSLY." If any outfit seems to deserve a stratospheric valuation, it would be eBay. Even as most dot-coms bite the dust, eBay doesn't seem to be slowing down. Third-quarter profits more than tripled, hitting $61 million, on sales that jumped 49%, to $289 million. For 2002, eBay is expected to earn about $233 million, up 153% from 2001, on sales that grew 56%, to $1.2 billion.
Says analyst Derek Brown, who had a buy rating before recently leaving San Francisco investment bank W.R. Hambrecht & Co.: "You've got a company that's executing almost flawlessly, has no real competition, and is on the front end of a massive opportunity."
That opportunity seems to keep growing as well. At its Oct. 30 analyst day, eBay said it's planning to expand beyond consumer-oriented goods early in 2003. It figures the market for industrial products, from restaurant equipment to medical gear, is potentially worth $1 trillion. At the same time, even in its top five markets -- cars, electronics, home products, fashion items, and sports -- eBay still has well under 3% of the total.
PUBLIC DEFENDER. That leaves a lot more room for possible growth. "Our dream of becoming the commerce engine of the Internet is coming true," says CEO Margaret C. Whitman. "We remain right on track to achieve the 2005 goal of $3 billion in sales."
That's why eBay executives sound more confident than ever -- even in their stock price. In a rare public defense of its lofty shares, eBay Chief Financial Officer Rajiv Dutta recently suggested that eBay's stock isn't really out of line -- even in comparison with leaders in other industries. For one, he noted that eBay's price-to-free cash flow ratio of 43 is less than half that of Wal-Mart's and less than Microsoft's. An even more arcane measure -- price-to-free cash flow-to growth -- clocks in at 0.8, way under Wal-Mart's 3.7 and Microsoft's 2.4.
The point: Because eBay's business takes little cash to expand, profit growth produces outsize cash flows. Dutta notes: "This is one earnings stream that you can literally take to the bank."
ACROPHOBIC. Dutta's math may get a little dizzying, but investors -- at least those who have already bought the stock -- share eBay's enthusiasm. "It's a reasonable price to pay for that growth," says David M. Hutchison, equity analyst with Insight Capital Management, a Walnut Creek (Calif.) concern that holds 557,000 eBay shares. "We see a lot of ways that growth can continue into the future."
For all that, it's easy to understand why some analysts and investors are feeling a bout of acrophobia coming on. RBC's Sutton says his big concern is early signs that the key underpinning for the stock -- eBay's growth rate -- could start to fall as early as 2003. He estimates that because supply of product is rising faster than the demand. The rate of successful auctions -- those that receive at least one bid -- has fallen from 62% a year ago to 56% now. He also points to eBay's own admission that the average selling price of products on the site is slipping, though it won't say by how much.
And while competition has scarcely dented eBay so far, it's heating up. Amazon.com has seen rapid growth in its Amazon Marketplace, which works like eBay. Sutton says large sellers he has talked to are starting to look at Amazon and even to traditional liquidators to sell large volumes of merchandise. "The sellers we speak to are fairly skeptical" that eBay can boost demand enough to absorb the higher amounts of products on the site, he says.
ABOUT TO FALL? Most analysts and investors, however, have no qualms about eBay's underlying business. What gets them is simply the breathtaking stock price. "It's a great company, no doubt about it," says Bruce J. Raabe, chief investment officer with Collins & Co., whose San Francisco Bay Area-focused Golden Gate Fund holds no eBay shares. "We've just always had an issue with valuation."
He thinks eBay's p-e ratio will fall to half its current level in roughly the next 18 months. If so, investors who don't own the stock might want to wait for it to come down a bit before making a bid for this Internet success story. Edited by Beth Belton