Markets & Finance

Marcial: Time to Bid on eBay Shares?


Pros figure that the Web auction pioneer is undervalued, especially as earnings prospects improve in coming quarters

Put it on eBay!

That's become a stock phrase for anyone who wants to sell stuff. It also demonstrates how much the name eBay (EBAY) has morphed into a generic term for an online auction marketplace where people get to trade just about anything.

It made eBay a sensation on Wall Street just as the Internet caught the fancy of investors in the late 1990s. The company went public in September 1998. From a split-adjusted $1 a share, the stock streaked to $29 the next year and just kept on flying. By late 2004, eBay reached a peak at $59.20 a share. Although it had grown phenomenally worldwide, creating a whole new industry, the novelty started to wear off. But eBay has proved it is here to stay despite the multiple challenges of maturity and competition.

In fact, it is a stock that now deserves new attention, say the bulls.

Since October 2007, when it traded at 40, the stock's value has tumbled nearly 50%. The stock is the kind of discounted product that would attract buyers if put on eBay's own site. But on the Nasdaq, where eBay is now trading at 23, the stock isn't catching fire. Although eBay dominates as the operator of the largest online trading community, rising competition, U.S. economic weakness, and a softening in the company's growth rate have turned off investors.

"enticing value play"

But the stock's sharp decline has only fortified the bullish case for eBay. "The selling in the stock is way overdone," says David Katz, chief investment officer at Matrix Asset Advisors, which manages some $1.4 billion and owns eBay stock. The big discount in the stock's price relative to eBay's vast assets and worldwide superiority in online auctions "make eBay a very enticing value play," says Katz. It is the kind of company, he argues, that deserves to be a core holding in most investors' portfolios. But of course price is the key to making an investment work. Right now, eBay's stock is selling at fire-sale levels, making it ripe for the picking, says Katz.

The company posted solid results in the second quarter with the number of active users of eBay's auction markets showing a significant increase. For the third quarter, total listings are forecast to jump 30%, to 720 million users. So far, listings in Asia/Pacific are up 25% in the second quarter, in Europe up 48%, and in North America 16%.

Management has adopted measures that should beef up earnings growth in the second half of 2008, says Katz. Apart from continuing to expand its online markets globally, eBay is also making sure that it provides a faster, easier, and safer trading experience for buyers and sellers. Through its numerous Web sites, the company pulls together millions of buyers and sellers worldwide, providing an online marketplace for the sale of almost all types of goods and services along with online payment facilities through its PayPal unit and Internet communications through its Skype division. Both PayPal and Skype posted strong results in the second quarter. but since they are low-margin operations compared with eBay's core auction markets, they tend to lower the company's entire margins, says Katz. So management is taking steps to boost margins at PayPal and Skype.

PayPal expansion?

One measure of a stock's valuation is the price-earnings ratio. EBay's average annual p-e went as high as 74.7 in 2004, when the company earned 57¢ a share. Today, eBay's p-e has dropped to 13, based on Thomson First Call's consensus 2008 estimates of $1.75 a share. "That shows how undervalued eBay is," says Katz. He figures that eBay deserves a p-e of at least 20, which equates to a stock price of $35 a share.

Scott Kessler, an analyst at Standard & Poor's, believes the new management team at eBay can re-ignite growth at the company's core business. Meg Whitman relinquished her positions of CEO and president in March and was succeeded by John Donahoe. "We see eBay as the clear leader in online auctions, a mainstream Internet retail destination, and major facilitator of large transactions involving cars and real estate," says Kessler.

He rates the stock a "strong buy," with a 12-month price target of $35 a share. Kessler is optimistic about the growth of eBay's presence worldwide, as well as the expansion of its PayPal operations which, he notes, is the world's leading pure online payment platform. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

"eBay's turnaround is still in its early innings, and the risk-reward remains attractive," says Shawn Milne, who follows eBay at Oppenheimer (OPY) and rates the stock outperform. While the stock trades at a depressed multiple, he notes, its peer group trades at a price-earnings ratio of 29.

For long-term investors, the deeply discounted stock price is an alluring entry point. With a pristine balance sheet with strong cash flow and no debt, eBay is an attractive haven during this anemic economic period. And when the economy starts revving up again, eBay will surely be among the first to benefit.

Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

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